The Euro finished the week at the bottom of the G10 rankings on concerns the war in Ukraine will not stop any time soon as well as jitters about the French presidential election. The carnage in the US bond market continues, with 10-year Treasury yields up an astounding 30 bp on the week, and the dollar reacted in the expected way by topping every major currency in the world save a handful of volatile EM ones. Ruble volatility continues and the currency is now higher than before Russia launched its invasion, but it is extremely illiquid and market quotations increasingly meaningless. The Chinese Yuan is proving a rock of stability amid currency market uncertainty, hitting fresh records on a trade-weighted basis in spite of the Chinese economic slowdown and Draconian COVID lockdowns.
Next week’s ECB meeting is shaping up to be a critical one. The conflict between hawks and doves we had predicted for some time has erupted, as the minutes from the previous meeting make clear, and we expect communications from the central bank on Thursday to reflect that, after some really ugly inflation readings. March inflation data out of the US (Tuesday) and the UK (Wednesday). It will be an unusually busy week for the Pound, as we will also get the February employment report on Tuesday.
Sterling has had a rough time of it over the past few weeks after dovish rhetoric from the Bank of England, However, the very strong March PMIs and what we expect to be equally strong labor market and inflation data should put a floor under the currency as we wait for the MPC members to acknowledge the reality of a fresh inflationary wave hitting an economy already at full capacity. We expect Cable to find a floor around current levels as the Bank of England stance becomes increasingly untenable.
The first round of the French presidential elections was a mild Euro positive, as Macron appears to go into the second round against Le Pen in a slightly stronger position than expected. More Euro positive news were a chorus of hawkish remarks from ECB members as well as some scathing remarks in the March meeting minutes about its staff’s almost incredibly optimistic inflation forecasts which expect a return to just on target inflation by 2023. Neither of these seems to have had much of an impact on the market, and all eyes now turn to next week’s ECB meeting. We think that even a slight change in tone from the heretofore dovish Lagarde could have a disproportionately positive effect on the common currency.
The minutes from the Federal Reserve meeting revealed a more aggressive than expected plan to wind down the Fed’s gigantic holdings of Treasury and mortgage bonds. Markets continued to ratchet up expectations of Fed hikes, and now expect rates to be above 3% at some point in the first half of 2023. It will be difficult to price in even more hawkishness from the Fed without the ECB at least closing the gap somewhat, which makes us think that the Euro may be due for a rebound soon, particularly if, as we expect, Macron wins the second round of the French presidential election two weeks hence.