Post date: 31/03/2022 19:00
The worldwide inflationary episode continues to upend expectations and historical correlations. The bloodbath in world bond markets took a turn for the worse last week, sending the 10-year Treasury yield close to the psychological level of 2.50% that was crossed at the start of this week. However, world stock markets continue to hold up well, as investors look for assets that could provide some protection against soaring prices. Emerging markets are the particular beneficiaries of this trend, as the commodities they export continue to rise in price and scarcity value. Special mention goes to our longtime favourite, the Brazilian real, up a scorching 5% for the week and an astounding 18% so far this year. The yen was once again the worst performer, as the gap between the dovish Bank of Japan and other G10 banks, which move towards tightening policy, grows larger.
Inflation data takes front and center this week, particularly in the Eurozone, where we expect the flash inflation number for March to soar to a fresh record on Friday. The US PCE inflation report is out Thursday, but it is for February so won’t provide much fresh information. Finally, the payroll report out of the US will be released Friday afternoon. The main focus there will be the evolution of wages, which so far have been lagging prices and fueling voter discontent with the Democratic administration in Washington. Strategists continue to revise upward their forecasts for commodity currencies, in line with our long-standing bullish views. The inflationary environment is here to stay and should provide a tailwind to emerging markets and G10 currencies of countries that are net commodity exporters.
As fast as economists are revising upwards their forecasts for UK inflation, the actual data continues to surprise to the upside. In February, prices rose 6.2% on the year. Sterling weakened after the news. Markets are starting to doubt the Bank of England’s resolve in getting inflation under control after the MPC dovish communications at its latest meeting. This week sees a slew of speeches from MPC members. Traders will be scrutinising them closely for further clarification of the muddled communications from that meeting. We wouldn’t be shocked by yet another change in tone that aligns the Bank of England better with other central banks and provides much-needed support for the pound.
The PMI indices of business activity were stronger than expected and consistent with only a modest slowdown in economic activity in the Eurozone as a result of the war in Ukraine. The ifo sentiment numbers were worse, but we think the PMIs are a better guide to future economic growth. Monetary and fiscal policy will remain very stimulative for the foreseeable future, and we think a recession remains very unlikely. March inflation numbers out Thursday could well top 7% on the back of sharp increases in energy prices. The core index is also expected to jump. We remain increasingly sceptical that the ECB can wait until late 2022 to hike, as markets are pricing in, and think it’s quite possible that incoming data will force the central bank to move before the summer. As and when markets price that in, the euro should find support.
The bloodbath in the US bond market has brought about the fastest repricing of Treasury yields in many decades, and losses in broad bond indices so far this year are the highest ever. This blowout in yields has brought the US dollar less support than it did in previous episodes. Fed officials are out in force telegraphing to markets that not only will there be hikes in every meeting, but those hikes could well be double the usual rations, at 50 basis points. PCE inflation report and the payroll numbers this week are all expected to be very strong and therefore should not stand in the way of further Fed hiking, but the market has already priced a lot of tightening this year and it will be hard to price in more, so the impact on the dollar should be subdued.