Jamie Jemmeson
September 27, 2021

Risk Drives the US Dollar while Market Watches Data for Further Clues on November Tapering

Dollar

A big driver of US dollar strength last week was the ongoing concerns about China’s property sector and the potential ramifications for the wider economy, resulting in a risk-off tone. In the meantime, the market was keen to articulate the latest tone from the Federal Reserve (Fed) monetary policy update. It wasn’t too long ago that the market was ear-marking this meeting to be the start of QE tapering for October. However, following some disappointing economic releases, these expectations dissipated. As expected, the Fed made no immediate changes to either its QE programme or interest rates. However, it did drop the strongest hints yet that it may soon start to curtail asset purchases unless economic conditions deteriorate. The Fed’s post-meeting statement noted that tapering ‘may soon be warranted’, which would suggest that a formal announcement could come at its next meeting in November. In addition, they added that tapering may end around mid-2022. The updated ‘dot-plot’ showed Fed policymakers evenly split between interest rates starting to rise in 2022 or 2023, a change from last time when most didn’t expect a rise until 2023.

Following the Fed’s suggestion that tapering of QE could be announced at November’s policy meeting, the market will now pay close attention to growth and inflation data in particular. Next week’s monthly jobs report will be of particular interest. In terms of data this week, the market will pay close attention to durable goods, consumer confidence and ISM manufacturing. In addition, Fed Chair Powell is due to speak on Tuesday and Wednesday. Following the hawkish signals at last week’s Fed meeting, the market will keep a close eye on the tone of his speeches and decipher for further clues on the Fed’s position regarding the tapering of QE.

Sterling

Following some disappointing data including the fourth consecutive monthly decline in retail sales meant that all eyes were on the Bank of England (BoE) meeting for further clarity of the outlook for interest rates and monetary policy. Before the meeting, Sterling had been under pressure following the “risk-off” tone in sentiment following various events and ongoing uncertainties. As expected, the BoE left policy unchanged and kept the Bank Rate at 0.1% and the Asset Purchase Facility at £895Bn. Recent developments in energy markets, combined with the continued build-up of price pressures resulted in a more vigorous debate around the near-term inflation outlook. The collective view of the MPC is now that following a projected rise in CPI inflation above 4% in Q4 2021, it could remain above 4% well into the second quarter of next year. This resulted in two members calling for the remaining portion of asset purchases, scheduled between now and the end of the year, to be curtailed immediately. Despite downgrades to Q3 growth expectation, markets are forecasting for UK Bank Rate to bring forward raising rates by around three months. A rise to 0.25% is now expected by February 2022, and to 0.50% by the August meeting. Sterling rebounded off the lows following the meeting but failed to erase the losses made in the early part of the week.

With no major data releases from the UK, the week ahead for Sterling is likely to be driven by ongoing risk concerns. Supply concerns remain, with Boris Johnson bowing to pressure from businesses by authorising a temporary visa scheme covering up to 10,000 foreign workers, to ease a shortage of lorry drivers that has caused widespread disruption. In the meantime, following the BoE meeting last week, BoE Gov is due to speak on two occasions this week (Monday and Wednesday). The market will keep a close eye on rhetoric as the market continues to second guess the timing of rate hikes.

Euro

The single currency was caught in the winds of the risk-off tone, depreciating against the US Dollar but making gains against Sterling. Economic data was disappointing, in both the service and manufacturing sectors where the pace of expansion was much slower than expected. Much of the focus was on the German elections over the weekend and the inevitable build-up. Germany’s centre-left Social Democrats (SDP) have narrowly beat the Christian Democratic Union (CDU) of outgoing Chancellor Angela Merkel. SPD leader Olaf Scholz says he has a clear mandate to form a government, but his conservative rival, Armin Laschet, is determined to fight on. Whilst there has been a coalition between the SPD and CDU for several years; this is unlikely to continue. Instead, the Greens and liberals are looking for a role in a new coalition. Chancellor Angela Merkel will remain in power until a new coalition is formed.

The week ahead is largely going to be dominated by the forming of a new coalition in Germany and the resulting ramifications for Europe’s powerhouse. European Central Bank (ECB) President Lagarde is speaking on two occasions (Monday and Tuesday), as head of the ECB, she has more influence over the euro’s value than any other person. The market will monitor her speeches for clues on future policy as well as the central banks view on elevated inflation. The region’s inflation reading will also be watched on Friday to articulate if there has been any directional change.

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