Inflation Worries Are Not Going Away
Amongst the many things I didn’t think I would be writing about at the end of the first quarter of 2023 was that sterling had made new highs for the year. Not only has sterling gained for five weeks in a row it is also the top performer in the G-10 currencies, as we mentioned last Friday and has risen over 5% against the greenback in that period. Giddy heights indeed; however, 1.2445 still seems to be the limit of its ambitions. Sterling is being helped by several factors. The perceived robustness of the UK banking sector is perhaps the most important, whilst the market is also starting to believe that the Bank of England will hike rates again at its next meeting. While the currency markets are often accused of short-termism, the signing of the far-ranging Indo-Pacific trade deal with CPTPP at the end of last week should also help sentiment.
The euro has also been performing well and would actually be quite a bit stronger if there weren’t concerns over its banking sector, as we have highlighted before. Unusually the communication from the ECB is clearer than the Fed’s, and after last week’s inflation data, another rise in euro rates is undoubtedly on the cards. Whilst the inflation headline numbers are subsiding quickly, the core data, arguably more critical, is staying stubbornly high, with data released last Friday reporting that it had ticked up to 5.7% last month. With Germany and France suffering from widespread strikes, there are also fears of a wage-price spiral emerging. The PCE data in the US on Friday was slightly lower than anticipated, which may lend succour to those in the doves’ camp. As we have said previously, the Fed, and to a lesser extent, other central banks, face the problem of balancing financial stability with fighting inflation. It’s a very fine line, and with borrowings in the US from the Fed still running high last week, it looks like the problems in the regional banking sector are still bubbling under. Worryingly, inflation may get a boost from the announcement of OPEC+ cutting production over the weekend, making the balancing act all the more difficult. We feel that the jump in Oil prices may switch the focus back to the inflation fight in the short term and increase the probability that the Fed will raise rates in May, consequently helping the dollar higher.
The week ahead is holiday-shortened, with the markets closed for Good Friday both in the UK and the US. For the first time we can remember, the US Labor Department will release its Non-Farm Payrolls report with the markets shut, making them highly volatile when they reopen in the US on Easter Monday. So, what can we expect from the Non-Farm number, and will it encourage further strengthening in the conviction that the Fed will continue to tighten policy? The market is calling the number around 200,000, which, if beaten on the upside, will lend more strength to the camp looking for a 25bp rise at the next Fed meeting on 3rd May. In the run-up to the data ADP will release its take on white-collar employment whilst the weekly unemployment number will be published, neither of which, in all honesty, tends to give much bearing on the big one, the NFP number. However, it is worth keeping an eye on the JOLTS number scheduled for tomorrow, which can be a good indicator of the economy’s underlying strength.
The rest of the world’s data dockets look a bit sparse next week, with only S&Ps Global Purchasing Managers Manufacturing Indexes published today and their Services and Composite Indexes on Wednesday. The other number to watch for is the European Producer Price Index tomorrow which will help indicate the future path of inflation. All quiet for the UK as well, apart from S&Ps Indexes, so the attention here may turn more towards the political spectrum as the local elections in May start to be discussed by the media. There will, of course, be plenty of speakers from central banks, including the arch dove Tenreyro who takes to the microphone tomorrow.
Of course, we mustn’t forget geopolitics which seems to be becoming more fraught than ever as China appears to be flexing its muscles. Traditionally, any escalation in global tensions would see a flight to the Swiss franc’s and dollar’s safe haven currencies. Still, after the recent woes in their banking sectors, the beneficiaries have tended to be the yen and, unusually, the pound. This may continue until concerns over stability in the banking sector finally subside, hopefully sooner rather than later.