The US inflation report overshadowed the June ECB meeting, but the market reaction was counterintuitive, to put it mildly. Although US inflation is currently at 5% a year and many prices continue to rise, investors have embraced the Federal Reserve’s rhetoric about the temporary state of affairs. As a consequence, the yields on US bonds fell, estimate Ebury analysts: Enrique Diaz-Alvarez, Matthew Ryan, Roman Ziruk.
Ebury’s comments:
In the case of emerging markets, the situation was mixed. Overall, the worst performing currencies this year had a good week, while the best performing ones were bad, which we think looks like closing. All eyes are now on the Federal Reserve meeting in June, which will be announced on Wednesday evening June 16. Policymakers’ declarations that they ignore inflation readings in the short term will be put to the test due to the exceptionally high performance of the past two months. Nevertheless, we expect the Fed to keep its word and postpone serious discussion on the reduction of the scale of purchases until September, when it has a clearer picture of the situation.
On Wednesday, we will also get the UK inflation reading in May, which will show to what extent the opening of the economy causes a similar price pressure as in the US. In turn, on Friday there will be a meeting of the Bank of Japan, in the context of which no major decisions are expected.
PLN
Last week the Polish zloty clearly weakened in tandem with the euro, losing almost 1%. The weakness of the currency, which previously experienced many weeks of appreciation, should be associated primarily with two issues: first, the dovish Polish central bank, and second, the marked strengthening of the US dollar at the end of the week.
The Monetary Policy Council in the statement after Wednesday’s meeting put strong emphasis on the issue of temporary factors behind the rise in prices and did not mention the possibility of monetary tightening. On Friday, answering selected questions from journalists at the press conference, MPC chairman Adam Glapiński referred to this issue, but his tone did not indicate that the interest rate change was imminent. The current rhetoric of decision makers may inhibit the zloty appreciation, however, taking into account that ultimately, after normalization of the economic situation, the cycle of rate hikes should begin, we do not think it has the potential to significantly weaken the currency. In the context of the zloty’s behavior in the coming days, we will focus mainly on the external situation.
EUR
As we expected, the European Central Bank did not introduce any changes to its policy during its meeting on June 10, and its president, Christine Lagarde, alternated between a casual and slightly dovish tone. However, clear upward revisions of inflation and GDP growth forecasts for 2021 have been published – importantly, the ECB predicts the euro area economy will return to pre-pandemic levels by the end of this year. The bank, like the Fed, views inflation as temporary. The asset purchase rate under the PEPP program remains unchanged. All in all, this is a dovish result. We expect that the debate between hawks and doves in the ECB will gain momentum and become important during the September meeting. It is likely that inflation data will surprise upwards by then.
USD
The market reaction to the extremely high inflation in the US was a bit surprising for us. The only, but unsatisfactory, explanation for this was investors’ positioning. Bond yields fell significantly, despite inflation hitting 5% annualized, and perhaps more importantly, core inflation of 3.8% annually and a whopping 8 3% annualized over the past three months After these developments, the dollar experienced a slight appreciation and investors are waiting to make a decision at the key Fed meeting this week.
The rhetoric of chairman Jerome Powell is likely to remain dovish and disregard for increases in inflation. However, we expect changes in the dot plot, illustrating the expectations of each FOMC member as to how high interest rates will be at the end of each of the next three years. We believe most will expect them to grow no later than 2023. We also see the possibility of the bond market losing all of last week’s gains, and even more, which could have a rather unpredictable impact on the dollar.
GBP
The most important UK publication released last week, the monthly GDP report, was quite good. The February-April period brought GDP growth by 1.5% as compared to a decline by 1.5% in the first quarter of this year, which shows the positive impact of lifting the lockdown on economic activity. This was largely included in the price of the pound, so it did not experience significant changes against the other G10 currencies last week. The employment report released on Tuesday 15th June will show the picture
distorted by various support systems and we do not expect it to have an impact on the market.
However, it may be different with the environmental inflation data. Surprises in this regard are becoming the norm everywhere, and if the UK is likewise, there may be voices in the market that the Bank of England will tighten its policy sooner than expected, which would be positive for
pound.
CHF
The Swiss franc soared last week, which was possible thanks to a significant drop in US bond yields. The ten-year bonds fell to 1.43% at some point, and the Swiss currency rose to its strongest position against the euro since February.
This week, attention will be paid to the Swiss National Bank. We are unlikely to see major changes in his assessment, but an upward revision of the inflation projection seems quite likely, especially due to the rise in oil prices. Given how sensitive the franc is to changes in US bond yields, the currency may react to signals from the Fed, which will be in the center of investors’ attention on Wednesday.
Source: Ebury and ISBnews
