Weekly Brief

Stagflation

GBP

Having waxed lyrical last week about how well the pound had been holding up given the circumstances, low and behold, this week started with sterling playing catch-up, or rather, selling-off. Markets struggled a bit initially to find the root cause for the decline, some analysts pointed toward how the UK economy would struggle in a land of weaker global growth, driven by the war in Ukraine.

Perhaps the increasing pressure on the Chancellor, as he tries to grapple with higher inflation, even higher energy costs, and the increasing cry for lower taxes to help the consumer, played a big part in the thinking here. That seems the most digestible argument to me, given that wages are by no means keeping up with inflation, and we are only just about seeing the higher cap energy costs filter through to the end consumer. That was before this latest price rises in commodities, by the way. So, the imminent spring Budget will see the Chancellor having to be more magical than Paul Daniels, and that creativity will also require some more of that magic fairy dust being scattered on increased defence spending, as the dark clouds of stagflation threaten to circle above.

As I said at the top, the pound started the week on the backfoot. GBP/USD had declined from 1.3400 to 1.3200 last week, with most of that on the back of that stronger February U.S Labor report. This week, GBP/USD continued the decline, dipping under 1.3100 for a spell, and then rebounding a touch in-line with the broader dollar decline on Wednesday.

GBP/EUR had a fascinating week too. Having reached a top nearing 1.2200 on Tuesday, the pound then fell sharply back to below 1.1900 by the end of the week. Those moves were more about the EUR (see next section), than anything sterling-specific, given the light UK data schedule to be had this week.

Next week’s BoE meeting promises to be intriguing, if not quite as exciting as the ECB. Having already raised UK rates twice, and given the conflict in Ukraine, there may be more of a reason for the BoE to take a pause, whilst they assess the impact on the economy. In the meantime, the housing market seems to be ignoring those rate rises, for now at least.

 

EUR

Sorry USD, but the EUR really is the most interesting currency in G10 just now. Last week saw periods of intense volatility amongst the EUR crosses. First, we saw a further sell-off for the single currency, driven of course by the war in Ukraine. The worry to markets was how exposed Europe is to Russian energy, and how that all fed into the impact for the European economy going forward. Understandably so, perhaps.

EUR/USD had slipped from 1.1400 to 1.0800 in just over 2 weeks, as a consequence.  GBP/EUR, as we said above, nearly reached 1.2200. It was a similar picture (of weaker EUR) across the board for the single currency. Then we had the comeback. Not quite at Rocky levels, but a combination of factors drove the strong move higher. Positive risk appetite in markets played a big part, but the impending ECB meeting also caused traders to take a pause.

That ECB meeting then did yield a big surprise. Markets had convinced themselves that the ECB would baulk at the prospect of ending QE early or raising rates in the region sooner now that future growth prospects were in question, however, the ECB didn’t read the script. Lagarde & Co instead said that they would look to increase the pace of tapering, or reduce its bond-buying scheme earlier than initially planned, to you and me. They also dropped the necessity to end QE ahead of raising rates. Small point, but that matters because if you can’t hike/won’t hike until you have ended QE, then when you end QE matters most. So, the chances of a rate hike from the ECB this year could be back on the table, albeit at a push.

 

USD

The latest U.S (February) jobs report – out last Friday, highlighted yet further growth in the labor market, and gave markets more evidence that the fed will raise rates this month – should they need it. Thursday’s inflation print was even more compelling, with inflation hitting a wallet-busting 40 year high of 7.9%, accelerated by gas, food and housing price increases. As I have said before, all of these numbers are a bit backward looking just now, and thus we can assume that they will break new records once the latest round of energy rises kick in.

The dollar, therefore, took a boost from both sets of data. With markets also reflecting a tendency to jump into ‘risk off’ mode at an alarming regularity just now, conditions have been favourable for the dollar bulls amongst us. The dollar index nearly made it to the key 100 psychological level, before running out of steam. Aside from EUR/USD and GBP/USD (mentioned above), the dollar made progress against the JPY and CHF, both safe-haven currencies, and a better measure of the greenback’s broad-based strength.

Next week’s FOMC meeting therefore looks like a 25bps hike is well and truly priced into proceedings. The Fed have said as much. The important bit for markets, and the dollar, will be the amount of hikes the fed are looking to achieve this year and ultimately reaching their ‘terminal rate’, or the rate they get to when they stop hiking, to you and me. If anything, that expectation has been watered down by markets over the past few weeks, as a more cautious approach is considered.  What Powell says is even more important than what he does then next week.

 

CAD

With Oil hitting levels not seen since 2008, and broader commodity prices surging, the conditions looked favourable for a stronger Canadian dollar. The Bank of Canada sure played their part, raising rates in Canada by 25bps to 50bps last week, and suggesting that there is ‘considerable space’ to hike again, with a 50bps hike possible. However, that greenback got in the way again here, and USD/CAD has been closer to 1.3000, than 1.2500 of late.

Of course, if risk appetite accelerates, then we could get the prospect of a stronger Loonie, yet weaker Oil prices, strange as it sounds. Today’s February employment report could help the Loonies cause if the estimates are correct, with a decent 150K + gain on the headline expected, coupled with a decrease in the unemployment rate to around 6.2% from 6.5%, as a broad-based recovery in the labor market ensues.  Loonie tunes indeed.

 

AUD & NZD

Both the AUD/USD and NZD/USD have been rallying sharply since the beginning of last month. Having been under 0.7000, AUD/USD reached a top just shy of 0.7450, before the greenback pulled back some ground. The Kiwi has rallied from 0.6550 to over 0.6900.

Those surging commodity prices have been a key factor here for the Aussie, and the war in Ukraine has seen a push for the likes of Australian Wheat to replace the shortfall. Between them, Russia and Ukraine had produced around a quarter of the global wheat supply. Furthermore, any ramp-up in risk appetite will help to push the Aussie higher. So, whilst the CAD (see above) has struggled, the Aussie has blossomed, and the chances of a an earlier than expected RBA rate hike have increased. Tuesday’s RBA minutes might give the market some clues.

 

One to watch… JPY

We’ve put the JPY on the podium this week. Unlike the Fed, Japan are not about to raise rates anytime soon, and therefore the JPY-crosses will perhaps be a cleaner way of monitoring the broader market barometer for risk appetite. Interestingly, having not had any form of inflation for as long as I can remember, the latest Japanese inflation print came out at 0.5%. Hardly a need to raise rates soon, but a real sign of how inflation is biting globally. The latest inflation print is due from Japan next Thursday, and markets expect a slight softening. The following day we get the latest BoJ meeting. Before all of that, I will pay very close attention to the direction of the JPY.

 

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