Post date: 15/11/2021 10:40
The market response to the blowout inflation report out of the US was unusual. This time, the dollar had no trouble rallying against its G10 peers. However, the true stars of the week were emerging market currencies in Asia and Latin America, led by the Brazilian real. A possible explanation for this dichotomy is the split between monetary responses to worldwide inflation pressures. While G10 central banks are for the most part happy to let inflation rip, keeping real rates at extremely negative levels, emerging market authorities have been much less sanguine and started aggressively raising rates several months ago. It’s still early in the process of monetary policy normalisation, but last week’s moves are interesting. We expect currency markets to continue to be driven mostly by inflation news and the different speed at which central banks normalise monetary policy. This week is particularly rich on the former, with inflation releases out in the Eurozone, the UK, Canada and Japan. Also important will be speeches by no fewer than eight Federal Reserve officials and two by ECB President Lagarde.
The UK economy expanded by 6.6% annually according to data released last week (1.3% QoQ), solid growth, albeit slightly under expectations. Sterling lost ground against the US dollar, but outperformed every other european currency as markets price back in a 50% chance of a first hike at the December meeting of the Bank of England. This week, a slate of key data covering the labour market and inflation will be released. The labour report will be the first one released since the end of the furlough scheme. Markets are bracing for yet another large increase in inflation, with a chance that the headline number will come in above 4%, which in our view should almost guarantee a December hike and be supportive for the pound.
It was a slow week for Eurozone data, and as such the euro mostly traded off news elsewhere, primarily the monster inflation report out of the US and the spike in yields there. The recent sharp increase in new COVID cases in Europe is, however, providing investors with a bit of a cause for concern. A handful of countries, including the likes of Austria, the Netherlands and Germany are preparing fresh restrictions, and it is likely that others will follow suit soon. This week, macroeconomic data is also sparse. The focus will be on central bank communications. Specifically, Lagarde will deliver a speech at a European Parliament on the topic of “from Recovery to Strength” which will be read closely to see if the European Central Bank continues to push back against market pricing of future ECB hikes.
There is no way to sugar coat the US inflation report for October. The headline and core rate both came in significantly above already high expectations. Inflation is now at a three decade high and few are predicting a pullback any time soon. Bonds sold-off sharply and for now the path of least resistance for yields is higher. This time the dollar benefitted fully from the inflation surprise and rate moves, at least compared to other developed-market currencies. If Federal Reserve officials speaking this week fail to push back against recent moves in hike expectations, the dollar rally could last a while yet.