Will headline or core move markets?
The US dollar index is down on the week amid both USD/CNY and USD/JPY softening due to signals of potential policy intervention by China and Japan. However, the US currency has erased half of its weekly losses ahead of the highly anticipated US inflation report due later today, which could spark more volatility across financial markets.
The consumer price index (CPI) data for August comes just a week before Federal Reserve (Fed) officials gather to decide on monetary policy. The Fed is expected to hold interest rates steady next week despite a recent run of resilient US economic data. Investors currently see the chances of another rate hike in 2023 as a bit below 50%, but today’s inflation report could jolt these expectations and rock global financial markets. With rising energy prices, the headline CPI is expected to accelerate by 0.6% compared to 0.2% a month ago, and by 3.6% on an annual basis, which may shift interest rate expectations higher and strengthen the dollar. However, it’s the core reading, excluding food and energy, that the Fed will pay more attention to and that is set to slow for a third month running from 4.7% to 4.3% y/y.
Inflation matters for the monetary outlook and the dollar, but appealing alternative currencies are lacking right now. Compared to US exceptionalism, the cyclical downtrend in other parts of the world like China and the Eurozone creates an environment of dollar outperformance, explaining the USD’s more than 5% gain in eight weeks. Until this narrative changes, we expect the dollar to remain firm in the short-term.
UK economy shrinks at fastest pace in 7 months
GBP/USD has only traded above $1.25 for 30% of this year and slipped back below this key level yesterday after the UK labour market report tilted on the dovish side. This morning, the slide has gained speed after UK GDP figures for July missed consensus expectations. The pound is weaker across the board with GBP/EUR slipping under its 100-day moving average for the first time since early May.
The UK economy contracted by 0.5% in July, worse than the expected contraction of 0.2% and the largest drop in monthly output since December 2022. All major sectors of the economy declined, including the dominant services sector. This adds to evidence the UK economy is losing momentum in the face of a sharp increase in borrowing costs, and the longer-term outlook is for stagflation which doesn’t bode well for the pound. The data comes a day after the UK labour market report showed the unemployment rate rising to a 2-year high and vacancies falling below 1mln for the first time in two years. Will this be enough to provide some respite from the Bank of England (BoE)?
Even though UK 2-year yields have moved lower, the market is still pricing in around an 80% chance of a BoE rate hike next Thursday. A hike beyond September is less assured though, with another rate rise by year-end assigned a 40% chance. This suggests the market may see the BoE delivering a dovish hike – raising rates but signalling a more neutral outlook. We’re watching GBP/USD closely today because a close below the 200-day moving average could see sterling’s descent gather pace.
Markets grasping for (internal) information
Investors are patiently awaiting the interest rate decision by the European Central Bank (ECB) on Thursday and are trying to gauge how likely another rate hike might be. This uncertainty lends itself to volatile pricing and headline-driven movements on financial markets. A single report from Reuters about ECB sources saying that the inflation projection for 2024 will be revised higher from 3% in June to above 3% led to markets fully pricing in another rate hike by the ECB by the end of the year. The euro remained unfazed by the news though, trading at around $1.0730 against the dollar.
At the same time, the cyclical downtrend of the global economy will most likely lead Germany to record another negative growth rate in Q3. Investors had previously pulled back their bets of another rate hike by the ECB on Thursday to less than 40% with only 33% of investors surveyed by the ZEW expecting interest rates to increase in the months ahead. The drop in investors’ rate expectations from July to September was the largest since September 2011, which back then was followed by an ECB rate cut two months later.
However, yesterday’s internal report about an upside revision of the ECB’s inflation projections and consequent rate hikes could mean that policymakers will choose to ignore the economic slowdown in favour of continuing to fight inflation. No economic data is scheduled in Europe today and tomorrow with the focus before the ECB meeting falling on US macro releases such as the CPI. EUR/USD is fighting to regain some ground and record its first weekly appreciation since the beginning of July. It will all be a matter of 1. how US inflation turns out and 2. if the ECB is willing to continue its fight against inflation.
EUR/GBP up over 1% since last week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: September 11-15
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
