Risk assets were steady to higher worldwide last week, as markets price in a modestly lower terminal rate from central banks and yields fall. Markets seem to be giving UK Prime Minister Sunak the benefit of the doubt on his promises to stabilise government finances, and the pound outperformed all its G10 peers to end up significantly higher against the dollar. The euro managed a middling performance, in spite of marginally dovish rhetoric from the ECB, while US economic data and corporate earnings came out on the bearish side, cementing the view that the Fed pivot to a wait-and-see attitude may not be too far in the future.
This week will be a crucial one for currency markets, and financial markets in general. The Federal Reserve meets on Wednesday, followed by the Bank of England on Thursday. The Fed is expected to hike another 75 bps, as is the Bank of England. However, the key in both cases will be the accompanying communications to markets. Central banks in Canada and Australia already have shifted to a slower pace of hikes, so we would not be surprised to see Fed officials leaning that way. The Bank of England is different in that a lot depends on the as yet undefined details of Sunak’s fiscal plans. Eurozone flash CPI data on Monday, and the US payrolls report on Friday, will round up an unusually busy week for currency markets.
We saw the first signs that the budget mayhem had impacted business confidence in weaker-than-expected PMI numbers for October. Other macroeconomic data was more mixed, coming slightly above admittedly subdued expectations. However, sterling trading remains fixated on politics. Prime Minister Sunak’s premiership is off to a solid start, with the pound trading above where it was before the disastrous budget announcement. Forecasting the Bank of England’s decision and communications is even more difficult than usual because Sunak’s budget announcement has been pushed back to November, and the MPC’s stance will be clearly dependent on the Government fiscal plans. We see a strong possibility of another three-way split vote on interest rates among MPC members this Thursday, making the task of calling the magnitude of the hike an extremely difficult one. Expect plenty of volatility this week as a result.
The PMIs of business activity weakened again in the Eurozone during October, but actual GDP data came stronger than expected in Germany. The ECB hiked by 75 bps and appeared to attempt some sort of muddled dovish pivot by tweaking its communications. In its statement, the bank dropped the language ‘over the next several’ meetings, in favour of expecting to raise rates ‘further’, though the reaction in the euro was not overly aggressive. As if on cue, German inflation came out much higher than expected at a knee-bending 11.6% annual rate – a full 10% higher than the ECB overnight rate after last week’s hike. Both headline and core inflation are expected to continue their march higher in October, and we think that President Lagarde will have to soon backtrack yet again on her perceived dovishness.
Second tier data in the US from the housing market, consumer confidence and durable goods orders all suggested that Fed hikes are finally beginning to have an effect. Weak tech company earnings also contributed to the sense that we may be reaching a pivot point, at least in the short-term, and that the Fed may be able to start easing off the brakes soon. The key, however, remains the labour market, where no signs of easing are evident yet. This week’s nonfarm payrolls report comes after the Fed November meeting, where another 75 bp rate hike is a done deal and the only question is whether Chair Powell hints that the central bank is comfortable with current expectations for a terminal rate near 5% next year. Any hint of the long awaited dovish pivot from the Fed could bring about a sharp dollar sell-off.