Post date: 22/03/2021 13:02
Last week, the Federal Reserve reiterated its openly inflationist stance when Chair Powell insisted that rates will stay at zero even if inflation overshoots the target. Treasury bonds continued to sell-off as market expectations of inflation rose to eight-year highs. Remarkably, risk assets and emerging market currencies took the events relatively well, with Latin American currencies, in particular, ended the week higher against the US dollar. This market action reaffirms our view that the dollar will struggle to gain in spite of higher bond yields in the US. The sea change in the Federal Reserve´s attitude toward inflation means historical relationships between asset classes are less useful now as a guide to the future.
This week, movement in US rates will continue to be the centre of attention for markets, including currency markets. The Eurozone PMIs on Wednesday should bring little good news given the slow vaccine rollout there and the renewed lockdowns in France. Given the increased market concerns over inflationary pressures, the US PCE inflation report for February on Friday should be another key data point for traders and investors.
Sterling continues to trade in a resilient manner against its peers, supported by the strong UK vaccination effort and the prospects for strong growth this year and next as the lockdowns are lifted. The Bank of England unsurprisingly kept both interest rates and the pace of bond purchases unchanged last week and, like the Federal Reserve, does not seem concerned with the increase in bond yields so far. The MPC also suggested that it will look through above target inflation in the coming months in favour of supporting growth, in the process pushing back against rising expectations for higher rates before the end of next year. We expect the pound to continue to trade sideways or modestly up against the US dollar and the euro over the short-term.
The EU’s sluggish rollout of the various COVID vaccines took a bizarre turn for the worse last week. Most major European countries decided to stop administering the AstraZeneca vaccine on the thinnest of statistical evidence, against the explicit recommendation of the European Medicaments Agency. While the halt lasted only a couple of days in most places, this will not improve the short-term economic outlook, already darkened by the restoration of lockdowns in France and elsewhere. While caseloads have not yet increased materially in the common bloc, rates of transmission suggest that cases are now growing exponentially and that a third wave of infection is likely on the way. Aside from the PMIs of business activity, the EU summit on Thursday should focus on the vaccine rollout and will certainly be looked at closely.
The FOMC meeting last week reiterated the extremely dovish stance of the US central bank. Chair Powell insisted that rates will be set at zero until some elusive and expansive definition of maximum employment is reached, and that for now any inflation spikes will be regarded as temporary and will not impact monetary policy. While an additional two members saw hikes before the end of 2023, the median dot in the FOMC’s ‘dot plot’ showed unchanged rates over the forecast horizon. Rates markets unsurprisingly sold-off again, and inflation expectations embedded in bond prices are now at the highest level since 2013. There is not a lot on the calendar to move currency markets until Friday, when PCE inflation data is released. We think that inflation data will become increasingly important for markets, so expect some fireworks on any upward surprise here.