Last week was a fitting end to a brutal first half of the year for risk assets generally.
Recession fears have intensified, to an unwarranted extent in our view. That makes this week’s payroll report out of the US key. We expect another strong report, with above-trend job creation numbers, record low unemployment and healthy nominal wage increases, which should help alleviate fears somewhat. Aside from that, the minutes for the last Federal Reserve and ECB meetings will be published and that should shed light on the trade off that central bankers see between reining in inflation and risking a sharp economic slowdown.
Figure 1: G10 FX Performance Tracker [base: USD] (1 week)
Source: Refinitiv Datastream Date: 04/07/2022
Most economic data out of the UK last week came out largely as expected, with one glaring and worrisome exception: the current account deficit, which surprised to the downside and is now in the high single digits as a percentage of GDP. Of course, these numbers are clouded by the massive increase in energy prices, where the UK is an importer, but nevertheless this is a key indicator to watch.
No major news this week means sterling will trade off developments elsewhere, though there are a few Bank of England speeches on tap. Any indication that policymakers are erring towards raising rates by 50 basis points at the next MPC meeting in August would be positive for the pound, and may trigger a recovery rally from currently suppressed levels.
While US inflation shows some signs of peaking, that is not the case yet in the Eurozone, partly because of the larger impact from energy prices and partly because of generally lagging economic data there. The mild relief we saw in the core inflation index last week was entirely due to one-off administrative measures in Germany, while double digit inflation in Spain made for some unpleasant headlines. More positive, and virtually unnoticed, was the fall in the unemployment rate to a new record low.
Figure 2: Euro Area Inflation Rate (2013 – 2022)
Source: Refinitiv Datastream Date: 04/07/2022
With a 25 basis point hike all but certain at the next meeting and a 50 bp one on the cards for the following one, we think that a lot of bad news is priced into the common currency at current levels, and there is room for a significant rebound as and when risk assets stabilise.
There were some encouraging signs last week that inflation in the US, while not yet falling, has at least stopped rising. The core measure of the personal consumption expenditures price index (PCE) undershot expectations and seems to have stabilised at an annualised level of around 4%, which is too high from comfort but considerably below headline inflation. Now that food and energy commodity prices have stopped rising and are in some cases falling, we could see lower inflation in the months ahead.
Figure 3: US PCE Inflation Rate (2012 – 2022)
Source: Refinitiv Datastream Date: 04/07/2022
We now think it is unlikely the Fed will hike 75bp again, which is at least moderately bullish for the euro and risk assets generally, particularly given markets are pricing in around a three-in-four chance of such a move at the next FOMC meeting on 27th July.
The Swiss franc continued to edge higher against the euro last week. In the middle of the week, the EUR/CHF pair fell below parity to its lowest level since January 2015. The franc rallied in line with its fellow safe-havens, as fears surrounding global growth intensified, souring risk sentiment. Last week’s sentiment data from Switzerland painted a mixed picture. Meanwhile, this morning’s inflation data for June rose to 3.4%, its highest rate since 1993. The higher-than expected reading, and evidence of strong price momentum (0.5% MoM in the headline), adds to pressure on the Swiss National Bank to maintain its hawkish bias and tighten policy further at upcoming meetings.
This week we’ll focus primarily on outside news. Heightened fears surrounding recessions globally are likely to shift sentiment this week, which we expect to be a key factor affecting the franc in the near-term.
The Australian dollar depreciated against the US dollar last week, in line with commodity currencies and risk assets in general, as fears about a possible global economic downturn increased. Following the sell-off, AUD is trading at its lowest level in two years, close to the 0.68 level on the dollar.
Attention in Australia this week will be firmly on Tuesday’s Reserve Bank of Australia meeting. Our out of consensus call for a 50 basis point interest rate hike at the June RBA meeting came to pass, and we expect another rate increase of the same magnitude this week. This is far from fully priced in by markets, which provides room for upside in the dollar. Forward guidance communications will also be highly important for the Australian currency. We believe the bank will signal that additional interest rate hikes are on the way, including another 50bp move in August, as domestic inflation shows no signs of abating.
Aside from this week’s RBA meeting, PMI and trade balance data on Tuesday and Thursday respectively will be worth keeping tabs on, while shifts in market sentiment will also continue to drive AUD in the coming days.
The Canadian dollar weakened against the USD last week, due largely to the general worsening in risk sentiment and easing in commodity prices. CAD did, however, outperform most of its G10 counterparts. There was no clear catalyst for this outperformance, although rising bets in favour of a bumper 75 basis point interest rate hike from the Bank of Canada at its meeting next week no doubt helped.
The June unemployment report out on Thursday will be key this week, as it will be the last important data point released ahead of next week’s Bank of Canada monetary policy meeting. The unemployment rate is expected to increase slightly, but remain at very low levels, with investors also on the lookout for continued signs of solid wage growth and healthy net job creation. Should this prove to be the case, then a 75 basis point rate hike at the next central bank meeting would become increasingly more likely. Together with the employment report, we think that oil prices and market sentiment will be the main drivers of the Canadian dollar this week.
The Chinese yuan edged lower against a broadly stronger US dollar last week, albeit the CFETS RMB index, which measures the currency against a weighted basket, managed to post yet another week of gains. An easing in covid fears as virus restrictions are lifted, and data pointing to a more robust than anticipated rebound in the Chinese economy both helped support CNY last week. The official composite PMI jumped to 54.1 in June, helped by much stronger-than-expected expansion of the services sector. Similarly to the official indicators, the Caixin manufacturing PMI, which is oriented towards smaller, private firms, also posted its first expansion since February.
Figure 4: China NBS PMIs (2019 – 2022)
Source: Refinitiv Datastream Date: 04/07/2022
In the first half of the week, we’ll continue to focus on the latest PMI data, with the Caixin services and composite PMIs out on Tuesday. Saturday will see the release of consumer and producer price growth data for June, which will be important for assessing future steps of the PBOC. So far, the bank has continued to pledge its willingness to support the economy, particularly focusing on credit expansion.
