Post date: 01/03/2021 10:47

The wild week in bond markets had a clear spill over into foreign exchange last week. A poor auction of Treasury bonds in the US was the proximate catalyst for a sharp move higher in yields. Bond investors have clearly been spooked by the combination of inflation-friendly monetary policy and the wall of supply hitting the markets as a result of massive fiscal deficits almost everywhere. G10 and emerging market currencies all sold-off in parallel with two conspicuous exceptions: the euro, and the Chinese yuan. The latter continues to behave more and more like a safe-haven and a reliable store of value in times of volatility.

This week, the focus will remain on the bond market. We have identified a disorderly sell-off in these markets as perhaps the biggest downside risk to our optimistic macroeconomic forecasts, although we still regard this as unlikely. While we expect yields to end the year considerably higher, we expect this sell-off to be a gradual one without significant impact either on risk assets or economic growth, for now. In addition, this week is quite data rich. Eurozone flash inflation for February is out on Tuesday, and we expect it to print above expectations. Finally, the US payrolls report for February, out Friday, should be consistent with a labour market that continues to heal the damage wreaked by the pandemic.


Sterling resisted the bond market mayhem last week better than all of its G10 peers, save the euro and the US dollar. Vaccine rollout numbers, where the UK is ahead of every other major country, continues to provide tail winds for the currency. More than 20 million people in Britain have now received at least one vaccine, almost 30% of the population. This has raised hopes of a faster unwinding in lockdown measures in the UK than most of its peers, particularly Europe. The Prime Minister’s roadmap for an easing in lockdown, unveiled last Monday, is a cautious one, but has at least provided some much needed clarity. The major news this week will be the announcement of the government budget on Wednesday. In the current environment, any hint of even a modest expansion in fiscal policy could have a positive impact on the pound.


In a week without a lot of fresh information outside the mayhem in bond markets, the euro was surprisingly resilient. It is quite likely that the common currency has been used to fund carry trades, where traders short the common currency and buy those currencies still offering positive interest rates. The unwinding of those trades amid the flight from risk may, therefore, be provided support. This week the focus will be on inflation data. We continue to expect positive surprises in inflation worldwide as healthy consumer balance sheets and pent up demand collide with still battered supply chains. Tuesday’s inflation print should be no exception.


Second-tier economic news last week out of the US continued the recent trend of positive surprises. Particularly notable was the strong print in durable goods orders, a sign that households and businesses are taking advantage of the extremely loose monetary and fiscal conditions. We see no reason to change our very optimistic outlook for the US economy, especially as the latest COVID wave recedes and the vaccination effort outperforms most major countries. All eyes now will be on Friday’s payrolls report, which should show a labour market that has turned the corner, with healthy job creation and reductions in the unemployment numbers.