The US dollar posted its first weekly loss in five weeks, despite an upside surprise in the September inflation report.
Treasury yields and the greenback initially rose after both headline and core CPI surprised to the upside, though by Friday both moves had fully reversed. The 10-year Treasury yield ended the week about 15bps lower, and the US Dollar Index fell. The proximate trigger was a sharp sell-off in AI-related stocks, viewed as bearish for the dollar given America’s heavy investment in artificial intelligence. The dollar's failure to rally on a hot US inflation print and a risk-off week also suggests a one-sided market in which most speculators who want to buy the dollar have done so already. We think the greenback has found a ceiling, at least for now.
The Fed is now in its blackout period ahead of the October meeting, and the main event of the week will be the release of the G3 PMIs for October on Friday. UK labour market data on Tuesday and September CPI on Wednesday are the last major releases before the Autumn Budget and next month’s Bank of England rate decision. Equity market volatility could spill over to currencies, as Tesla and Meta report earnings on Wednesday and AI wobbles have become a major market driver. The following week is packed: the UK Budget and Fed decision on the 28th, and the ECB a day later.
GBP
Sterling was the best performer among the major currencies last week, gaining almost 1% against the dollar and edging higher against the euro, and gilts rallied alongside the global bond market. August GDP surprised to the upside, and annual growth is now the strongest in four years. While we don’t think that this will be enough in of itself to convince the Bank of England to raise rates next month, it won’t do anything to dissuade policymakers to hike and swaps continue to almost fully price in 25 basis points of tightening. However, Governor Bailey said last week there was little evidence so far of energy prices feeding into wages and broader prices, which makes Tuesday’s wage data and Wednesday’s CPI figures critical.
Investors will inevitably also have one eye on next week’s Autumn Budget. The IMF has said that the UK need not speed up its deficit reduction, though it also warned that Britain would need to stay the course with its fiscal consolidation, rather than giving it a free pass. Markets so far appear unruffled as we head into budget day, which could open up some downside should the government fail to sufficiently rebuild the fiscal headroom, while unveiling bigger spending increases and back-loaded tax hikes that could deepen the fiscal quagmire and weigh on the growth outlook.
EUR
The common currency recovered modestly, posting its first weekly gain in over a month and its biggest daily rise in two months on Thursday. The euro was a clear beneficiary of the dollar’s pullback, since speculative positioning against it is the most extreme in years. Short covering could extend this bounce even without any good news from Paris. The underlying problems have not gone away: French fiscal consolidation remains unlikely before next year’s presidential election, and the ECB seems reluctant to tighten further. The widening rioting and protests in France could also begin to creep into stocks, bonds and the euro.
Friday’s flash PMIs are the only major release before next week’s European Central Bank meeting. Economists are expecting a mild softening in activity, though even a strong report here will not be enough to persuade the Governing Council to raise rates this month. Focus will instead be on Lagarde’s comments on the situation in France and her language pertaining to the likelihood of a December hike.
USD
Our call for a moderate core inflation print was not borne out, as core CPI rose 0.3% in September. Market pricing of an October Fed hike briefly spiked after the CPI report, then settled back as a couple of Fed officials signaled little urgency. We maintain our call for a hold this month, but expect the decision will be contested and we will not see a repeat of last meeting unanimity. Yet, with most data not screaming out for higher rates, and the US midterm elections around the corner, we think that the majority of the committee will be comfortable in holding fire until December.
We note that last week's price action suggests bad inflation news no longer seems able to push the dollar higher. If the AI correction deepens, its implications for US growth and investment are a clear negative for the greenback. Unlike the global bond rout of September, the AI wobbles are a US story, and so the flight-to-safety bid does not go to the dollar.
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