Currencies trade in tight ranges as central banks hint at further tightening. G10 currencies all ended the week within less than 1% of where they had started it. Rates continued to rise in the main economic areas, as central bankers at the ECB’s Sintra conference generally delivered a hawkish message and core inflation remains stubbornly high everywhere. However, risk appetite remains resilient, stock markets are actually rising and, on net, FX traders seem unsure of where to go next; hence the tight trading ranges.
In spite of the long 4th of July holiday, the main news this week in international markets will come from the US. On Wednesday, we’ll get the minutes from the last meeting of the Federal Reserve, which will be scrutinised for clues on the timing of further interest rate hikes in the US. The June nonfarm payrolls report will be released on Friday, which is expected to show continued strength in the labour market. The key to the latter will be whether we see any hints of acceleration of wage growth.
A quiet week in the UK saw sterling trade in rather tight ranges with both the euro and US dollar. The pound continues to benefit from the Bank of England’s hawkish turn, most notably the surprise 50bp interest rate hike at its June meeting. Market expectations of the terminal rate in the UK continues to approach 6.5%, the highest in the G10 by some margin, and there are few signs as yet that the UK economy cannot bear it. BoE governor Bailey gave absolutely nothing away during his Sintra appearance, neither pushing back against market pricing, nor condoning further aggressive tightening. We are in the midst of a rather quiet period of UK economic data, with no more than revised first quarter GDP data out last week, and the updated June PMIs this week. In the absence of any bad news, investors will likely continue to take an optimistic view on the UK economy, while betting on continued hawkishness from the BoE. This is a bullish combination for sterling.
If the speeches by European Central Bank officials last week are anything to go by, the Governing Council remains squarely focused on bringing down inflation, and the end of the hiking cycle is not in sight just yet. Speaking in Sintra last week, president Lagarde again all but confirmed that another 25bp rate increase is on the way later this month – indeed this is now more than fully priced in by swap markets. However, weak news from China and general gloom from the manufacturing sector are keeping the euro from benefitting too much from the ECB’s hawkishness. Even after the recent increase in expectations for terminal rates, we still think there is plenty of room for additional hikes, and do not think that the ECB rate can peak below 4%. Last week’s flash inflation report offered some support for our view. Core inflation, which the ECB is increasingly highlighting in its communications, slightly missed expectations, although actually rebounded a bit relative to the previous month and shows every sign of stabilising at an unacceptably high level above 5%.
Economic data in the US has been surprising to the upside lately. Last week we saw strong durable goods and new home sales reports. Weekly jobless claims remain at low levels and GDP numbers for the first quarter were revised up, to 2% annualised, on stronger consumer spending and exports. The Fed’s preferred measure of inflation, the PCE index, was a miss, although the core PCE inflation measure remained stubbornly high at 4.6% in May. Expectations for further Federal Reserve rate hikes continue to be ratcheted up, but this has so far been of limited help for the US dollar, partly because expectations for hikes are rising across the G10. A 25bp hike is now almost fully priced in for the July meeting, though futures currently only see around a one-in-three chance of another beyond then, so there may be room for dollar upside should the Fed continue to strike a hawkish note in the coming weeks. This week, we expect the run of good news to continue with a strong labour market report. However, the impact in the dollar will be limited, unless we see signs of a reacceleration in wages.