Dollar extends rally as US inflation rebounds
A modest upside surprise in the US September inflation readings added to the upward pressure on long-term Treasury yields, which underpinned the dollar rally.
Highlights:
USD extends rally on US inflation surprise.
ECB seen cutting rates by another 25bps this week.
UK CPI report, Labour budget eyed by investors.
Hawkish RBA meeting minutes keep AUD well bid.
RBNZ delivers dovish surprise with 50bp cut.
China stimulus measures disappoint markets.
The picture of a US economy that is growing strongly, with a labour market still at full employment and inflation levels modest, but on an upward trend, makes it difficult for other G10 currencies to rally against the greenback. However, the rally was more subdued last week, with most currencies ending the week within 1% of where they began it, suggesting that US economic outperformance is now fully priced in, and it will be difficult for the dollar to rally much further in the short term.
Focus shifts back to Europe this week. The news flow will be dominated by the ECB meeting on Thursday, when policymakers are universally expected to cut rates by another 25bps amid signs of economic stagnation in the Eurozone. There is more uncertainty around the tone of the bank’s communications, particularly the extent to which the central bank is concerned by the notable recent weakening in leading economic indicators. We also have a batch of key data out of the UK, starting with employment data for the months of August and September on Tuesday, and then September CPi inflation on Wednesday.
USD
Long term interest rates, and with them the dollar, have risen steadily since they hit a low right after the Fed’s 50bp cut. Last week’s inflation numbers further fuelled this trend. Core inflation for September came in higher than expected, and our favourite inflation indicator, the three-month moving average of this index, has now risen for three consecutive months to an annualised level closer to 4% than to 3%.
This is not yet enough to derail the Fed’s commitment to a cut rate at each of its remaining meetings in 2024, but with the US economy growing at 3% and the labour market in full employment, it suggests that the bottom for US rates is closer than markets are currently pricing in. There isn’t a huge amount of economic news out of the US this week, although we will be looking to Thursday’s retail sales report to get the latest read on the state of consumer demand.
EUR
Dismal readings from the Eurozone economy continue to weigh on the common currency, although the recent upward revision to the September PMI data has somewhat allayed investor concerns. The announcement of aggressive stimulus in China has partly counteracted the gloom, even if markets have been left underwhelmed by the details of the measures.
The focus among markets will be on the tone of the communications at the ECB October meeting on Thursday. The central bank is normally reluctant to over communicate, particularly in meetings like this week, where the staff forecasts will not be updated. A lack of commitment to an aggressive calendar of interest rate cuts may finally put a floor under the common currency.
GBP
Sterling has retraced some of its blistering 2024 rally in the last two weeks, a retracement triggered initially by dovish comments by the Bank of England governor Andrew Bailey. However, we think that the bullish case for the pound remains, supported by attractive valuation, relatively high rates and a resilient economy, which is likely to ensure that the MPC’s easing cycle remains a rather gradual one.
The various labour data points and, critically, the September inflation print, will be a test for our view this week. The consensus of economists expects labour data consistent with a full employment economy and inflation numbers trending down, but still considerably above Bank of England targets, both of which should be supportive of the pound. Investors will also have one eye on this month’s budget announcement from the new Labour government, which is expected to see the unveiling of a number of revenues raising tax hikes.