Post date: 07/06/2021 11:06
The dollar rallied late in the week against its G10 peers, only to give up most of those gains after a mildly disappointing payrolls report on Friday. The jobs data is still hard to interpret, but other measures of world growth continue to show signs of strength and inflationary pressures are not letting up. Most emerging market currencies managed to end the week higher, as commodity prices continue to rise. The Brazilian real was the undisputed winner among the majors, with the New Zealand dollar the worst performer. Two events will dominate traders attention this week, both on Thursday, starting with the June meeting of the ECB. While no change in monetary policy settings is expected by us or the market, there is the potential for a slightly less dovish set of communications than the market is expecting, which could provide a boost to the common currency. As the meeting happens, we will receive the May inflation report from the US, so Thursday afternoon promises to be a volatile time for trading.
The strength in the PMIs of business activity for May and recent less-than-dovish comments from Bank of England policymakers raise the prospects that the UK may actually lead both the Federal Reserve and the ECB in hiking rates. We think this possibility is behind much of the recent strength in the pound, and recent economic data continues to support that thesis, particularly last week’s services PMI that rose to its highest level on record. There are no market-moving releases this week that will add much information to the current picture, so expect sterling to trade off events elsewhere, notably the ECB meeting on Thursday.
The May flash inflation report out of the Eurozone made it clear that it is not exempt from the inflationary pressures that are building up worldwide. The headline rate finally broke above the 2% level for the first time since 2018. The core rate rose more modestly to 0.9% and is still below the ECB’s target. We think there is plenty of room for upside surprises here in the coming months. The key to the ECB meeting this week will be whether the “significantly” higher rate of bond purchases announced in May is scaled back in view of the strengthening economy. We think the ECB is not quite ready to take that step, though the staff forecasts will certainly reflect a more optimistic outlook. Overall, we expect the euro to drift higher, though more as a result of general dollar weakness than specific euro strength.
The US payrolls data for May provided further confirmation that supply constraints are becoming the bottleneck to US growth, and that excess demand will continue to put upward pressure on prices. The headline number of 559k jobs looked healthy enough, but it fell short of consensus, and the labour force participation rate stagnated. Wages rose more-than-expected, in another sign that employers are competing harder to fill positions. We think that generous unemployment benefits, closed schools and worker relocation during the pandemic will continue to constrain hiring and thus booming demand will result in increased inflationary pressures over the next year at least. If the Federal Reserve fails to respond, as seems likely, we do not think this will be positive for the dollar.