The US dollar traded in a fairly tight range against most of its peers last week, ending slightly lower against most European currencies, save the pound. The moves were all modest, although it is remarkable that yet another week of rising long-term rates in the US failed again to boost the greenback significantly. This suggests that the dollar already prices in a very positive scenario for the US economy and higher yields for much longer at current levels. Together with stretched trader positioning and a growing long consensus, we think that upside for the US dollar may be limited from here.
This Thursday’s European Central Bank meeting will be the main focus for investors this week. No changes in policy are expected, so attention will be on the communications. On the macroeconomic front, the all-important PMIs of business activity could be market moving. The data for the US, Eurozone, and the UK will all be released on Tuesday. Gloomy readings are expected in Europe, contrasting with a more solid tone in the US.
Later in the week will see the release of the personal consumption expenditures inflation (PCE) report in the US, the Federal Reserve’s preferred measure of consumer prices. Traders will also be closely following the developments in Israel and Palestine, although the impact of the crisis in financial markets in general, and currencies in particular, has so far been rather limited, and contained the modest safe haven flows into the likes of the Swiss franc.
Higher than expected UK inflation numbers and weak retail sales in September were unwelcome news for the Bank of England last week. Stubbornly high core inflation readings and a certain loss of economic momentum are consistent with stagflation, and very high wage increases raise the risk of second-round effects and a solidification of inflation expectations at current high levels. While the pound is trading at undeniably attractive valuation levels, the Bank of England’s dovish messaging and reluctance to hike rates any further may delay any sustained rally in the near-term. Upcoming data on unemployment (Tuesday) and the October PMIs (Wednesday) will be important for sterling this week. Investors will also have one eye on next week’s MPC meeting for November. No change in rates is expected, although investors will be hoping for more clarity on the bank’s near-term plans for policy.
The stabilisation in Chinese macroeconomic data should have provided a positive backdrop for the common currency, but the Middle East crisis may be another headwind for growth, mainly through higher energy prices. The ECB must navigate these stagflationary risks, and on Thursday we expect the central bank to leave policy unchanged. Indeed, swap markets effectively see no chance of any change in rates and believe that the next move in rates will be to cut at some point towards the middle of 2024. President Lagarde will have to walk a fine line, as risks to growth have materially increased, but core inflation remains stubbornly high, and its downward trend remains very tentative. Should Lagarde voice heightened concern over the state of the bloc’s economy, then the euro may come under fresh selling pressure towards the end of the week. Conversely, any form of push back against market expectations for rate cuts would be unambiguously hawkish for the common currency and could trigger a knee-jerk rally from currently suppressed levels.
The US economy continues to shrug off the effect of relentlessly rising interest rates. In spite of Treasuries above 5%, and mortgage rates above 8%, economic news continues to surprise on the upside more often than not, including last week’s retail sales report for September. FOMC chair Powell delivered a mixed set of remarks during his speech last week and, following some choppy trading, the impact on the dollar was rather neutral. While Powell kept the door open to further hikes and noted that policy was ‘not too tight’, he also flagged signs of a cooling in the labour market and the impact of higher yields on a tightening in financial conditions. This week’s quarterly GDP growth number is expected to print above 4% in annualised terms, which is consistent with nominal GDP growth of around 8%. The gap with the economies across the Atlantic could not be starker, and the question is to what extent this gap is already reflected in both high dollar levels and market consensus about further dollar appreciation.