Sovereign International Daily Market Report
Euro hits one-year highs as US inflation continues to cool
Once again, the dollar was firmly on the back foot during London trading on Thursday, grinding lower off the back of further signs of an easing in US inflationary pressures.
Indicators of both consumer and producer price data have undershot expectations this week, while simultaneously exhibiting clear signs of a downtrend. According to data released yesterday, US producer prices dropped by the most since the start of the COVID-19 pandemic in March (-0.5% MoM) and rose by only 2.7% on a year previous - the slowest pace since January 2021. Not only does the data suggest that the Fed’s aggressive pace of policy tightening in the past year is indeed working, but that additional interest rate hikes are probably unlikely to be needed beyond the May FOMC meeting.
The US dollar has reacted as one would expect to sign of a cooling in price pressures, selling off against almost every other major currency. Wednesday evening’s FOMC meeting minutes, which were somewhat on the dovish side, can perhaps partly explain the extent of the move. The minutes noted that ‘several’ members considered not voting for a rate hike last month, although ultimately this was unanimously agreed. Fed members also now see a mild US recession later in the year because of the recent banking turmoil. All in all, this not exactly consistent with language that would suggest that the Fed has much further to go in the current tightening cycle.
Interestingly, the euro has outperformed its peers in the past few days, with the common currency surging back to its highest level since April 2022 on Thursday. We largely attribute this to growing expectations in favour of a widening in US-Euro Area rate differentials this year. While the Fed appears likely to adopt a ‘one and done’ strategy, the ECB clearly has a little way more to go. Recent ECB communications have been largely on the hawkish, with members Holzmann and Vasle appearing either in support or open to another 50bp hike at the May Governing Council meeting. As things stand, this is still only roughly 40% priced in by swap markets, so there remains room for more upside in the euro should the bank spring a hawkish surprise.
Sterling was also able to capitalise on the broad weakness in the dollar, rallying up and briefly touching its strongest position since June. That said, the pound did slip up against the euro yesterday, which we think is perhaps in recognition of lingering concerns about the state of Britain’s economy. Most indicators of UK economic activity have surprised to the upside recently, although yesterday’s monthly GDP print for February was a slight disappointment, with the economy posting flat growth versus the +0.1% consensus. While the upward revision to the January number (0.4% vs. 0.3% initial estimate) made up for this shortfall, the data is only really consistent with rather modest expansion, with the IMF warning that the UK economy would be the worst performer in the G20 this year.
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Focus in markets will remain on the US today, with the release of the latest retail sales data set for 13:30 BST, 14:40 CET.
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