Risk assets struggled all last week as global economic sentiment took a turn for the worse. The PMIs of business activity, perhaps the most timely indicator of economic activity, surprised to the downside, particularly in the Eurozone, reviving recession fears. The dollar generally benefits from uncertainty and flight from risk, and last week was no exception. The greenback outperformed every major currency, save for the Canadian dollar. The worst performer was again the Turkish lira, as markets reacted to the disappointingly small rate hike from the country’s central bank by sending the currency down to yet another record low.
This week is pretty light in data. Two events should focus the markets attention. The ECB’s Sintra conference of central bankers will feature speeches from president Lagarde and Fed Chair Powell, which will be closely scrutinised for clues about future policy moves. The Eurozone flash inflation report for June will bookend the week and, as usual, we will be paying very close attention to the stickier core inflation subindex.
It was an intense week in UK financial markets. The May inflation report delivered yet another nasty surprise in both the headline and the core indices, with the latter rising to yet another three-decade high. The report must have set off all the alarms in the Bank of England, as soon afterwards the Bank of England surprised markets with a 50bp rate hike, instead of the expected 25bp.
We have been saying for months that rates over 6% in the UK were a real possibility and, after last week’s fireworks, markets finally agreed with us, pricing in a terminal rate over 6%, the highest among advanced economies. Sterling failed to benefit from the thoroughly hawkish announcement, perhaps due to heightened recession fears and the market’s lack of confidence in BoE decision making, remaining in a fairly tight range against both the euro and the US dollar.
Bad news from the PMI business activity numbers last week, consistent with deep contraction in the industrial sector, put an end to the recent euro rally. The service PMIs also experienced an unexpected fall, and the overall number is hovering around the line between contraction and expansion, seemingly indicating an economy that is stalling.
The ECB is now between a rock and a hard place, facing stagflation. In spite of the economic slowdown, the core inflation number for June out this Friday is expected to rebound and remain well above 5%. We expect the ECB to make good on its promise and prioritise the inflation fight. However, further gains in the euro may have to wait for a clear sign that the Eurozone economy is on a growth path.
In an unusually quiet week for US data and news, the dollar traded off events elsewhere, particularly the dismal Eurozone PMI numbers out on Friday. A slowing global economy, rising risk aversion, combined with a Federal Reserve that is not yet finished with hikes, is bullish for the US dollar. Chair Powell’s semi-annual testimony to Congress delivered no real new takeaways of note last week, although he did at least once again stress that US rate cuts were a long way off, and that a couple more hikes could be on the way in the meantime.
It remains to be seen whether actual hard data confirms the softening we are seeing in the PMI numbers. However, the dollar may be entering a wait-and-see period while investors await further inflation reports and Federal Reserve communications to gauge how many hikes are left in the current interest rate cycle.