FX outlook: Parky’s quick take – 12 July 2021

12 July 2021

Neil ParkerFX Markets Strategist

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What’s happening with currencies this week? Neil Parker, Market Strategist shares his views.

USD bounces back as safe havens get a boost

United Kingdom: Confirms re-opening; June inflation and May labour market data in focus

The UK Prime Minister Boris Johnson’s announcement at the beginning of last week that the UK would drop the vast majority of its domestic Covid constraints and restrictions was well trailed. Consequently, it did not prompt any significant moves in the financial markets. There was further positive news for the travel industry with the Transport Secretary, Grant Shapps, announcing that the requirement for double vaccinated travellers to quarantine on return from Amber list countries would be dropped (such that the rules for those double vaccinated would be the same as travel to Green list countries). The combination of factors could prove a further positive for the UK economy, re-invigorating the last elements of the UK economy that had been forcibly closed due to Covid.

As for the data and surveys, these were a mixed bag, with the housing market figures conflicting with one another. The Halifax house price data for June reported a drop in house prices, for the first time since January, conflicting with Nationwide house price figures the week earlier, but the Royal Institution of Chartered Surveyors house price balance rose to a fresh high in June. The only other significant release was the May Gross Domestic Product (GDP) figures. These recorded a further expansion in growth, but much less than was expected. That was because services output expanded by roughly half of what was expected and construction output fell, albeit after a much smaller fall recorded in April versus initial readings. As such the outlook is marginally weaker than it was, but nothing more than that.

For this week, the key releases are June consumer price inflation on Tuesday and the May unemployment figures on Wednesday. The consumer price figures are expected to record a rise in headline inflation, but the core inflation rate is expected to hold steady at 2% according to market consensus. The labour market figures are predicted to record a rise in employment in the three months to May, and the headline rate of unemployment holding at 4.7%, with a risk of a fall in the rate, likely larger than the risks of it rising again.

For the GBP, a rebound in the rate versus the USD and EUR at the end of last week papered over the cracks of renewed weakness. Last week the GBP/USD hit a low of $1.3742 and remained on a general downward trajectory, whilst GBP/EUR tested above €1.17 briefly last week, but yet again failed to sustain those gains. The risks are for a further fall in the GBP over renewed rallies, with the UK fundamentals not offering any significant support.

Europe: European Commission revises up growth forecasts; final June inflation figures in focus

The European Commission’s Summer forecasts revised up growth for 2021 and 2022. The 2021 growth forecast was revised up from 4.3% to 4.8%, while the 2022 forecast was revised up marginally from 4.4% to 4.5%. The figures for inflation still strongly indicate that the EU Commission see the price increases as temporary, with inflation of 1.9% in 2021 and 1.4% in 2022. Later in the week, the European Central Bank (ECB) altered its inflation target. They moved it from below but close to 2% to a symmetrical target around 2%. That gives the ECB more leeway to allow for temporary overshoots in inflation and to support the case for full employment and faster economic growth.

The EUR has remained under pressure, and the fact that the ECB has adjusted its inflation target implicitly signals a lower for longer stance on monetary policy, despite the fact that the economy is recovering. There are plenty of concerns around the recovery and the evolution of Covid, and those are good enough reasons to keep both monetary and fiscal policy accommodative. Compared against the risks of a short-term overshoot in inflation, which is unlikely to last much into 2022, the ECB seem to have struck the right balance.

There are final June consumer price figures released this week from Euroland. There is already an expectation that the headline inflation rate will slip back beneath 2%. That is already priced into market thinking and the EUR.

In terms of the EUR’s moves this week, further upside might prove difficult to secure against the USD, with the markets focused on the current reduction in risk appetite. That is the current dominant theme in the asset markets, and the question will be what can turn the tide on this? Could it be the Q2 earnings season with many companies about to announce their results? Perhaps, but only perhaps.

United States: Fed minutes show little discussion of taper; US inflation, Beige Book and retail sales in focus

Last week’s Federal Reserve minutes of the June meeting pointed to only vague talk about the need to reduce the monetary stimulus being pumped into the US economy. That set of minutes seemed to confirm that any tapering to the asset purchase program wasn’t imminent, and that despite the fact that the US core consumer price index (CPI) inflation rate hit a multi-decade high in May. Moreover, with some signs of weakness in parts of the US economy, the authorities are mindful that the recovery is still only in its early phases.

The data and surveys last week recorded some evidence of that weakness. The Institute for Supply Management’s (ISM) index for June slipped to a reading of 60.1, from 64.0 in May, which was only the lowest reading since February, but still signalling a slowing of activity momentum. There was also more volatility in the jobless claims data, with claims rising in the latest weekly release, but continuing to decline on the continuous claims basis.

This week sees a whole plethora of releases due. The focus will undoubtedly be on the Federal Reserve’s current economic assessment, or Beige Book, released on Wednesday. This should report that the economy is still growing strongly: the labour market improvement continues at pace, but also that the housing market is under a little pressure; the surveys point to slowing in the pace of expansion; and there is an uncertain outlook for business investment. Ahead of that we get the consumer and producer price inflation figures for June, and following the Beige Book there are June industrial production and retail sales figures released.

The USD is trading more strongly not because of the strength of the US economy, but because the markets are currently looking for safe havens. It is unlikely that the data or events this week will offer a sufficiently robust counterpoint to current market behaviours. The USD is likely to attempt to make renewed gains, but that could be interrupted if there are positive data surprises from any of the major economies.

Central banks: Rates left on hold last week but cracks emerging

Last week saw interest rates left on hold by the Bank of Israel, Reserve Bank of Australia (RBA), Central Bank of Sri Lanka, Bank Negara Malaysia and National Bank of Poland. However, that wasn’t the end of the story. The Bank of Israel remained concerned about the return of Covid and financial instability more than any inflation risks. The RBA announced a pared-back extension of the asset purchase programme, but expected rates to be kept at record low levels for another two and a half years. Sri Lanka kept rates on hold despite concerns over inflation, and stated it would use FX reserves to partially repay $1bn of bonds maturing later in the month, to reduce concerns over a possible default. As for the Bank Negara Malaysia, they left the door open for an interest rate hike but that probably won’t come until 2022. The minutes from the Mexico’s Banxico latest meeting recorded two dissenting votes against the decision to hike interest rates by 25bps. The two dissenters viewed such a move as hasty, abrupt and erratic, giving the impression that recent inflation shocks could be permanent.

This week we have the Reserve Bank of New Zealand, Bank of Canada, Central Bank of South Korea and Bank of Japan all meeting. No central bank is set to alter its monetary stance, but there could be hints at hikes or at the timing of asset purchase tapering. For some central banks though, particularly in South Korea and Japan, risks are that new waves of Covid could extend the need for additional loosening rather than vice versa.

To read the previous quick take, click here

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