Dollar rally stalls as risk seeking trend returns
Financial assets worldwide rallied, as US stocks broke to all new highs and commodity prices rebounded from
their post-Fed sell-off.
Currencies behaved much as they had before that Fed meeting. The dollar resumed its downward trend,
safe-havens like the Japanese yen and the Swiss franc suffered and commodity-dependent currencies
outperformed, particularly Latin American ones.
Markets seem to think that Federal Reserve communications since the June meeting have walked back at least
some of the perceived harkish tone. We tend to agree, on the basis that talk is cheap and political resistance
will make it difficult to change the strongly inflationary policy mix in the short- and medium-term. This week the
focus returns to macroeconomic indicators, particularly the June flash inflation print out of the Eurozone on
Thursday and the employment report out of the US on Friday.
The UK PMIs of business activity came in somewhat below expectations last week, albeit remaining at very
strong and near record high levels indicating growing economic activity across most sectors.
For its part, the Bank of England essentially punted to August and September any serious discussion of policy
tightening. It’s understandable; by then the picture on whether inflationary pressures are transitory should be
clearer. With these major macroeconomic and policy news out of the way, the UK calendar looks thin and
sterling should trade mostly off of events elsewhere.
In contrast to the UK, the Eurozone PMIs came out even stronger-than-expected, and in fact reached 15-year
highs as pent up demand is finally released by the lifting of the pandemic restrictions. It looks increasingly likely
that our call for a stronger and faster than expected rebound, following on the heels of the US experience, will
be borne out.
Inflation reports everywhere have taken increased importance, and the flash inflation report for June in the
Eurozone will be no exception. We see scope for yet another upward surprise, which could add fuel to the
euro’s rebound from its post-Fed lows.
The slate of speeches from Federal Reserve officials last week added nuance to the hawkishness apparent in
the June meeting communications. It appears that the institution is split over Chair Powell’s position that
inflation will come back down without any need for policy tightening. This is likely to remain a rhetorical
exercise for now, since even the most hawkish members do not envision hikes until late-2022. Mere jawboning
is unlikely to have any significant effect on markets, and we expect that the trends toward higher asset prices
and stronger inflationary pressures will be with us for a while yet, an environment that is particularly supportive
of emerging market currencies.
The labour report on Friday will provide more insight on the tension between strong demand and a supply side
that is struggling to rehire and rebuild capacity in the service sector after the pandemic disruption. We think
we’ll see significant job creation, another downtick in unemployment, but perhaps stronger wage hikes than
the market is expecting.
The Swiss franc stabilised against the euro last week after an earlier sell-off. Nevertheless, the currency was
among the worst-performers in the G10 alongside the other safe-havens as markets returned to risk seeking,
setting aside signals from the Fed.
Contrary to the previous, rather uneventful week in terms of domestic news, this one will bring a number of
readings from Switzerland concentrated around the middle of the week. While neither are expected to rock the
boat, we’ll be closely watching Wednesday’s leading KOF indicators index and Thursday’s inflation data for
June. CHF positioning data from CFTC will also catch our attention as recent data showed an increase in
speculative net longs to the highest level since March.
The Australian dollar suffered one of the larger sell-offs in the G10 following the Fed’s June meeting, although
it was the third best performer last week, rebounding to around the 0.76 level versus the US dollar.
Headlines out of the country have, however, been largely dominated by the news of fresh lockdowns over the weekend.
New case numbers are still comparatively low, but there are early signs that the delta variant is beginning to
spread aggressively among the population in some of the major cities. A two-week lockdown has been
imposed in Sydney in an attempt to rein in infection levels. With only around 23% of the population
vaccinated, these mini-lockdowns are likely to remain a thing for a while, which undoubtedly presents a
possible downside risk to AUD.
Trade data for May will be released on Thursday, although other than that this week is likely to be a relatively
CAD edged marginally higher versus the dollar last week as a handful of FOMC members backtracked on the
bank’s hawkishness from its June meeting. The Canadian currency remains a favoured destination for investors
among the G10 and has been able to recover around a half of its post-FOMC losses already, despite some
relatively disappointing domestic economic news out last week.
Retail sales sank in April during the country’s third wave of infection, down 5.7% on a month previous – its
largest decline since the peak of the downturn in April 2020. Since then, however, case numbers have dropped
significantly and Canada has rolled out vaccines at a rapid pace. We see this downturn in consumer spending
as a temporary blip and expect data in the coming weeks to show that the economy ended the second quarter
of the year on a much stronger note. Thursday’s manufacturing PMI for June could provide early indication of
The yuan spent much of last week stuck within a relatively narrow range versus the dollar, ending more-or-less
where it began it. The People’s Bank of China has increased the size of its daily Open Market Operations
(OMO) for the first time in four months in the past couple of trading days from 10 billion yuan to 20 billion
yuan, although we see this as a no more than a technical change. Indeed, there has been very little reaction in
the FX market worth noting.
The monthly PMI indices out of China will be released this week. Investors are bracing for a fairly marked
slowdown in the non-manufacturing index on Wednesday from 55.2 to 52.7. If confirmed, this would be further
evidence that the recovery in the Chinese economy from the pandemic is slowing and that we may be seeing a
further narrowing in the gap in economic performance between China and most other nations.