Post date: 06/09/2021 11:51

The Federal Reserve cannot be happy with the US payroll report for August. Weaker than expected employment growth shared the headlines with strong wage gains, suggesting that inflationary pressures will not be as transitory as it hopes. The US dollar promptly sold off even as US yields rose, a reversal of the usual correlation between the two. Risk assets put in a mixed performance last week. Commodities rose strongly to a fresh five-year high, pulling emerging market currencies with them, in a further sign that inflationary pressures are not abating. Equities had a rougher time, dragged down by the downbeat payroll report. The unambiguous loser of the week was the US dollar, down against nearly every major currency. With the end of the holidays, focus now shifts to the major central bank meetings in September, led off by the ECB on Thursday and the Fed in a couple of weeks. The unusual stagflationary tone of the most recent macroeconomic news, particularly the US, makes it particularly hard to predict how policymakers will react. We expect at least some spirited debate within the ECB council, though it is not clear the consensus is there yet to start reducing the monthly PEPP purchases of sovereign bonds.


Data out of the UK suggests that the economic recovery is on track there, and markets are expecting a strong July monthly GDP number this week. However, the Bank of England will also have to deal with the global dilemma posed by strong inflationary pressures in spite of reasonable labour market slack. We think that market expectations for reductions of sovereign bond purchases and future hikes in the UK are too dovish, and look forward to the September MPC meeting as a potential catalyst for a sterling rally.


The flash inflation report in the Eurozone provided yet another disagreeable surprise. Headline and core components both rose strongly, and the increase can only partially be attributed to one-off factors. It seems clear that the ECB will face the same conundrum as the Federal Reserve: how to deal with persistent inflationary pressures even though labor markets have yet to return to pre-pandemic levels. This week’s meeting will be finely balanced, and we expect at the very least to see the beginning of serious dissensions within the council, which could be supportive of the common currency.


The US payroll report carried a distinctly stagflationary odour, with a disappointingly low job-creation headline coupled with a strong gain in wages. While the latter would be welcome in general, we should note that these increases continue to lag most inflation measures and that in real terms we have seen so far wage reductions overall. As in the ECB’s case, we continue to expect the debate within the Fed to intensify, as it becomes increasingly unclear whether additional monetary stimulus will do more good than harm in these circumstances. Regardless, the fall in the US dollar in spite of rising yields is more easily explained in a stagflationary context.