Post date: 25/07/2022
Signs of US slowdown slam dollar, euro mixed on ECB hawkish surprise. Disappointing economic data out of the US brought yields down worldwide and removed any chance of a 100-basis point interest rate hike from the Federal Reserve this week. The surprise 50bp hike from the ECB had surprisingly little immediate impact on the common currency, which nevertheless joined in the general bounce back against the US dollar. Commodity currencies both in the G10 and emerging markets performed particularly well as commodity prices stabilised. Wednesday's Federal Reserve meeting will dominate financial news this week. Also important will be the inflation report out of the US and the Eurozone, both out on Friday. The key question for markets is how fast the slowdown in activity evident in most economic areas will translate into downward pressure on inflation data. This will be the key question the Federal Reserve will be grappling with at its July meeting.
Macroeconomic news out of the UK took a clear turn for the better last week. Activity surveys surprised to the upside and remained consistent with steady growth. The labour market continued to generate jobs at a healthy clip in May, while the June retail sales numbers came in better than economists had anticipated. Finally, while headline inflation remains sky high, core inflation has now declined for two consecutive months. Sterling did not react much, moving mostly with the euro against the dollar, but this positive news flow could set the stage for a rally in the next few weeks, especially as valuation remains supportive of the pound.
The ECB surprised markets with a 50-basis point rate hike, an event to which we had assigned a 50% probability. The initial positive reaction of the currency faded away somewhat as markets still don't feel they didn’t receive enough details about the ECB’s new anti-fragmentation tool. On a side note, it did away with forward guidance, part of a much needed move away from relying on its thoroughly inadequate forecasting capacity, on which we have commented often. This uncertainty, combined with negative surprises in the PMI activity numbers, which suggest that the Eurozone economy is stagnant, capped the euro gains against the dollar and kept it hovering not far from parity. All eyes will now be on Friday's flash CPI numbers, which are expected to show that core inflation has not yet peaked in the Eurozone.
There were undeniable signs of an economic slowdown in the US last week. Weekly jobless claims continue to tick up, albeit from an extremely low level. Higher mortgage rates continue to drive a housing slowdown, though housing starts remaining historically high. Most worrisome in our view was the drop in the PMIs to levels consistent with outright contraction. While central banks worldwide have consistently surprised on the hawkish side, we do not expect this to be the case next week at the Federal Reserve July meeting, as signs of a US slowdown should be enough to keep its increase to 75bp. More generally, we think outsize rate increases are now a thing of the past, and we should revert to the 25 or 50 bp of the past after the July meeting, which could cap dollar gains.