Markets Await Fed and BoE

GBP

The pound managed to stay flat against the euro but lost half a percent to the dollar in a week which saw strong inflation numbers but poor retail sales. It would seem markets are starting to weigh up the possibility of global stagflation as prices rise but economic output fails to increase. One of the main signs of this is rising energy prices in UK with two energy companies unable to keep up and going out of business. The jobs report was as expected with ILO unemployment slightly down from the previous month at 4.6% versus 4.7%.

It’s a big week for the FX markets with both the Federal Reserve and Bank of England updating their monetary policy. The recent data releases from the UK have underperformed compared to the Bank of England’s predictions. This adds risk to the pound as investors have started to downgrade their predictions of a strong economic recovery for the UK which will have a knock-on effect on the pound. The pound is likely to be sensitive in the lead up to the MPC announcement as traders react to rumours about the stance of Andrew Bailey and his team.

USD

The dollar was the second best performing G10 currency last week and only just lost out on the top spot to the Japanese Yen. A combination of a selloff in global equity markets and strong US retail sales were the main factors driving strength in the dollar. Though it wasn’t all positive for the dollar as there is a creeping sense that with higher vaccination rates, Europe could be slightly more resilient than the US to fresh waves of the pandemic in the northern hemisphere this winter. On the data front, US CPI missed expectations for both the monthly and yearly reading, which should indicate a more dovish Fed.

As mentioned above the highlight for the dollar comes on Monday with Fed’s interest rate decision and monetary policy statement. Rates are expected to be held at 0.25% but as always, markets will be paying close attention to the following statement from Jerome Powell. The dollar could be boosted by growing financial risk in China and how Chinese real estate developer Evergrande will resolve its $300bn debt hangover. Most presume that some form of debt restructuring is arranged such that a crisis of confidence does not spread within the Chinese financial sector.

EUR

The euro manged some short-term strength versus the dollar last week before misplaced speculation about the prospect of a 2023 interest rate rise was reportedly quashed by the European Central Bank, leaving the Euro at the mercy of a stronger dollar and faltering global markets. The FT reported that it had seen an unpublished internal study at the ECB suggesting that inflation could sustainably hit 2% by 2025, such that the ECB could start raising rates in 2023. Though downplayed by the ECB, this is important as it shows ECB hawks are trying to open a debate on monetary normalization.

The euro will take a back seat this week with markets focusing on the Fed and Bank of England. The only data of note out of the EU comes on Thursday with PMI data for Germany and the EU Markit PMI Composite, both expected at a slight increase compared to the previous month’s reading.