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Dollar rises as markets shift focus to central bank policy

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19 July 2021

Written by
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

The US dollar ended the week higher against every G10 currency, save the New Zealand dollar.

T
he latter currency grabbed the spotlight as its central bank, the RBNZ, suggested it is ready to join Norges Bank as the first central banks to start hiking rates. This is a notable development and suggests that in the medium-term currency markets will be increasingly driven by expectations and relative timing of central bank’s exit from ultra-loose monetary policy. However, the Brazilian real stole the spotlight among major emerging market currencies, rebounding strongly from its recent sell-off as the government raised its economic growth forecast.

US rates markets managed to shake off the shocking US inflation report for June, but we think that burgeoning inflation pressures and the central bank response to the problem will be the key macroeconomic issue for markets in the months ahead. The ECB July meeting on Thursday takes on added importance, and not only because it is the first such meeting after the strategic review. Friday could be another volatile date as the advance PMIs of business activity are released in the Eurozone, the US and the UK.

Coronavirus fears ease

GBP

The UK inflation report for June provided yet another significant upside surprise, as strategists scramble to bring up their forecasts in line with reality.

In our view, the main question is now the speed at which Monetary Policy Committee members start turning hawkish in reaction to these and other inflation pressures worldwide. Two of them did so last week, which validated our view that the Bank of England may be one of the first major central banks in developed economic areas to start hiking rates, and makes us bullish on sterling.

EUR

May industrial production in the Eurozone was a bit weaker than expected, but markets discounted fully such a lagging piece of news.

ECB president Lagarde ignited interest in this week’s July ECB meeting by suggesting that the strategy review announced earlier this month will be discussed at length. Market expectations are for very dovish communications in line with the new symmetric inflation target, but we think that gathering inflation pressures (though lagging in the Eurozone) are going to be an increasing headwind for ECB doves, with positive implications for the euro over the medium-term.

 

USD

US Treasuries staged a surprising rally in the face of yet another inflation shocker. Headline inflation rose 5.4% on the year and the less volatile core index was still up 4.5%. The latter one has increased at an annualised rate of 10.6% over the last three months. For now, markets are hesitating as to whether to punish or reward the dollar for this combination of low yields and high inflation, but we still think over the medium-term the path of least resistance for the greenback is down.

There won’t be too much in the way of major economic news out of the US this week, although we could see a bit of attention given to Friday’s preliminary PMI data.

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