First inflation uptick in 12 months?
Uncertainty in the US and European banking sectors, rising energy prices and weak economic data out of China have pushed global equities lower this week. US stock benchmarks are on track to fall for the second week in a row with the US Dollar Index pushing for its fourth consecutive weekly appreciation. All eyes are now on the upcoming US inflation report, which could show consumer price growth rising for the first time since July 2022.
The US dollar continues its ascent from the multi-month lows reached at the beginning of July. Since then, surprisingly weak European and Chinese macro data have been pushing the currency to near a one-month high. The upward momentum has been limited by the bets that the Federal Reserve (Fed) is done raising interest rates, with markets putting the probability of another hike at only 14%. This number might go up today, as the year-long slide of US inflation might have stalled in July.
The consensus expects inflation to have risen from 3% in June to 3.3% in July. We expect a weaker number, but base effects are currently working against the disinflationary trend. Today’s CPI number will be an important gauge for the Fed, which has already increased interest rates 11 times from March 2022 onwards to a 22-year high. US yields held steady in yesterday’s session, trading at around 4.8% (2-year) and 4.01% (10-year).
Pound rides wave of risk sentiment
The pound remains at the mercy of global risk sentiment, which has recently taken a negative turn. The US credit rating downgrade last week and weak trade figures from China this week, have both clouded the global economic outlook. GBP/USD has suffered three weekly declines on the trot and is on track for a fourth as it struggles to maintain levels approaching $1.28 after having slipped to a 6-week low last week.
Sterling’s 6-month correlation coefficient with the S&P500 index is at its highest in over a year, signally its ever-increasing sensitivity to global risk sentiment. The outperformance of global equity markets this year, coupled with surging Bank of England (BoE) interest rate expectations helped the pound climb as much as 8.6% higher against the US dollar at its July peak above $1.31. However, as well as the recent bout of risk aversion denting demand for riskier assets, the repricing of the BoE terminal rate from 6.5% to around 5.7%, where it has stabilised, has also dragged sterling lower. Further downside risk remains a concern given the current market pricing may still be overestimating how high BoE rates will go. UK inflation and labour market reports next week will be critical in determining whether this is the case or not. Meanwhile, the latest forecasts by the National Institute of Economic and Social Research (NIESR) assign a 60% probability of the UK facing recession next year.
From a positioning standpoint, last month we noted the overcrowded bullish bet on sterling, with net-long GBP positioning near its highest in about 16 years. Indeed, speculators have since cut their bullish sterling positions for the second week in a row in conjunction with GBP/USD slipping about 3% from its 2023 top.
A lot of small issues are piling up in Europe
Yesterday’s rise in natural gas prices caused by the threats of energy workers in Australia striking have pressured global risk sentiment. The possibility of a potential output loss from the second largest exporter of liquefied natural gas has seen prices for the commodity rise by as much as 9% in yesterday’s trading. As Russia has stopped supplying Europe with any gas, the continent has turned to other sources and countries for support. This makes European assets more prone to react to headline news.
At the beginning of the week, the Italian government announced a levy on excess banking profits, which spooked markets and erased $10 billion from the European banking market value. Now, some parties have backtracked on the potential windfall tax, stating that a cap to limit the impact for many lenders would be introduced. This issue will remain on investors’ minds as the agreement between the parties seems to have been rushed and unfinished at the time of the announcement. European banks have already suffered and underperformed its global peers since the Global Financial Crisis and remain vulnerable to negative policy changes.
Given scarce data releases in Europe, investors have been focusing on the US and political issues. EUR/USD has been weakening as of late, but the downside seems to be limited as investors don’t want to make a conviction call before the release of US inflation. EUR/USD is trading below the $1.10 threshold within the short-term range between $1.09 and $1.1250.
Energy prices are on the rise
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: August 7-11
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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.
