Post date: 21/02/2022 12:10
Inflation and central banks have taken a backseat to geopolitics in financial markets, and currency markets are no exception. Among the G10 currencies, the Japanese yen and the Swiss franc, the transitional safe-havens, rallied against the US dollar. It must be noted that commodity currencies, like the Australia and New Zealand dollars, did reasonably well, as commodity prices show resilience to the flight to safety flows. Unsurprisingly, Eastern European currencies were the worst performers, dragged down by the turn for the worse in news out of the crisis in Ukraine.
The main macroeconomic releases on tap this week are the PMI advance indices of business activity in the US, Eurozone and the UK. However, the geopolitical crisis in Ukraine will probably overshadow them. It is not yet clear what impact a full on conflict would have on the EUR/USD exchange rate. While the dollar has traditionally been a safe-haven during crises, the rally in US yields that would likely ensue would knock off one of the supports underpinning the recent dollar rally.
Almost every single inflation report from a major economic area has come out above expectations, in spite of the relentless ratcheting up of the latter. The UK last week was no exception. The headline rate inched up to a new multi decade record at 5.5%, with the core rate not far behind at 4.4%, signalling that inflationary pressures are spreading. The labour report and retail sales also surprised to the upside, lending support to the hawks in the Bank of England and hence to the pound, which held its own quite well in spite of the geopolitical deterioration. In addition to the PMIs of business activity, the docket this week is unusually busy with no fewer than six Bank of England MPC members scheduled to speak.
While ECB President Lagarde has continued to push back modestly against expectations of Eurozone hikes, her chief economist Lane appeared to back away from his extreme dovish views last week, finally acknowledging the possibility that the deflationary environment prevalent in the teens may never return. This week´s PMIs may be overshadowed by the first February flash inflation data from France, which is almost certain to show further sharp increases. There is still plenty of room for markets to price in a faster schedule of hikes from the ECB, and we expect the common currency to be well supported as they do.
This week will be a relatively slow one for US data releases, with just PMIs and PCE inflation on tap. Focus should remain on geopolitical headlines on one hand, and Federal Reserve communications on the other, with five Fed members slated to speak during the week. We wait for the uncertainty over the dollar reaction to a potential worsening of the crisis described above to be resolved soon. Unlike other major economic areas, particularly the eurozone, it will be difficult for US rates to price much faster hikes than they already do, so there is scope for a partial unwind of the dollar rally against the euro.