19/10/2021 - WEEKLY MARKET REPORT


Dollar sells off after another strong US inflation report


One of the key correlations beginning to establish itself in the post-pandemic world seems to be the negative one between US inflation and the dollar.


Yet another strong CPI report showed headline inflation above 5% for the fifth consecutive month. Yields did not move much as a response, but the US dollar lost ground for the week against every major world currency.


The only exceptions were the Japanese yen, weighed down by the relentless rise of commodity prices and risk appetite, and the Turkish lira, tripped once again by Erdogan’s rate shenanigans.


This week is light in terms of macroeconomic releases or policy announcements. Watch out for the September inflation report out of the UK on Wednesday, which may solidify expectations for a 2021 hike. The Eurozone PMIs of business activity on Friday will give us a timely read on the degree to which the economic recovery there is softening; however, market expectations are still for a strongly expansionary read.


GBP


Strong labour market data and industrial production numbers out of the UK bring us closer to a 2021 hike by the Bank of England, which looks set to act much earlier than the Federal Reserve. BoE Governor Bailey warned again over the weekend that the bank ‘will have to act’ in order to curb inflation, and that has further brought forward market expectations. Futures are now pricing in this first small 15 basis point hike at the next MPC meeting in November.


This week's CPI report is therefore key, as it will be the last major data point to inform the Committee's decision. Both the headline and core numbers are expected to print above 3%, even before the lifting of the energy price caps adds fuel to the inflationary fire. In our view, this should be enough to warrant a 2021 hike and provide strong support for sterling.


EUR


The euro was one of the laggards last week among currencies and risk assets generally, most of which outperformed against the dollar. The ECB appears set to lag almost all of its major peers in the removal of monetary policy accommodation, and markets are not pricing in hikes until well into the future. In this context, we have pushed downward our forecasts for the euro against other G10 and emerging market currencies.


Short-term, market expectations for the October PMIs appear to be quite subdued, so there is room for a positive surprise that would provide support to the common currency.


USD


Yet another month with headline inflation above 5% and the core rate above 4% are driving home our view that inflationary pressures are unlikely to be as short-lived as the Fed was hoping during the summer. As a result, a taper announcement at the Federal Reserve’s next policy meeting in November now looks all but assured.


With the US fiscal deficit in double digits and real rates way below zero, we think the rally in risk assets in general and commodities in particular still has plenty of room to run. This is not necessarily a positive background for US dollar performance, and we continue to see a weaker greenback against most of its peers, particularly commodity-exporting emerging market currencies.


CHF


The Swiss franc continues to outperform its safe-haven counterparts, although it seems quite expensive at current levels, particularly against the euro, its main reference point. Some calmness in US yields throughout most of the week appear to have helped the franc. In recent days, the currency has also been supported by increased market pricing of monetary policy tightening from the Swiss National Bank. Last week the one-year

swap rate reached its highest level since late-2018 and overall rates suggest that the markets expect the SNB to start tightening policy as soon as next year, which we think is an overreaction considering developments on


Swiss inflation and the bank’s recent rhetoric.

Similar to the previous one, the economic calendar in Switzerland is mostly empty this week, so we’ll continue focusing primarily on outside news.


AUD


The Australian dollar ended last week higher against the US dollar, due to rising commodity prices and a broadly weaker greenback. Higher oil and iron ore prices have helped AUD rally since the start of October, with the currency now trading just shy of its strongest position in a month.


Australia's seasonally adjusted unemployment rate was lower than market expectations last week, rising to 4.6% in September 2021, little changed from a near 13-year low of 4.5% in August. On the pandemic front, Australia's largest city, Melbourne, ended its strict lockdown, as the country aims to live with the virus through increased vaccinations and a gradual reopening. This reopening should present some upside for Australia’s economic outlook.


This Tuesday will see the RBA’s meeting minutes published, and could give us some clues as to the future of monetary policy in Australia.


CAD


The Canadian dollar ended last week higher against the US dollar, with the USD/CAD cross trading at around a 3-month high, partly due to an increase in global oil prices.

Last week’s rally in oil prices, which rose above $85 a barrel for the first time since October 2018, has offset recent strength of the US dollar driven by heightened expectations that the Fed will soon begin to cut stimulus.


At the same time, investors have strengthened their expectations for another cut in the Bank of Canada’s bond-buying scheme at the end of the month. We think that it is now highly likely we see a halving in the pace of weekly asset purchases to $1 billion, with rhetoric that would pave the way for hikes at some point in early-2022.


This Wednesday will see the September inflation report published, followed by the publication of August retail

sales on Friday.


CNY


The Chinese yuan ended the week higher against the US dollar, as did most EM currencies, but its gains were minimal, which is to be expected from a low volatility currency.

The focus this week will yet again be on Evergrande. The developer will officially enter default if it doesn’t meet the payment for its offshore bond in USD, which had a deadline in late-September and a 30-day grace period. Recently a number of other Chinese developers, including Fantasia and Sinic, have experienced similar credit issues. Authorities, however, don’t seem to be worried about contagion fears, at least based on recent communications from the PBoC. During its briefing on Friday, Zou Lan, PBoC’s head of the financial markets department, described the risk of spillover to the financial industry as ‘controllable’. In addition to Evergrande, the market is digesting today’s GDP release from China that showed a more pronounced than expected slowdown in the third quarter.


The economy grew only by 4.9% year-on-year and 0.2% from the previous quarter, a very low rate by any means. This, coupled with hard data for September and China’s energy problems, further adds to worries about the country’s economic prospects. In addition to the

number of current issues, this week we’ll focus on the PBoC interest rate decision on Wednesday. No change in prime rates is expected.



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