FX Daily: DM currencies struggle from inflation worries turning into stagflation
DXY sank 0.8% to 105.69 on Thursday after its two-day recovery from 105 stalled below 107. The US Treasury 10Y yield could not hold above 2.75% and stay near the 2.50% Fed Funds Rate. After the US technical recession in 1H22, markets prefer to depend on data, and not more bold Fed narrative, to assess if the Fed can keep lifting rates to cool inflation with a soft landing. With the Fed banking on the tight labour market to justify more hikes, markets will not welcome any downside surprises in today’s US monthly jobs report. According to Bloomberg consensus, nonfarm payrolls will likely slow to 250k in July from 372k in June. On a 4-week moving average basis, initial jobless claims had already increased to 255k from 232k over the corresponding period. Although the employment indices in the ISM surveys have improved, they held below their breakeven 50 levels. Given the second monthly increase in continuing claims, the unemployment rate might rise after holding steady at 3.6% for four months. A fifth drop in average hourly earnings growth to below 5% YoY should help worries of a wage-price spiral.
In line with our expectations, the Bank of England meeting was a limited “buy the rumour, sell the fact” event. GBP initially plunged from 1.2210 to a low of 1.2066 after the Monetary Policy Committee voted 8-1 to lift the bank rate by 50 bps to 1.75%. The dissent voted favoured lifting rates by the same 25 bps pace. Although the BOE projected inflation rising to 13% YoY in 4Q22 from 9.4% in June, its bleak assessment of a prolonged UK recession sent the 10Y Gilt yield down to 1.81% from 1.93%. However, by the end of the session, GBP and the 10Y yield recovered to 1.2160 and 1.89% respectively.
The BOE’s bearish economic outlook was felt across markets. Weak demand worries sent Brent crude oil prices farther below USD100/barrel to USD94, down 16% this week. Developed Market currencies are trapped in ranges, up on soft landing hopes and down on recession fears. Like the Fed, the larger-than-usual hikes by the Reserve Bank of Australia and the BOE were greeted with lower 10Y bond yields. The market’s message was simple. The faster and larger central banks hike, the smaller the window to keep doing so without driving the economy to a standstill. Herein lies the ugly difficulties posed by stagflation posed to policymakers. As more Western countries confront the same challenge, it will be harder for markets to find relative value in the DM currencies. Maybe it’s time to give Asian currencies the benefit of the doubt.
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