Enrique Diaz Alvarez, Chief Financial Risk Officer, Ebury.
The significant positive surprise in US June inflation numbers set financial markets roaring higher on expectations that the Federal Reserve is very close to the end of hikes. US rates dropped sharply, jokes beyond July were priced out, and unsurprisingly the dollar lost ground against every major currency worldwide, as investors cheered and risk assets soared. The week’s winners were the Scandinavian currencies and the Swiss franc, all of which were buoyed not only by the dollar’s fall but also by extensive short covering.
The market reaction to the inflation news was completely understandable, but we do wonder if the dollar has fallen too far, too fast. This week should see subdued summer trading in FX markets, with limited news on tap. The UK inflation report for June out Wednesday will be key for Sterling but also the Euro. It remains to be seen whether the disinflationary trends evident in the US will be replicated soon in Europe, and this report should offer insights.
GBP
Sterling soared higher against the dollar last week in line with every worldwide currency, though it lagged a bit against the Euro. High interest rates and better than expected data continue to support the Pound. May GDP outperformed expectations in spite of the negative impact of the coronation holiday. However, the key number for Sterling is the inflation report out Wednesday. MArkets are expecting a drop in the headline number and stable core index, which should be consistent with another 50 bp hike at the August meeting of the Bank of England and continued Sterling strength.
EUR
The disinflationary news in the US sent the Euro straight higher, and the common currency broke cleanly out of the range that had held for most of 2023. The move is understandable and in line with our forecasts, but gloom around European growth may provide some headwinds in the short term. The Euro may have a difficult time rallying given stretched market positioning until the state of the eurozone economy is clarified, and the pessimistic PMI survey numbers are confirmed or refuted by hard economic data.
USD
The June inflation report confirmed that the US inflation is slowly but clearly headed the right way. Inflation undershot expectations in both the headline and core indices, and the latter three-month running average is now down to 4% on an annualized basis. The Fed is still likely to hike again in July, as it has precommitted to do. However, any further hikes would need significant upside surprises in inflation data and economic activity which are unlikely. With the Fed hiking cycle coming to a close, the backdrop turns more favourable for our core view that emerging market currencies have further to run.
