Weekly Brief

Stagflation

GBP

What do you worry about most, inflation or growth? That’s the tricky question facing many central banks including the BoE at the moment. Having raised UK interest rates by another 25bps yesterday lunchtime, the BoE then delivered the dovish commentary that we had all anticipated. In fact, that commentary was much more downbeat than we thought, with the BoE warning of a potential recession in the UK, as inflation likely gets pushed beyond 10%, driven ever higher by surging energy prices. On that, the impending European ban on Russian Oil imports is helping to ensure that the spot price for Oil remains anchored firmly above $100pbl.

Interestingly enough, there was more of a split amongst the BoE than you might have expected, with three members voting for a 50bps hike, and the six winning members opting for the 25bps move. The three in the 50bps camp must have had both eyes on the inflation outlook. It is that sudden, worrying outlook for growth that really caused a stir, however, with the increasing prospect of stagflation in the UK, being highlighted by the BoE. Even if they didn’t say it quite like that. Maybe the BoE have been reading our updates.

The pound took the news badly. GBP/USD slipped from over 1.2600 to under 1.2330 in the space of a few hours. That’s over 2%, which may not sound like much, but for a major currency pair in G10-land, any move beyond 2% in a day is quite a rarity. The pound suffered losses elsewhere, but to a lesser degree. GBP/EUR has now given up any short-term ambitions of sustaining a move above 1.2000. By the European close yesterday, the pair had slipped back as low as 1.1700.

Looking ahead, markets are still pricing in several more rate hikes by the BoE this year. Either the market will need to re-think this expectation, or the BoE will feel that the UK economy is frothy enough to withstand the impact of these projected moves, and maintain hiking rates, to keep pace with market expectations. In the meantime, if economic data continues to soften, then the pound will likely remain a target.

 

EUR

The single currency has faced headwinds throughout the week, even if it was not driven by central bank moves and chatter about central bank moves, for once. The energy crisis is damaging growth prospects for the region, and given that Europe is in the process of banning Russian Oil imports, that is only likely to make matters worse.

Much as in the UK, weaker Euro-area data has been trending of late, with the latest German Factory Orders missing estimates by some margin, and exports declining 3.3% through March. Softer PMIs for Germany were only partially offset by stronger numbers in Spain, France and Ireland.

EUR/USD has taken its direction from the dollar side of the pair, however. Having rallied in tandem with other currencies immediately after the Fed meeting on Wednesday, and breaking back over 1.0600 for the first time in a week, the pair slipped back to 1.0500 through yesterday. Given that we have to wait a week for the next key Euro-area data (inflation), the single currency is likely to play second fiddle to the dollar again.

 

USD

What a difference a day makes. Wednesday evening, and shortly after raising rates by 0.25%, the Fed were telling us that 75bps rate hikes were off the table, the dollar was in freefall, and markets were rallying hard on the news. Fed Chair, Jerome Powell, implied that further 50bps rate hikes were likely over the coming months. Markets could live with this, as they had already priced the prospect of three consecutive 50bps rate hikes well into proceedings before yesterday’s FOMC meeting. The bit that had been a concern heading into the FOMC, was whether the Fed would tell us in their updated forward guidance that they might need to go even stronger with U.S rate hikes to achieve their ultimate aim of combating inflation.

The good times were short-lived. By the close of play yesterday evening, the dollar had clawed back the previous day’s losses, as a broader risk-off mood had quickly engulfed markets. The yield on the U.S 10 year quickly moved over 3%, as concerns over a weakening global economy accelerated. The BoE may have played their part in installing another bout of widespread risk-aversion.

What can we learn from these moves? Well, this pattern of flip-flopping is likely to persist as markets try to determine whether inflation continues to be the dominating driver, or whether the dark clouds of weaker growth start to resemble the winter skyline in London. For now, the greenback still rules the waves, but signs of weakening U.S data could yet unsettle markets. With this in mind, today’s April Payrolls data matters. It might not matter quite as much as it usually does just now, but with a weaker ADP print on Wednesday, markets are bracing themselves for potential weakness in the labor market. Next week it is all about inflation again. It really is flip-flop season.

 

CAD

The BoC are expected to keep pace with the Fed with regard to Canadian interest rate hikes through this year. A strong economic outlook, surging inflation and high commodity prices have played their part in cementing this view. Today’s Canadian April payroll report could further endorse it. Markets expect Canadian unemployment to drop to just over 5%, with another 55k net new jobs created. That would be another record low.

In a speech on Monday, BoC governor, Tiff Macklem, refused to rule out the prospect of raising Canadian interest rates by more than 50bps, even if he did say that this move would be ‘unusual’. It would be unusual for Canada to move at a faster pace than the U.S, so we would expect the BoC to maintain the 50bps path for the foreseeable future.

For the Canadian dollar, you really do have to look beyond USD/CAD to make a fair assessment of the Loonie’s performance overall. The moves in USD/CAD have been totally dominated by the greenback, and having moved as low as 1.27 and change yesterday morning, the pair rallied with gusto back up to 1.2850. As we said, look beyond the USD/CAD pair though, and there is clear evidence of broader Canadian dollar strength. GBP/CAD has slipped as low as 1.5700 – we were above 1.6400 in the middle of last month. EUR/CAD has been on a constant downtrend since the beginning of February, which has resulted in the pair falling from above 1.4600 to under 1.3400.

 

AUD & NZD

The RBA surprised many in markets with a 25bps rate hike (to 0.35%) earlier this week. Whilst you can understand why the RBA moved, the timing was the surprising bit, given the impending Australian general election, later this month. The move represented the first hike from the RBA in more than 11 years. Changing times.

RBA governor, Philip Lowe, said immediately after the announcement that ‘the economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than was expected. There is also clear evidence that wages growth is picking up’. Let’s hope that the last bit accelerates quickly.

The Aussie spiked in the immediate aftermath of the announcement, with AUD/USD ultimately piercing 0.7200 after the Fed. Much the same as every other currency yesterday, the pair quickly lost its recently-gained ground, and slipped back under 0.7100.

As is often the case, the Kiwi has mirrored the performance of the Aussie. NZD/USD dropped to a cycle low of 0.6400 yesterday, having been over 0.7000 exactly a month to the day. This move is all the more compelling when you consider that the RBNZ (much the same as the BoC) recently raised New Zealand interest rates by 50bps, with the prospect of further, big hikes down the road. When the greenback wins, it conquers all.

 

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