Post date: 22/08/2022
US bond yields have now retraced the fall that followed the positive inflation report from the week prior. Federal Reserve officials talked up the prospects of another jumbo interest rate hike in September, and markets are now equally split between a 50-basis point and a repeat of the previous meeting 75bp increase. Risk assets gave up some of their recent gains, and understandably the dollar bounced back strongly against every major peer worldwide. In this context, the Chinese yuan held up relatively well in spite of recent weakness in the Chinese economy, rising against every G10 currency, save the US dollar.
This week, the critical PMI advance indicators of business activity will be released in the US, the UK, and the Eurozone. Current levels mostly hover around the 50 line that separates expansion from contraction, so these numbers take on added importance. At the end of the week, markets await headlines and speeches from the annual meeting of the world’s central bankers in Jacksonhole, Wyoming. In particular, Chair Powell’s speech on Friday is expected to offer some clarity on the speed of coming hikes and, just as important, his expectations on how high rates will have to go before inflation is brought back under control.
Bank of England policy makers received an unpleasant jolt last week, in the form of a significant upward surprise in the inflation numbers for July. Both the headline and the core rate soared to fresh record highs, the former now in double digits and expected to peak at 13% in the autumn. Markets rushed to price in more hikes from the Bank of England, but the threat of stagflation meant that sterling failed to benefit and fell against both the dollar and the euro. The PMIs in the UK have held up better than in the Eurozone, suggesting a more resilient economy than is priced in at current pound levels, but this view will be tested this week when the advance August numbers are released on Tuesday.
Last week was a typically sluggish summer one in the Eurozone. With little macroeconomic or policy news, the euro mostly traded down as US rates soared and sentiment towards the Eurozone economy deteriorated on soaring energy prices. While macroeconomic news out of the bloc has held up reasonably well so far under the circumstances, the jump in energy prices continues to worsen the outlook and has helped drive EUR/USD back through parity levels this morning. As elsewhere, the PMI advance indices on Tuesday will be key. However, given how far behind the curve the ECB is with respect to inflation, we do not think that it can afford to let up on policy normalisation, even if a mild recession materialises.
Strong second tier data and a determined push back form Fed officials against any notion of a ‘dovish pivot’ drove US rates higher last week, and this in turn boosted the dollar. Last week’s FOMC meeting minutes were actually initially seen as dovish, although investors appeared to have a change of heart as focus shifted to the Fed’s comments on inflation, which indicated members saw no let-up in price pressures. This week, the PMIs are released on Tuesday, as elsewhere. However, they typically make less of a splash in the US. Markets will look to the PCE inflation report later in the week to corroborate the good news from the CPI report. Regardless, it is unlikely that the Fed will be deterred from its hiking campaign and the main question for Chair Powell at Jackson Hole will be whether 50 or 75 bp are coming in September.