Post date: 27/09/2021 11:27

We have been pushing for a while the idea that currency markets will now be mostly, if not exclusively, about the relative pace of central bank policy tightening, with inflation data a close second. In line with this narrative, the Norwegian Krone was the week’s best performer on the back of the first G10 hike of the cycle by Norges Bank. We add that market expectations of what these central banks will do and say seem to be remarkably dovish. The Federal Reserve seemed to do no more than validate most expectations with the suggestion that tapering will start in November, and yet investors sent yields violently higher, indicating that this was a hawkish surprise to most.

The sell-off in US rates as markets braced for the withdrawal of monetary stimulus hammered major emerging market currencies, all of which ended the week down against the dollar, save the Russian Ruble, which was buoyed by rising energy prices, especially in Europe. Meanwhile, the fallout from the Evegrande crisis in China continues to be limited. With major September central bank meetings out of the way, focus should now shift to macroeconomic data, with inflation front and center. The September flash inflation report for the Eurozone will be published, and markets are expecting another jump in both the headline and core numbers to bring Eurozone inflation more in line with the US and the UK.


Sterling was torn between the undeniably hawkish meeting of the Bank of England and the news flow of supply constraints, soaring energy prices and developing shortages. The big surprise from the BoE was that another MPC member, Dave Ramsden, joined existing hawk Michael Saunders in voting for an immediate reduction in the pace of QE purchases. Ultimately we think the former will have a longer lasting impact, especially as there is a decent chance rates in the UK will go up ahead of every other major G10 country, possibly before the end of this year or, more likely, in early 2022. We regard the recent weakness in sterling as a buying opportunity, as a tightening of monetary policy remains the key narrative for appreciation throughout the G10.


As in the US, macroeconomic data from the Eurozone is starting to take stagflationary overtones. The September PMIs of business activity pulled back, albeit from very high levels, on a general theme of supply chain disruptions, constrained output and increased pricing power. We fully expect the key flash inflation report out this week to confirm this. Strategists have been busy revising their forecasts upward for both the headline and core numbers, but we still see room for a surprise. This would call into question whether the ECB can afford to lag other central banks in removing monetary accommodation and could be bullish for the common currency.


The Federal Reserve September meeting seemed to surprise markets that had expected a more dovish message, even if the suggestion that the taper will start as soon as the next meeting was widely anticipated. Markets may also have been spooked by the dot plot, in which half of the participants now expect a hike in 2022 rather than 2023. At any rate, bond yields in the US shot up and the dollar was dragged along with them, although perhaps not as much as may have been expected given the magnitude of the move in bonds. This week, we would fade any moves resulting from the debt ceiling fight, which we regard as pure political theatre. We will be paying close attention to the publication of the PCE deflator numbers, which have traditionally been the Fed’s preferred measure of inflation.