The Jackson Hole annual conference of central bankers delivered few surprises. The Federal Reserve is less convinced than markets appear to be that inflation has been beaten, and rates are likely to remain at or above 5% for an extended period of time. By contrast, the European Central Bank is caught between a rock and a hard place. The leading indicators of economic activity are weakening, although there are few signs yet that the key core inflation measure is on a meaningful disinflationary trend. Fuelled by expectations that US rates will stay higher for longer, and safe-haven flows induced by ongoing concerns over the state of the Chinese economic recovery, the dollar has rebounded against every other G10 currency in the past month. Emerging market currencies have also sold-off across the board of late, albeit they put in a stronger showing last week, particularly commodity currencies on the back of increasing commodity prices. This week’s data-packed calendar on both sides of the Atlantic should shake any remaining summer torpor off currency markets. On Thursday, there are two crucial inflation numbers: the August flash CPI report in the Eurozone, and the somewhat lagged, but still important, July PCE inflation report out of the US. Then, on Friday, it is payrolls day in the US, with all eyes on the wage growth print.
The UK PMIs of business activity came out considerably worse than expected last week, and are now consistent with an actual contraction. We note that recent hard data numbers have not been nearly as dire as these surveys indicate, but the latter are timelier and a reason for concern. This disappointing economic news weighed rather heavily on GBP, which ended last week at the bottom of the G10 FX performance dashboard. Market pricing still assigns a near certainty to another interest rate increase from the Bank of England in September, and expects almost three hikes more before the end of the cycle. These are the highest rates in the G10 and explain why sterling is still the second-best performing currency in the G10 so far in 2023. We remain cautiously optimistic on the pound, although are really looking closely to see whether economic data validates the plunge seen in business confidence over the next few weeks.
Economic data out of the Euro Area last week heaped further pressure on the ECB to wrap up its hiking cycle before there are any clear signs that core inflation is on its way down. The PMIs for August were even more dire in the Eurozone than in the UK. Both the services and manufacturing indices are now printing below the level of 50 representing contraction, which is the lowest level since the first winter pandemic lockdowns. ECB President Lagarde scrupulously avoided any precommitment for the September meeting at the Jackson Hole conference. Markets remain split almost 50/50 on the possibility of a September hike, as recent data seems to suggest that a pause may be on the way. This week’s crucial inflation report for August will probably seal the deal one way or the other, and the impact on euro trading should be significant.
The US economy seems to be diverging sharply from those across the Atlantic, experiencing a late cycle acceleration instead of slowing down. Retail sales are surging, as is industrial production, and the labour market has barely weakened at all. The Federal Reserve continues to sound rather hawkish, and while we may be one hike away from the end of the cycle, or there already, we expect that it will be a long time before we see any rate cuts, particularly given limited scope for fiscal easing. The US labour market report this week should continue to show an economy at full employment that is finally delivering meaningful real wage increases to workers. Economists are pencilling in an easing in the net job creation number to 170k, from 187k, although average hourly earnings are expected to remain unchanged at 4.4% year-on-year.