For the first time in a while, most of the major currencies traded in tight ranges last week, with the exception of the yen, which continues to rally amid rising expectations for a faster pace of Bank of Japan policy
Macroeconomic news out of the US has turned somewhat more negative lately, which has marginally closed the gap between the world’s largest economy and the European ones. The February PMI figures, in particular, came up weaker than expected in the US, and more or less as expected in the Eurozone and the UK. As we have been saying for months, current dollar levels price in extreme economic divergence and/or tariff risk, and are susceptible to sizable corrections if either of those factors turn out to be weaker than expected.
Tariff worries seem to be on the backburner for now, although that can change at any time of course. This week is light in economic releases, with the main focus likely to be the January PCE inflation report out of the US on Friday. There will be plenty of major central bank speeches throughout the week, as well as the minutes from the last ECB meeting on Thursday. In addition to any headlines on tariffs, the political fallout from Trump’s upending of Europe’s security architecture and the German elections will probably have as much, or more, impact as economic releases for now.
The raft of economic news that we received out of the UK last week displayed a distinctly positive tone. The January labour market report showed yet another jump upwards in wage growth, while the latest retail sales figures surprised meaningfully to the upside, pointing to far greater resilience in domestic demand than had been anticipated. The PMIs of business activity came in more or less as expected, with the composite index continuing to show positive, albeit relatively modest levels of growth in the economy.
Yet another higher than expected inflation number also served to support sterling, as it makes it more difficult for the Bank of England to justify interest rate cuts. While two members of the MPC, Dhingra and Mann, are clearly in favour of a more aggressive pace of easing, we do not believe that their views are shared among the majority of the committee. The UK’s relative isolation from Trump’s tariffs (Britain actually runs a goods deficit with the US) could also see the pound well supported in the coming weeks.
While the PMIs in Europe did not undershoot expectations quite as much as they did in the US, the number was nevertheless disappointing. The composite index came in at just 50.2, down from 50.5 and breaking a four month improvement streak. This remains consistent with economic expansion, but only just, and the data will do nothing to dispel concerns over another prolonged period of stagnation, particularly given that Trump’s tariffs loom large in the background.
So far, the euro has proven resilient to the jolt to European security arrangements brought about by Trump’s apparent pivot to Russia, but this adds to long-term concerns. As always, the key question is how much of this is already priced in by the very strong levels of the dollar – we think that practically all of it is. In addition to the minutes from the latest Governing Council meeting, this week’s speech by ECB member Schnabel could be key on Tuesday. The fallout from the German election results could also be important for the common currency – the euro has received a small boost so far, as it looks as though the CDU/CSU will be able to form a coalition with the SPD without support of a third party.
Last Friday saw an unusually bad slew of economic data from the US. Business sentiment fell sharply in February, while consumer long-term inflation expectations rose to a 30-year high. We will await confirmation of this weakening trend in the weekly jobless claims and the February payrolls report in two weeks, but for now this data was enough to keep the dollar somewhat on the backfoot, in spite of the significant increase in geopolitical risks.
With little macroeconomic or policy news to guide currency markets, we will be paying particularly close attention to any developments on tariffs or clarification of the US position with respect to European security in the coming week. PCE inflation numbers out of the US on Friday will, as always, also be closely monitored by FOMC officials. Following last week’s disappointing PMI numbers, markets are now back eyeing two interest rate cuts from the Fed this year, as opposed to just one, but this stance will likely be tested this week.
