Volatility Picks Up, With The Dollar Starting The Week Strong
The dollar ended last week on the front foot, benefitting from a softening of investor sentiment (evidenced by a modest sell-off in equity markets). This saw GBP/USD drop back into the lower half of the $1.38-1.39 range, while EUR/USD fell back below the $1.18 threshold. We note that in recent months risk appetite has trended to decline around mid-month, which we believe may be driven by dealers’ hedging activity ahead of the monthly Options Expiration date. If this is a case of history repeating itself rather than the beginning of a prolonged bout of risk aversion, equities should rebound later this week with the dollar subsequently moving lower.
Data-wise, there is a busy calendar in the US, though it may play second fiddle to developments with respect to risk appetite. The highlight is the release of US CPI inflation figures for August tomorrow, which is expected to show a modest easing of price growth as transitory factors in sectors most sensitive to the reopening (i.e transport, hospitality & recreation) begin to fade. However, inflation looks to set remain well above its 2% target (f’cast 5.3% from 5.4% in July) as supply chain disruptions and labour shortages continue to push prices higher. Indeed, we expect to see a broadening of inflationary pressures in the coming months, with rental costs, also set to rise sharply. This should act as a tailwind for the dollar, as we struggle to see Fed rate hike bets being unwound when inflation is 3 full percentage points above target despite the central bank’s insistence that it wants to see a return toward maximum employment before tightening policy.
Sterling traded in a relatively wide range last week, with GBP/EUR touching lows nears €1.161 but subsequently rebounding above €1.17 as investor sentiment improved. A series of hawkish comments from Bank of England speakers that suggested rate hikes could be on the table in 2022 given the likely persistence of labour shortages also acted as a tailwind. This morning, the currency is slightly on the back foot and we see some scope for this softness to persist as investors remain in risk-off mode.
This week, the schedule should nominally offer some support to sterling, but as in the US this may not be enough to offset the impact from the risk-averse backdrop. Employment data for the 3-months to July will feature tomorrow and will be examined for any signs of deterioration in labour market conditions ahead of the expiration of furlough at the end of this month. A key issue at present is sectoral imbalances, with slack in some industries (e.g. Air travel) and shortages in others (e.g. transportation). These imbalances may take up to 2 years to correct according to the CBI without an easing of immigration restrictions, prompting fears of stagflation (slowing growth and high inflation).
Indeed, inflation is projected to have jumped to 2.9% y-o-y in August (figures due Wednesday), though to a significant degree this will reflect base effects associated with last years Eat Out to Help Out scheme. Inflation is expected to hold well above the BoE’s 2% target through H221, as supply-side pressure remain acute and base effects linked to a spike in energy prices (Ofgem price cap will rise in October) and a VAT cut reversal. Against this backdrop, we anticipate BoE officials will remain hawkish and this will see sterling remain reasonably well-supported (absent a sharp deterioration in the epidemiological situation or sell-off in equity markets).
The schedule is quiet in the eurozone this week and will thus offer limited direction to the euro. The only item of any interest is the publication of industrial output figures for July, which are expected to show a modest increase in output after a soft Q2.
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