FX Daily: Less risk tolerance after risk rally

Supply-side constraints on slower growth and high inflation this week.
Philip Wee25 Oct 2021
    Photo credit: Unsplash Photo

    The negative impact from persistent supply-side constraints in slowing economic growth and keeping inflation high will be on the minds of central bankers and investors in the final week of October. USD could regain its composure if stock market sentiment wanes amidst higher bond yields. US equity futures are looking open weaker on Monday after record highs in the Dow and S&P 500 last week. The US 10-year treasury yield revisited 1.70% for the first time since May and is expected to hold above 1.60%.

    Many G10 countries are set to join China in reporting slower GDP growth. US will kick off on Thursday with 3Q GDP growth decelerating to an annualized 2.8% QoQ from 6.7% in 2Q. On Friday, EU growth is set to moderate to 2.1% QoQ sa from 2.2%, and Canada to 4.3% YoY from 4.7%. Last week, China’s growth slowed to 4.9% YoY from 7.9%.

    Discomfort will remain elevated over high and persistent inflation. On Friday, consensus expects US PCE deflator to pick up to 4.4% YoY in October from 4.3% in September; core inflation is seen rising to 3.7% from 3.6%. Fed Chair Jerome Powell acknowledged that supply-side constraints might last longer and lead to entrenched inflation expectations at businesses and households. US Treasury Secretary Janet Yellen believes US inflation will stay high through 1H22 before easing in 2H22. The Fed has paved the ground to start tapering asset purchases at the FOMC meeting on 3 November. Sharing the Fed’s view on rolling back Covid-led monetary stimulus, the Bank of Canada might taper at its meeting on 27 October. USD/CAD probably bottomed at 1.23 after it fell from 1.29 this month.

    GBP’s rally stalled around 1.38 alongside the FTSE 100 index at 7200 even though the market discounted a 15bps increase in the Bank of England’s bank rate to 0.25% on 3 November. Although UK CPI inflation slowed to 3.1% YoY in September from 3.2% in August, BOE Governor Andrew Bailey warned that action was needed on inflation. BOE Chief Economist Huw Pill reckoned inflation would rise slightly above 5% in early 2022 before coming off in 2H 2022. However, business leaders told MPs that the supply chain crisis will extend into 2023 with small businesses suffering most from labour shortages and price increases. The threat posed by accelerating inflation to government debt will also be on the mind of Chancellor of the Exchequer Rishi Sunak when he presents Autumn Budget 2021 on 27 October. Covid cases are rising again with UK having one of the highest infection rates in the world; the reimposition of restrictions this winter cannot be ruled out.

    EUR/USD has been in a 1.1620-1.1670 range since 19 October. EUR will be caught between a weaker EUR/JPY (like other JPY crosses vs AUD, NZD and CAD) and a higher EUR/GBP if risk appetite falls. At its governing council meeting on 28 October, the European Central Bank is probably more convinced than its peers that inflation is transitory. EU CPI inflation out the next day is expected to accelerate to 3.7% YoY in October from 3.4% in September. However, core inflation is set to be unchanged at 1.9% and below the official 2% target. Also released on 29 October, the ECB Survey of Professional Forecasters should see the ECB completing its Pandemic Emergency Purchase Programme in March 2022 and holding off rate hikes until 2023 or later. Longer-term, EUR is vulnerable from an ECB that is dovish against the Fed and the BOE.


    Philip Wee

    Senior FX Strategist - G3 & Asia
    [email protected]

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