ederal Reserve communications were somewhat on the dovish side, leading to a drop in US treasury rates. However, a soft inflation print across the Atlantic and the standoff over the Italian budget tanked the Euro and dragged down every European currency.

Sterling outperformed in relative terms, as some of the negativity around the Salzburg talks was unwound. Emerging markets had a mixed week, with Latin American currencies generally bouncing back strongly, while Asian ones continued to underperform, dragged down by US-China trade tension.

This week promises to be a volatile one, as headlines from the UK Conservative Party conference will compete with those from Italian politics to drive Euro and Sterling. The week will be capped by the key US monthly payrolls report on Friday.

Major currencies in detail

GBP

Last week vindicated our view that current Sterling levels vs. the Euro and the Dollar are pricing in something close to a worst-case scenario, and that the mere absence of bad news leads to Pound outperformance.

This view will be tested again this week as the governing Conservative Party conference kicks off, with the consequent danger of negative headlines. Beyond Brexit, the PMI business activity surveys out Wednesday will focus attention.

EUR

The news that the Italian budget by the right-populist government would reach 2.4% of GDP a year for the next three years, considerably higher than the targets previously agreed with the European Commission, put the Euro on a wrong foot all week.

The soft flash inflation news did not help, and raised serious questions over Draghi’s optimism that it is on a path to reach the ECB’s target over the medium term. While headline news came out mostly as expected, the more important core indicator, which excludes volatile food and energy components, dipped below 1% again. Our call for ECB hikes in Q3 2018 is contingent on a sustained pick up in this critical indicator, and so far we are not seeing it.

USD

The Fed’s widely expected hike in rates last week was coupled with a somewhat dovish assessment of the long-term equilibrium rates. The statement suggested that the bank no longer regards current policy settings as accommodative and that we may be closer to the end of the hiking cycle than most observers think. While Treasury yields fell as one would expect, the Dollar did not, as European political troubles overshadowed this news.

Friday’s key payrolls report will be the main data point out of the US economy this week. The headline number is expected to stay strong, but again the key will be to see whether the tentative upward trend in wage gains we saw in the previous report is maintained.