In a reversal of recent trends, financial market volatility was focused on currency markets, even as equity indices and bonds stayed in tight ranges.
The star of the week was again the US Dollar, rising against every G10 and major emerging market currency. Since neither the Federal Reserve meeting nor the US payrolls report added much in the way of new information, it seems like the main source of Dollar strength was market positioning. Speculative investors as a group still have sizable bets against the US Dollar and, as the rally in the Euro falters, they appear to be scrambling to cover their positions and in the process push the greenback higher.
We expect volatile trading this week around the release of US inflation data on Wednesday and the key Bank of England meeting on Thursday. The MPC is almost universally expected to hold rates unchanged, though we think there is a non negligible chance of a surprise hike.
GBP
Sterling was swept up last week in the general sell-off against the US Dollar, and ended the week essentially unchanged against the Euro. This is not a bad result considering the PMI indices of business activity came in under expectations, and the news from Brexit negotiations indicated little headway is being made.
All eyes are now on the Bank of England meeting on Thursday. Consensus has shifted against a hike over the last two weeks, after dovish comments from Carney and weak economic data. The key will be to see the split in the MPC vote. Any more than two dissenters voting for an immediate hike should be a positive for Sterling.
EUR
Last week saw yet another batch of weak economic data releases out of the Eurozone. The unexpected fall in underlying inflation in April, from 1.0% to 0.7%, is partly due to seasonal effects related to the timing of the Easter holiday. Nevertheless, it really brings into question the ECB staff forecasts for rising inflation this year and next, and hence the prospect of an end to asset purchases in 2018.
This week looks pretty quiet on the data front, so the main driver for the Euro should be the reaction of ECB officials to weak inflation data in their communications to markets.
USD
Both the Federal Reserve meeting on Wednesday and the US payrolls report on Friday went more-or-less as expected. The Fed left markets guessing as to whether we will see two or three further hikes in 2018. Net job creation in April came in slightly under expectations, but positive revisions to prior months offset this. Elsewhere in the report, more of the same, as unemployment fell again to 3.9% but wages failed to accelerate from their 2.6% annualised rate of increase.
The key event for this week is the Consumer Price Index release on Wednesday. Any increase in the core number from its current 2.1% (and hence above the Fed target) would certainly result in higher US yields and a rising US Dollar.