The euro seemed to be about to lock in a decent performance last week, buoyed by expectations of a hawkish ECB and a labour market report in the US that signalled to the Fed that pressures there may be easing.
An energy supply shock, while unemployment remains low and inflationary pressures are at record levels, poses an unusually difficult challenge for the ECB at its meeting on Thursday. Traders will be looking at a finally balanced decision between hiking interest rates by 50 or 75 basis points, as the Governing Council tries to make up for lost time. The gas shock last week adds even more uncertainty to the decision. Not much news out of the US in a holiday-shortened week, but the leadership contest to succeed Boris Johnson as UK prime minister may add some volatility to sterling.
Figure 1: G10 FX Performance Tracker [base: USD] (1 week)
Source: Refinitiv Datastream Date: 05/09/2022
GBP
A raft of second-tier data points last week all came out stronger-than-expected in the UK: retail sales, house prices and mortgage approvals, as well as an upward revision to the manufacturing PMI. None of this was particularly helpful to sterling, which continued to track the euro down against the US dollar, but it does seem to indicate that people calling for an immediate recession have got a bit ahead of themselves.
Focus this week will be on the outcome of the leadership contest in the Conservative party. Should Liz Truss be announced as the winner, then the news may be positive for sterling, at least in the short term, given her focus on additional fiscal spending, more trade protectionism and, therefore, tighter monetary policy. This is a mix that has proven currency-positive, historically speaking, though it’s worth noting that at this point basically no one expects anything other than a Truss victory.
EUR
Inflation data out last week confirmed that the ECB faces perhaps the toughest job of any of the world’s major central banks. Inflation yet again surprised on the upside, in both the headline and core indices, and in both cases printed another all-time record for the Eurozone. The ECB meeting is perhaps the most critical this year. The inflation numbers are awful and the central bank is clearly behind the curve; at the same time, the energy shock that has resulted from Central Europe’s dependence on Russian gas is unlike that seen anywhere else.
Figure 2: Euro Area Inflation Rate (2013 – 2022)
Source: Refinitiv Datastream Date: 05/09/2022
We think that the ECB will still hike by 75bps, as the level of rates in the Eurozone lags hopelessly behind its peers and economic reality, and there isn’t much that monetary policy can do to conjure up gas and alleviate shortages.
USD
The key US labour report provided welcome relief to the Federal Reserve on Friday. While job creation continues apace, dispelling fears of a recession in the US, the labour force expanded and wages rose less-than-expected. This signals that labour demand remains hot, as confirmed by the JOLTS job openings report earlier in the week, but that it’s resulting more on an increase in the size of the workforce than on a wage spiral.
Figure 2: US Nonfarm Payrolls (2021 – 2022)
Source: Refinitiv Datastream Date: 05/09/2022
Rates came down in the US as a response, and the week would have been a difficult one for the US dollar had it not been rescued just before New York closing time on Friday by that Gazprom announcement on the indefinite suspension of gas deliveries.
CHF
The Swiss franc has been on the back foot throughout most of the past few days. On Wednesday, the EUR/CHF pair returned back above the 0.98 level, although it gave up some of its gains later in the week as Russia’s energy saga entered into another chapter. The Nord Stream 1 gas pipeline is off again, this time indefinitely, leading some investors to seek safety in the safe-havens.
Nonetheless, growing expectations that the ECB will be more aggressive in policy tightening seems to be capping gains for the franc. While the SNB could follow with a similar-size increase of its own later this month, the gap in expectations for policy action in the medium term between the two has widened quite a bit recently, in favour of the euro. Looking ahead the franc is likely to continue to react to shifts in sentiment and monetary policy. This week’s ECB meeting and headlines regarding the energy situation in Europe will likely dominate trading.
AUD
The Australian dollar depreciated sharply last week, with the AUD/USD pair trading below the level of 0.68, close to 2020 lows. With no major news last week, the strong US dollar and falling commodity prices weighed on the Australian currency.
This week will be an important week for AUD, with the Reserve Bank of Australia meeting on Tuesday and the second-quarter GDP data to be released the following day. Looking ahead to the bank’s meeting, markets expect the RBA to raise interest rates by 50 basis points. A smaller hike of 25bps is entirely possible, in our view, and could be negative for the Australian dollar, although markets will also be paying close attention to the bank’s comments on upcoming rate hikes. A hawkish tone indicating further rate hikes in the future, and that fighting inflation remains the bank’s priority, would be positive for AUD.
CAD
The Canadian dollar depreciated against the US dollar last week, in line with the other major currencies, although it managed to end it as one of the better performers in the G10. Second quarter GDP data did not help CAD, as it showed that the Canadian economy grew at an annualised pace of 3.3%, below the Bank of Canada’s estimates and market expectations.
The Bank of Canada is expected to deliver a 75 basis point rate hike at its meeting this Wednesday, a smaller rise than the previous one. While inflation remains high, macroeconomic activity data has started to show some signs of worsening, which is likely to justify the smaller move. Still, we expect the bank’s tone to remain hawkish and concerned about inflation. August employment data will also be released on Friday, which will be important for the Canadian dollar and expectations for future rate hikes.
CNY
The Chinese yuan fell to the lowest level since August 2020 against the US dollar this morning, with the USD/CNY pair seemingly heading towards the key 7.0 level. Increasing monetary policy divergence with the rest of the world, rather underwhelming domestic economic data and a series of worrying headlines, with the latest ones again focused on Covid, have weighed on the Chinese currency in recent weeks. Recently China imposed a lockdown on the country’s sixth largest city, Chengdu.
The zero-Covid push continues to threaten economic activity. While the PMI data suggests that the services sector sustained a decent expansion in August, both the Caixin and official data showed a contraction in manufacturing activity. There’s a myriad of factors to watch with regard to China in the near term. We’ll be keeping a close eye on the inflation data, with the gap between PPI and CPI price growth expected to have narrowed further in August.
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Source: Worsening energy crisis knocks off euro in the last hours of Friday trading | (ebury.com)
