Soft data drags ahead of Jackson Hole
After spiking to a 6-week high yesterday, the US dollar index pulled back sharply following weaker-than-expected global purchasing manager indices (PMIs), which muddied the interest rate outlook and sent US yields lower. The Jackson Hole symposium will be the main focus today and Friday, with markets particularly concentrating on speeches from Federal Reserve (Fed) Chair Jerome Powell and European Central Bank (ECB President Christine Lagarde.
The dollar’s correlation with rate differentials has been strong over recent weeks. With US yields stretching higher, as has the dollar. But with global manufacturing output still in contraction and activity in the services sector rapidly declining since May, 10-year US yields tumbled 13 basis points to 4.198%, their sharpest one-day slide in more than three months. This dragged the dollar lower against basket of currencies. Meanwhile, US chipmaker, Nvidia, saw its share price surge over 6% in after-market trading after revenue more than doubled in the latest quarter. This provided a boost to global risk sentiment and equity markets climbed as a result, which also weighed on the dollar. Still, in the short-term, we expect the US dollar to remain firm due to global and especially China growth concerns relative to US economic resilience. Dovish Fed pricing in the short-term may not be enough to drag the dollar much lower so long as this narrative continues to play out.
Although the Fed has a tightening bias still, and Powell is unlikely to remove that at Jackson Hole, we expect the Fed to start cutting rates in the first half of 2024. Historically, the dollar index has lost around 3% over the 250 trading days following the peak of the Fed funds rate.
Sterling steadies after volatile session
Flash UK PMIs were worse than expected with the composite PMI unexpectedly slipping to 47.9, the lowest in 31 months. This spurred a big repricing of UK rate expectations with investors now seeing the Bank of England’s (BoE) key interest rate peaking at 5.78% as opposed to 6%. The pound plunged over a cent against the US dollar to re-test a key support just above $1.26.
Elsewhere, sterling suffered steep losses against the Japanese yen, but managed to stay around the €1.17 handle against the euro. Sterling’s sell-off was contained thanks to a rebound in the risk environment following the fall in US yields and the rise in equities. GBP/USD is back near $1.27 today, three cents above its year-to-date average. Short-term interest rates remain a key driver of the pound’s fortunes and although yesterday’s weak PMIs shaved a chunk out of pricing for the BoE hiking cycle, the fact that the UK central bank is likely to raise rates more than the Fed and ECB should keep sterling supported in the near-term. However, with manufacturing output falling to a 3-year low and the services sector now in contraction due to sluggish domestic economic conditions and higher borrowing costs, UK recession fears are back on the table and a further repricing of BoE rates lower is a threat to sterling.
Additionally, on the inflation front, average cost burdens increased at the slowest pace since February 2021 and the inflation of prices charged moderated to its lowest level in two and a half years. This combination of a slowdown in both activity and inflation should give the BoE food for thought in advance of its next interest rate decision in September.
Europe is contracting again
The European PMIs for August have disappointed on every front, confirming the fragile economic outlook for the region. The set of weak data prints as of late have pushed rate hiking expectations for the ECB down, putting pressure on the euro in the process. However, at the level around $1.0850, EUR/USD is still just 3.7% away from its multi-month high reached in July last year a $1.1270.
The composite PMI fell to from 48.6 in July to 47 in August and has therefore been negative for three consecutive months now. While the manufacturing gauge did improve across the European member states, the fall of the services PMI more than compensated for the slight industrial recovery. A 5-point drop in the German services gauge like we saw in August has only been recorded on three other occasions (2006, 2007, 2020) and highlights how the delayed impact of the global tightening of monetary policy is starting to ripple through to other parts of the economy.
As we mentioned recently, soft and hard macro data point to a subdued outlook and leave us with a slight negative bias for the German economy going into the second half of the year. While we are not expecting a severe contraction of GDP growth, signs of a strong recovery are broadly missing. It has to be noted that the subdued reaction of the euro to these data misses has to be seen as a potential limitation to the euro’s downside. However, without any positive catalysts, any upside might be limited as well.
GBP & EUR tumbles after dismal PMIs
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: August 21-25
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