Post date: 11/10/2021 12:04
Last week provided strong validation for our view that inflationary pressures will be here for longer than G10 central banks expect. Oil prices, and the energy complex in general, rose strongly for the week, as did sovereign bond yields worldwide, driven higher by rising inflation expectations. For now, risk assets are weathering the storm, and most equity indices eked out a win for the week. Notably, the dollar failed to benefit from the severe back up in US treasury yields, which are starting to get close to the summer highs. The fact that inflation expectations, not real yields, are driving the rise in yields may explain the dollar’s underperformance this week. This week the focus will be on the key September inflation report out of the US, published Wednesday, followed the same day by the release of the minutes from the Fed September meeting. The latter will contain interesting, albeit somewhat dated, insights into the mindset of the Federal Reserve’s plans for accommodation removal.
Signs that the gasoline shortages have peaked in the UK and increasing Bank of England hawkishness boosted the pound, which was one of the better performing European currencies last week. Our view that a rate hike in the UK could happen before year end was supported by weekend remarks from two MPC members, including Governor Andrew Bailey, which sounded worried about the prospects of “very damaging” inflation. Fellow MPC member Michael Saunders also warned households to get ready for a “significantly earlier” interest rate hike. It is clear that a hike may be coming as early as the November meeting, which should lead markets to seriously reprice their interest rate expectations, and that should provide a definite boost to sterling.
The key question in the Eurozone will be whether the impulse from the reopening and spending of the European funds will be enough to offset the weakness caused in the manufacturing sector by the worsening supply chain issues. We remain optimistic, but must admit that the balance of risks has shifted somewhat to the downside given the disproportionate impact of soaring energy prices on the European economy. This week, August industrial production numbers are published, but we think the report is too lagged to have significant market impact, and the euro will follow developments elsewhere.
The headline of the September labour market report in the US was disappointing for the second straight month, but the details were somewhat more encouraging, notably the drop in unemployment and acceleration in wage growth. All in all, the job market recovery continues, albeit at a slower pace than the Fed would hope for, and probably not fast enough to expand supply fast enough to bring inflation down any time soon. We should get confirmation for this from this week’s inflation data report. Markets are expecting yet another month with headline inflation above 5% and core inflation above 4%. The impact of another upward surprise in this data point is anybody’s guess, but lately the dollar has tended to underperform whenever market expectations of inflation increases.