The dawning realisation that Federal Reserve hikes in 2019 are not guaranteed send US interest rates lower again, and they in turn dragged the dollar lower. The Euro largely ignored the French protest against Macron, while Sterling remains wobbly as May’s deal looks certain to be rejected by Parliament. Beyond the G10, firmer oil prices mean the strongest currencies were those of oil exporting countries like the Russian Ruble and the Colombian peso, while oil importers Turkey and South Africa suffered.
This week we expect currency volatility to return with a vengeance. Tuesday’s Parliament vote on May’s Withdrawal Agreement will probably bring extreme volatility to Sterling. The ECB meeting on Thursday could potentially squeeze the Euro higher if the path towards higher rates remains unchanged in spite of recent data weakness.
Needless to say nothing matters for Sterling other than the Brexit vote this week and its ramifications. There is near universal agreement that the deal will not pass, but the margin of defeat will be key. We think a margin of defeat beyond 80 votes or so would lead markets to price in the fall of the Government and possibly a significant likelihood of a hard Brexit, sending the Pound tumbling.
The ECB meeting on Thursday will clarify whether recent disappointments in eurozone data have led the Council to consider delaying its timetable for future hikes. We think the downdraft in PMI business of economic activity are temporary, but it’s harder to dismiss the softness in core Eurozone inflation. However, market expectations are already extremely dovish, and interest rate markets are pricing that the depo rate will not reach zero until 2021 – way too dovish in our view. We think the risks around the ECB meeting are clearly biased towards a less dovish than expected outcome and consequently a short squeeze pushing the euro higher can’t be excluded.
While the headline numbers from the payroll report were somewhat disappointment, we think the report was overall consistent with a labour market that is still strengthening modestly. However, we agree with the market’s perception that Fed hikes into 2019 are far from guaranteed, and the FOMC is likely to take a pause to see if quiescent inflationary pressures take a leg up. We do not expect this to happen any time soon. We still expect a hike in the upcoming December meeting, but now expect no change at all in 2019. The stage is set for other G10 currencies to begin a slow convergence towards US rates, and we expect this to be modestly negative for the US dollar.