G10 currency trading was fairly uneventful last week, as the dollar had a mixed reaction to the relentless march higher in interest rates, as risk assets took it in stride. Emerging market currencies were the stars last week, led by the Latin American ones. The reopening of the Chinese economy after the end of COVID lockdowns is going better than expected, boosting sentiment on commodity exporting countries. The Chilean and Mexican pesos topped the charts, rallying by over 2% against the US dollar. In Europe, yet another upward surprise in inflation, with the core climbing to yet another record high, meant higher European rates and a stronger euro.
The trend is now that strong economic and inflation data in the US is being matched elsewhere, and rates are rising in parallel across most economic areas, so that the dollar fails to benefit much. This trend will be tested in the coming days by Fed Chair Powell’s semi-annual testimony to Congress on Tuesday, and the US payrolls report on Friday. Markets are expecting a slowdown in job creation from the monster levels reported in January, but to a level still consistent with an extremely tight labour market. We will be focusing mostly on the wage numbers, where an upward surprise may provide further fuel for the increase in interest rates.
News out of the UK last week was in line with what we have come to expect: stronger than expected economic data and confusing Bank of England communications. BoE governor Bailey provided very little clarity on future policy, warning that rates may have peaked, while failing to rule out additional hikes. In our view, another hike at the 23rd March meeting is all but guaranteed, and with limited fresh data out between now and then, markets may be slightly under-pricing the possibility of another 50bp hike. January monthly GDP is the main data point on tap this week, but we continue to think that the gap between market expectations of Bank of England hikes and likely outcomes should be a tailwind for sterling in the coming weeks.
The factors supporting higher interest rates in the Eurozone, and consequently a stronger euro, remain firmly in place. On the one hand, inflation continues to surprise the upside. There is no sign as yet that core inflation has peaked, unlike the US, and indeed this key print rose to a fresh record high in February.
On the other hand, growth numbers continue to surprise on the upside and the impact from the fast Chinese rebound has yet to be felt. Rates in Europe are rising even faster than in the US and this is putting a floor under the common currency. Retail sales for January will be in focus Monday, but the euro may largely trade off news elsewhere this week.
Strong business activity PMI and weekly jobless numbers confirmed that the US economy is so far shrugging off the impact of rate increases and is, if anything, picking up speed. This brings up the possibility of a 6% peak in Federal Reserve rates, although the US dollar is not benefitting as much as rate expectations elsewhere are rising even faster. The key now is whether the Fed switches back to 50bp hikes at every meeting until a clear downward trend is evident in the monthly inflation numbers. Powell’s testimony to Congress this week will be as critical (if not more) as the payrolls report on Friday. Given the recent string of upside surprises in US data, we think that another hawkish turn is all but guaranteed.