Post date: 18/10/2021 10:49

One of the key correlations beginning to establish itself in the post-pandemic world seems to be the negative one between US inflation and the dollar. Yet another strong CPI report showed headline inflation above 5% for the fifth consecutive month. Yields did not move much as a response, but the US dollar lost ground for the week against every major world currency. The only exceptions were the Japanese yen, weighed down by the relentless rise of commodity prices and risk appetite, and the Turkish lira, tripped once again by Erdogan’s rate shenanigans. This week is light in terms of macroeconomic releases or policy announcements. Watch out for the September inflation report out of the UK on Wednesday, which may solidify expectations for a 2021 hike. The Eurozone PMIs of business activity on Friday will give us a timely read on the degree to which the economic recovery there is softening; however, market expectations are still for a strongly expansionary read.


Strong labour market data and industrial production numbers out of the UK bring us closer to a 2021 hike by the Bank of England, which looks set to act much earlier than the Federal Reserve. BoE Governor Bailey warned again over the weekend that the bank ‘will have to act’ in order to curb inflation, and that has further brought forward market expectations. Futures are now pricing in this first small 15 basis point hike at the next MPC meeting in November. This week’s CPI report is therefore key, as it will be the last major data point to inform the Committee’s decision. Both the headline and core numbers are expected to print above 3%, even before the lifting of the energy price caps adds fuel to the inflationary fire. In our view, this should be enough to warrant a 2021 hike and provide strong support for sterling.


The euro was one of the laggards last week among currencies and risk assets generally, most of which outperformed against the dollar. The ECB appears set to lag almost all of its major peers in the removal of monetary policy accommodation, and markets are not pricing in hikes until well into the future. In this context, we have pushed downward our forecasts for the euro against other G10 and emerging market currencies. Short-term, market expectations for the October PMIs appear to be quite subdued, so there is room for a positive surprise that would provide support to the common currency.


Yet another month with headline inflation above 5% and the core rate above 4% are driving home our view that inflationary pressures are unlikely to be as short-lived as the Fed was hoping during the summer. As a result, a taper announcement at the Federal Reserve’s next policy meeting in November now looks all but assured. With the US fiscal deficit in double digits and real rates way below zero, we think the rally in risk assets in general and commodities in particular still has plenty of room to run. This is not necessarily a positive background for US dollar performance, and we continue to see a weaker greenback against most of its peers, particularly commodity-exporting emerging market currencies.