We are just a few days away from the queen appointing our new prime minister (PM), with Liz Truss the clear leader amongst the conservative party members who get to decide on behalf of the rest of us, who is to run the country until the next general election. In order to gain support from within the party and then (hopefully) the broader public, Truss has declared that she would like to help those suffering from a crippling cost of living crisis, by reducing their tax burden. If Truss gets the job and goes through with the tax cuts, then the speed that inflation accelerates in the UK is likely to increase by a significant margin.
This potential inflation bomb has not been lost on analysts, with some now openly suggesting that UK inflation might move beyond 20% before easing, accelerated by the increasing cost of wholesale gas prices, which represent a large chunk of the UK electricity supply. Whilst the UK may not rely as much on Russian gas as the rest of Europe, the UK still imports most of its needs, and those imports are based on the daily spot price of wholesale gas, which of course is itself impacted by Russian supply factors.
Perhaps it has been aided by the fact that we are so close to announcing our new PM, but markets have suddenly targeted the pound, resulting in steady declines for sterling throughout the week. GBP/USD briefly traded under 1.1500 yesterday, which is within 1% of the low ‘cable’* achieved at the beginning of the COVID days, when the sanctuary of the greenback was very much the order of the day.
*Cable refers solely to the GBP/USD exchange rate
The latest economic data will do little to help the ECB sleep at night, as we approach next week’s key ECB meeting. The latest reading for the region has seen inflation top 9%, marking the highest level since the inception of the single currency. Whilst Germany’s inflation level may not have exceeded initial estimates of 8.8%, the data did little increase the perception of imminent easing of inflation throughout the region. There was also evident weakness in Manufacturing for the block, with the region-wide S&P Global Manufacturing PMI print consolidating below the key 50 region.
With inflation surging, growth stalling, plus an escalating energy crisis which will deteriorate further as the weather turns, there is increasing pressure on the ECB to accelerate the pace of rate hikes, starting with a potential 75bps move next week. Interestingly enough, many of those cries have recently surfaced from within Germany, which is a far cry from the old days for the region’s biggest economy. Any mention of a rate hike back then was quickly dismissed by German officialdom. However, the argument to hike just now is more complex one for the ECB, as is much like that of the UK just now, especially given the much-publicised pressure on Euro area peripheral government debt. Interestingly enough, wholesale gas prices (finally) fell sharply this week, after Europe prepared to intervene directly in energy markets, as part of a package aimed at assisting consumers as the winter approaches.
As far the single currency, well the sheer strength of the greenback has ensured that EUR/USD is finding it tough to break meaningfully back above parity (1.0000), even if moves under have not slipped below 0.9900, but the broader Euro is faring slightly better. GBP/EUR is especially weak, moving from nearly 1.1900 at the end of last week, to just over 1.1500. EUR/JPY has also moved from 136.00 to 140.00 at a time when risk really has been off for markets.
Stronger economic data in the US has been a drag on markets and asset prices of late. Whilst this may sound counterintuitive, the theory behind this is relatively straightforward – the stronger the economic data, the more that the Fed will likely be inclined to keep hiking U.S interest rates, and the worse that becomes for the prospects for risk assets. This is especially true of tech/Nasdaq stocks, which tend to trend lower as interest rates move higher. Of course, the impact to currencies in a risk-off environment is one of a higher dollar, which has been a consistent theme accompanying the weaker market backdrop. If markets could sense that keynote data, especially the likes of inflation, are showing signs of peaking, then they will quickly start to price this in.
Of course, the key is the data and whilst there have been clear signs of weakness amongst the likes of the housing market, there have been plenty of green shoots elsewhere to suggest that the US may not quite yet be going down the same road as the UK and Europe. This week saw another healthy-looking ISM Manufacturing PMI report, with August’s print of 52.8 matching that of July. Both Employment and New orders components moved well over the key 50 threshold. Only Prices Paid, which slipped below estimates of 55.5 to 52.5 looked soft, and that bit needs to be monitored, as this could be a sign of a lower, long-term inflation outlook.
Today’s August jobs report is also expected to reflect continued healthy job creation in the US. After last month’s blockbuster 528k print, markets are expecting a slight consolidation to around 300k. The latest ADP (private payrolls) report came in under estimates on Wednesday at around 132k (exp 200k), but we have long since given-up trying to blend the two. As always, wage growth and participation levels, as well as any sizeable revisions to previous data, will be closely monitored.
As for the dollar, well there has been consolidation for the greenback through the week, but the consolidation has remained fairly constrained. More of a stop and reflection at these lofty levels really. The dollar index is still below 110.00, but all of that may change come lunchtime today. The services side of the ISM PMI report will be aired next week, and is probably the standout economic data reading to monitor as far as the greenback is concerned, as we move ever-closer to the next FOMC meeting.
Whilst the latest GDP reading from Canada may have reflected unexpected weaking, slipping to an annualized rate of 3.3% against estimates of around 4.4%, analysts still remain confident that the BoC will stick to their guns and raise Canadian rates by another 75bps at their meeting next week.
In all likelihood, the BoC will probably deliver what markets refer to as a ‘dovish hike’, with the BoC likely to shift their narrative from extended hikes to a pause in the cycle, and future data dependency, as they assess the impact of the previous moves before deciding on their next move.
As for the Loonie, well USD/CAD has surged to new cycle highs over the past week, briefly popping its head over 1.3200, before retreating. As is the case with all of the dollar crosses, that move is mostly down to independent dollar strength, although energy prices have declined sharply across the board, which has probably helped to give the Loonie a heavy bias. GBP/CAD is now within earshot of a look at 1.5000, with the declines there down to sterling weakness (see GBP).
After the BoC, Friday’s August employment data will give markets a better glimpse of how things are looking under the hood. A slight reduction in headline net change in Employment is currently forecast.
AUD & NZD
The RBA are meeting next week to decide on whether to hike Australian rates from the current 1.85% level. Market consensus expects the RBA to hike by 50bps, with future moves more data dependent, and much more likely to be in smaller increments of 25bps a meeting. Those hikes might run until early next year – assuming there are no wobbles in the economy, or if inflation accelerates at such a pace that the RBA need to plant a ‘whatever it takes’ line in their statement, much the same as the Fed.
Interestingly enough, should the RBA move to 2.25%, they will be within 25bps of their so-called ‘neutral rate’ of 2.5%, which is a theoretic rate achieved that implies an economy is neither expanding or contracting. Of course, it is an impossible feat to achieve or clarify, but central banks love to refer to it.
Just a day after the RBA, the latest growth figures for Australia are released, which were at 0.8% (QoQ/Q1) last time round. As for the Aussie and Kiwi, well the greenback has left its mark here too, with AUD/USD slipping back to a low under 0.6800, and NZD/USD moving close to 0.6000 once more.