Post date: 18/07/2022
The peak in US inflation has been getting pushed into the future for some time, and June was no exception. The unpleasant surprise sent the dollar soaring generally, but the euro put up a spirited defence of the psychologically important parity level and, after breaching it briefly, managed to end the week above it. Markets are now pricing in some possibility of a nearly unprecedented 100 basis point rate hike at the next Federal Reserve meeting, and in this context it is somewhat reassuring that risk assets like stock markets and emerging market currencies managed to end the week flat to slightly down. All eyes now are on the ECB meeting on Thursday. With a 25 bp hike baked in and markets pricing a 10% chance of a 50 bp surprise, there will be some room for appreciation if the ECB decides to jolt markets. The Bank of Japan also meets, and it’s expected to remain the odd one out in monetary policy, hanging on to its pre-inflation extreme accommodation. Inflation in the UK (Tuesday) and July PMI leading indices across most major economies will round out an extremely busy week.
Solid economic data for May published last week in the UK, notably the May GDP print (Figure 2), did little to help the pound, which fell against every G10 peer, except the Japanese yen. CPI data out on Wednesday is likely to rise to yet another multi-decade record, which together with the hawkishness suggested by recent Bank of England speeches would validate our expectation for a double-sized 50 bp hike in August. The labour market report this week will also tell us whether second round inflationary effects are becoming evident in the wage-setting process. The PMIs of business activity will bookend this extremely busy week, and consensus expects them to all remain safely within expansionary levels.
New out of the Eurozone economy last week was mixed, with a sharp contraction in car registration but a positive surprise in May industrial production. Markets roundly ignored these second-tier reports, and are focused on two key events. In addition to the European Central Bank meeting on Thursday, the Nord stream one gas pipeline is scheduled to restart gas deliveries on the same day, which could make for some seriously volatile trading. Investors are concerned that the 10-day maintenance period could be delayed beyond this date. The market is set on a 25 bp hike on Thursday, which would open a window for the ECB to surprise markets and begin to restore its inflation-fighting credibility. But perhaps more important than the actual policy move will be the level of unanimity that is achieved around the anti-financial fragmentation toolkit, which is a euphemism for restarting the purchase of weak peripheral bonds using freshly printed euros. This promises to be one of the busiest trading weeks in many months for the common currency.
The hopes that inflation in the US has seen its peak, which were fanned by last month’s PCE report, were dashed by another unpleasant surprise in the June CPI report. However, we think that hikes of more than 75 bps are unlikely, and markets have got ahead of themselves in pricing their likelihood, and the scorching dollar rally is becoming vulnerable to a correction in those expectations. This week, the dollar will cede the spotlight to other currencies, particularly the euro, as only second-tier data gets published. For once, the dollar should trade off developments elsewhere.