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We have been arguing for some time that currency markets will now be primarily, if not exclusively, focused on the relative pace of central bank policy tightening, with inflation data coming next.
I
In line with this story, the norwegian krone was the best performance of the week following Norges Bank’s first rise in the G10 of the cycle. We add that market expectations for what these central banks will do and say appear to be remarkably accommodating. The Federal Reserve seemed to only validate most expectations with the suggestion that tapering would begin in November, and yet investors sent returns violently higher, indicating that this was a hawkish surprise for most.
The liquidation of US rates As markets braced for the withdrawal of monetary stimulus, major emerging market currencies hit major emerging market currencies, all of which ended the week lower against the dollar with the exception of the Russian ruble, which was supported by rising energy prices, especially in Europe. Meanwhile, the the fallout from the Evegrande crisis in China continues to be limited.
With the major central bank meetings in September over, attention should now turn to macroeconomic data, with inflation in the foreground. September’s Eurozone inflation flash report to be released, and markets expect another leap in headlines and basic numbers will bring Eurozone inflation more in line with that of the United States and the United Kingdom.
GBP
The pound was torn between the undeniably hawkish Bank of England meeting and the news of supply constraints, skyrocketing energy prices and developing shortages. The BoE’s big surprise was that another MPC member, Dave Ramsden, joined existing hawk Michael Saunders in voting for an immediate reduction in the pace of QE buying. Ultimately, we believe the former will have a more lasting impact, especially since there is a good chance UK rates will go up ahead of all the other major G10 countries, perhaps before the end of this year or, more likely, early 2022.
We view the recent weakness in the pound as a buying opportunity, as a tightening of monetary policy remains the key narrative of appreciation across the G10.
EUR
As in the United States, macroeconomic data for the euro area is beginning to take on the appearance of stagflation. September activity PMIs retreated, albeit from very high levels, on a general theme of supply chain disruptions, constrained production and increased pricing power. We expect the key inflation report released this week to confirm this.
Strategists have been busy revising their forecasts upwards for the main and key figures, but we still see room for a surprise. This would call into question whether the ECB can afford to lag behind other central banks in removing monetary accommodation and could be bullish for the common currency.
USD
The Federal Reserve’s September meeting appeared to surprise markets expecting a more accommodating message, although the suggestion that tapering will begin as early as the next meeting was widely anticipated. Markets may also have been frightened by the dot plot, in which half of participants now expect a rise in 2022 rather than 2023. In any case, bond yields in the United States have skyrocketed and the dollar has been dragged along with them, but maybe not. as much as one would expect given the scale of the evolution of bonds.
This week, we would tone down any movement resulting from the fight against the debt ceiling, which we see as pure political theater. We will pay close attention to the release of the PCE deflator numbers, which have traditionally been the Fed’s preferred measure of inflation.
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