Written by Convera’s Market Insights team
Dollar supported by last week’s CPI surprise
Boris Kovacevic – Global Macro Strategist
The US dollar’s six-day slide ended on Thursday with a better-than-expected US inflation print showing how consumer prices remain too elevated for the Federal Reserve (Fed) to consider talking about cutting interest rates again. Inflation remained steady at 3.7% in September, after having fallen to 3% three months prior. However, core inflation dropped to 4.1%, marking the lowest growth rate since September 2021. While markets have increased the tail risk probability of another rate hike in either November or December to around a one-in-three chance, the base case remains an unchanged rate all throughout July 2024, when investors price in the first monetary easing by the Fed.
The conflict in the Middle East has also started impacting US households with the Michigan University reporting a third consecutive monthly drop of US consumer confidence in October. The Index came in at 63 this month compared to 68.1 in September. While the correlation between sentiment and consumer spending has not held up this year amid a tight labour market, the consumer could come under pressure as excess savings start to deteriorate. US Secretary of State Antony Blinken is currently visiting the region as the conflict between Israel and Palestine is risking turning into a broader war. Brent crude pushed beyond the $90 mark after Israel announced a ground invasion of the Gaza Strip.
Gold, the US dollar, and government bonds have all enjoyed positive returns during the past few days, but the typical safe-haven flow has come short. Markets are still primarily focused with global macro and gauging when the G3 central banks will starting cutting rates again. This dynamic will stay in place until the situation in the Middle East starts impacting oil exporting countries like Iran or Saudi Arabia, in which case the capital rotation into safe assets would accelerate. Today will be lackluster on the data side with the focus shifting to tomorrow’s release of retail sales, industrial production, and the NAHB housing sentiment.
ECB to hold rates as Germany falls into recession?
Boris Kovacevic – Global Macro Strategist
Companies in the Eurozone increased industrial production by more than expected in August, with the boost in durable consumer goods driving the rise. Economists had expected a slight contraction by 0.1%, which was well surpassed by the actual 0.6% increase in production. It would be too early to turn bullish on Europe because of one data surprise as the continent continues to struggle with high inflation and interest rates and the effect of geopolitical turmoil on its economy. However, the next two weeks will be accompanied by a plethora of data points, which will be important in gauging where the European economy will eventually bottom out.
The likelihood of Germany entering a second recession this year has nonetheless increased in recent weeks. Europe’s largest economy is set to record negative growth in the two final quarts of this year, which would drag the overall GDP growth for 2023 into negative territory. The International Monetary Fund, which released new projections on Tuesday, singled Germany out as an underperformer and the only G7 country not expected to enjoy growth this year. The institution pointed out structural problems and shifting geopolitical tides, which could hamper economic activity for the years to come. Still, economists have mostly pushed back their expectations of the first rate cut by the European Central Bank. Governing Council members spoke at the sidelines of the IMF’s annual meeting and supported the view that rates would be higher for longer.
The euro enters the week on slightly weaker footing, having been pushed to the lower $1.05 level by the stronger than expected US inflation print last week. The lack of economic data today will shift focus to political issues. New developments in the Middle East will certainty influence markets. Investors are also waiting on Italian Premier Giorgia Meloni unveiling how much tax cuts and family subsidies will drag down the Italian deficit this and next year and if Poland’s ruling party lost its absolute majority in the election.
Wages and inflation to drive BoE outlook
George Vessey – Lead FX Strategist
It’s one of the biggest weeks of the month in terms of UK economic data, with the most significant pieces published tomorrow (employment report) and on Wednesday (inflation report). Both reports could impact expectations of Bank of England (BoE) action in November, with markets currently pricing around a 25% chance of a hike.
Sterling has been swinging with global risk appetite recently, hurt by escalating geopolitical risks sparking a rise in safe haven demand and oil prices. Last week, gold prices rose over 3%, the VIX index rose over 15% and oil prices over 5%, a combination of moves only witnessed a handful of times in history. Sterling erased its gains from earlier in the week to finish back under the $1.22 threshold versus the US dollar but squeezed out a third weekly gain on the trot against the euro. The pound will remain sensitive to global risk sentiment, and investors will remain largely preoccupied with events in the Middle East, but attention will also be on key UK data. While the average earnings data may stay close to record highs, other labour market measures, such as the ratio of job vacancies to unemployment, are likely to be less robust. Moreover, UK inflation is expected to continue falling, which could see BoE rate hike bets slide and further weigh on sterling.
However, digging deeper into the UK inflation story, we note that more than 80% of Britain’s CPI basket remains above the BoE’s 2% target. So, although the BoE might be done hiking, interest rates are likely to remain around 5.25% for some time. GBP/USD’s strong support lies at $1.2035, a 7-month low which traded two weeks back, whilst resistance lies around $1.2360, its 50-week moving average. Given the challenging international environment right now, we expect FX volatility to pick up from here, a trend that usually occurs in the final quarter anyway.
Safe haven gold up over 4% from last week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: October 16-20
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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.
