Post date: 05/09/2022
The euro seemed to be about to lock in a decent performance last week, buoyed by expectations of a hawkish ECB and a labour market report in the US that signalled to the Fed that pressures there may be easing. However, the announcement by Gazprom that it was cutting off gas supplies to Western Europe indefinitely late-Friday sent the euro, and indeed most currencies, tumbling against the dollar. This news brings the prospect of widespread shortages of energy in Europe closer to reality and has increased market jitters surrounding the possibility of a global recession. An energy supply shock, while unemployment remains low and inflationary pressures are at record levels, poses an unusually difficult challenge for the ECB at its meeting on Thursday. Traders will be looking at a finally balanced decision between hiking interest rates by 50 or 75 basis points, as the Governing Council tries to make up for lost time. The gas shock last week adds even more uncertainty to the decision. Not much news out of the US in a holiday-shortened week, but the leadership contest to succeed Boris Johnson as UK prime minister may add some volatility to sterling.
A raft of second-tier data points last week all came out stronger-than-expected in the UK: retail sales, house prices and mortgage approvals, as well as an upward revision to the manufacturing PMI. None of this was particularly helpful to sterling, which continued to track the euro down against the US dollar, but it does seem to indicate that people calling for an immediate recession have got a bit ahead of themselves.
Focus this week will be on the outcome of the leadership contest in the Conservative party. Should Liz Truss be announced as the winner, then the news may be positive for sterling, at least in the short term, given her focus on additional fiscal spending, more trade protectionism and, therefore, tighter monetary policy. This is a mix that has proven currency-positive, historically speaking, though it’s worth noting that at this point basically no one expects anything other than a Truss victory.
Inflation data out last week confirmed that the ECB faces perhaps the toughest job of any of the world’s major central banks. Inflation yet again surprised on the upside, in both the headline and core indices, and in both cases printed another all-time record for the Eurozone. The ECB meeting is perhaps the most critical this year. The inflation numbers are awful, and the central bank is clearly behind the curve; at the same time, the energy shock that has resulted from Central Europe’s dependence on Russian gas is unlike that seen anywhere else.
We think that the ECB will still hike by 75bps, as the level of rates in the Eurozone lags hopelessly behind its peers and economic reality, and there isn’t much that monetary policy can do to conjure up gas and alleviate shortages.
The key US labour report provided welcome relief to the Federal Reserve on Friday. While job creation continues apace, dispelling fears of a recession in the US, the labour force expanded, and wages rose less-than-expected. This signals that labour demand remains hot, as confirmed by the JOLTS job openings report earlier in the week, but that it’s resulting more on an increase in the size of the workforce than on a wage spiral.
Rates came down in the US as a response, and the week would have been a difficult one for the US dollar had it not been rescued just before New York closing time on Friday by that Gazprom announcement on the indefinite suspension of gas deliveries.