US inflation shocker makes for volatile trading week
Risk assets worldwide are hanging on near all-time highs, but are looking wobblier after a week that saw the
inflation surprise in the US we had been warning about for some time.
Considering the scale of the surprise, it’s somewhat surprising that US 10-year Treasury rates only rose by
0.04%. Nevertheless, this move was enough to upend commodity markets and sent some ripples through
emerging market currencies, which ended the week mostly if not uniformly down against the US dollar.
This week, the minutes of the Federal Reserve meeting will be published on Wednesday. We expect the
market to largely ignore them as the inflation surprise means they are somewhat out-of-date. The preliminary
PMIs of economic activity for the US, Eurozone and the UK all come out Friday, in what we expect to be the
main event of the week for markets. Beyond data and policy, the market seems to still be digesting the
dramatic increase in at least short-term inflationary pressures in the US. We think that, once it does, the path of
least resistance for the greenback will continue to be down.
Relief about the outcome of the Scottish elections and the lack of prospects for a renewed push for
independence was reinforced by a spate of very positive reports on housing prices, monthly GDP for March
and BRC retail sales. Sterling soared last week, ending the week higher against every major G10 and emerging
market currency worldwide.
This week, in addition to the always key preliminary PMI activity numbers for May on Friday, we look forward to
the inflation report on Wednesday. Markets are expecting a modest rebound in the core number. It will be
interesting to see whether the massive surprise in inflation we saw last week is a worldwide phenomenon or
remains for now limited to the US.
Investor confidence numbers in the Eurozone last week confirmed the turn to the better in European
expectations and leading economic indicators generally. We think one of the key financial and economic
factors for 2021 will be how the Eurozone bounceback compares to the US one, both in terms of speed and
the accompanying inflationary pressures.
Due to data lags, we will not have a clear picture until midsummer, however. For now, we will focus on the
leading indicators of economic activity such as the PMI indices out Friday. Another positive surprise in the
services index could provide a late-week boost to the euro.
The long anticipated increase in inflation in the US burst into full view last week. Headline inflation is running at
4.2% on the year ended in April. More ominously, the steadier core index that strips out volatile food and
energy components experienced the biggest jump since 1981; the three-month annualised rate is now running
at almost 5%.
The key now will be the reaction from the Federal Reserve. While they have been making dovish sounds about
looking past short-term price pressures and keeping policy at extremely stimulative settings, it is possible some
members may have been rattled by the burst in inflation. As for currency markets, very low rates and rising
inflation has seldom been a positive mix for any currency, and we do not expect it to be different this time.
The franc finished last week little changed against the euro and around the middle of the G10 performance
dashboard. Trading was, nonetheless, quite volatile. The choppy moves can mostly be explained by two main
factors: US data surprises, which triggered sharp moves in US yields and the broad FX market, and increased
interventions in the market from the Swiss National Bank.
SNB interventions appear to have increased markedly in the past few weeks, judging by the central bank’s sight
deposits data. Weekly deposits jumped by 3.6 billion francs in the first week of May, the highest increase since
July 2020, jumping by another 2.8 billion francs last week. This could be just a temporary response to the
currency’s recent resilience and will probably normalise later in the year should the franc to be pressured lower
by improving risk sentiment and higher US yields. In the short-term we’ll continue to focus on outside news,
while also keeping tabs on the changes in SNB sight deposits and positioning data.
The Australian dollar retreated against its peers last week, ending as the worst performer in the G10. A
combination of the strong US inflation data and heightened risk aversion have weighed on the highly
risk-sensitive AUD in the past few trading sessions. A new wave of the COVID-19 virus appears to be sweeping
through southeast Asia. This new worrisome increase in contagion has not only sapped investors appetite for
risk, but soured sentiment towards the Australian currency, given the country’s close economic ties with the
region. Thailand, Japan, Malaysia and a handful of other nations in the continent have seen new cases rise
sharply and most have not yet vaccinated enough of their population to ease lockdown restrictions.
News on the COVID front out of southeast Asia will likely remain a key driver for AUD this week. We will also
be keeping tabs on Tuesday’s RBA meeting minutes and Thursday’s monthly labour report.
CAD ended trading last week more-or-less unchanged versus the US dollar, holding onto its mantle as the best
performing G10 currency so far in 2021. Indeed, net CAD longs rose to their highest level since November
2019 in a clear indication that investors are turning increasingly bullish towards the currency. Elevated longs
do, however, usually suggest that a retracement is perhaps on the cards and given the balance of risks and
extent of the currency’s recent move higher, we think that there is a good chance that this may come to pass in
the next couple of weeks.
There was very little macroeconomic news out of Canada last week, which was partly a reason why volatility in
the USD/CAD cross was limited. This week should be a much busier one in Canada. Inflation data for April, out
on Wednesday, will give us a decent idea as to whether the surge in price growth in the US is localised or a
more widespread phenomenon. We will also be keeping tabs on Thursday’s ADP employment report for April
and Friday’s retail sales data for March. The latter runs on a bit more of a lag, and therefore may well be
overlooked by currency traders.
The rally witnessed in the dollar following the much stronger-than-expected US inflation print allowed the
USD/CNY cross to retrace around half of its move lower from the week previous last week. Even after the
retracement, the yuan is still trading just shy of its strongest position versus the dollar since June 2018, a
combination of a broadly weaker dollar and the impressive economic outperformance experienced by the
News regarding the latter out this morning was mixed, albeit still pointed to solid expansion. Fixed asset
investment data for April came in above consensus, although retail sales growth for last month fell short of
economists expectations. Sales grew by just 1.75% month-on-month and 17.7% year-on-year, half the pace of
the previous three months and well short of the 24.9% consensus. With no real major economic data out of
China on the calendar this week, attention will be on the PBoC’s May meeting on Thursday. Barring any
surprises here, we expect the yuan to be driven largely by goings on elsewhere.