Last week saw volatile trading in currency markets without the emergence of any clear trend. Sterling was the week’s winner, as markets ignored weakness in UK retail sales, while the yen underperformed all other G10 currencies when the Bank of Japan kept its ultra-loose yield curve management policy intact at its January meeting. Emerging markets currencies were mixed, as strength in the Chilean peso and most East Asian currencies were offset by sharp falls in the Brazilian real and South African rand. Political concerns are mounting, particularly in the case of the former. This week is relatively quiet in terms of policy announcements, but there will be quite a bit of macroeconomic reports. We expect to see a meaningful rebound in the Eurozone indices as fears of recession recede. The PMIs of economic activity for all the major economic areas are released on Tuesday. Later in the week, attention will be focused on the first read of US fourth-quarter GDP growth (Thursday) and the US PCE inflation report (Friday). The former is expected to show healthy growth, and the latter should confirm the modest downward trend in core inflation – both should be welcome news to the Federal Reserve.
The UK saw the same kind of mixed bag of economic data as the US. The employment report for November was strong, notably the surprise to the upside in nominal wage growth, and core inflation once again showed no sign of easing. December retail sales were weak, however, perhaps dragged down by the cold snap and the timing of the World Cup. Markets chose to focus on the positives and sterling topped the G10 tables last week, closing at the highest levels against the dollar since last summer. We still expect the Bank of England to hike its base rate by 50bps next week, even as the Fed downshifts to just 25 bp., so the path of least resistance for the pound in the short-term appears to be up. The key for sterling will be the consensus, or lack of it, in favour of additional tightening beyond next Thursday’s MPC meeting.
Optimism continues to rise that the European economy will avoid a recession. This week, investor sentiment and new car registrations added to the upbeat mood, but the main confirmation will have to come from the PMIs of business activity for January that will be published on Tuesday morning. China’s exit from zero-COVID continues to fuel the euro rally, as does the sense that while the Fed can afford to downshift its monetary tightening, the ECB cannot. A couple of ECB speakers, including president Lagarde, should provide further confirmation of the recent hawkish pivot and help the euro along. ECB member Knot, who is admittedly one of the more hawkish members of the committee, said at the weekend that he expects the Governing Council to raise rates by 50bps at both the February and March meetings, with more to follow thereafter. Should other ECB members echo this sentiment, then the euro could be in for a good week.
We saw a dump of mixed economic data reports out of the US last week. Strong labour market data, notably another sharp drop in initial jobless claims, contrasted with weakness in the admittedly very volatile monthly retail sales data. Interest rates experienced a volatile week but ended up more or less where they had started. Federal Reserve officials are unlikely to make market-moving statements so close to the key February meeting, but the GDP numbers and, more importantly, the PCE inflation report could affect the narrative that the Fed is close to done in its tightening cycle. We will be paying close attention to the PCE core inflation number, perhaps the single most important inflation indicator in the eyes of the central bank.