The traditional relationship between interest rates and currencies re-established itself with a vengeance last week.
The minutes from the last Federal Reserve meeting left no doubt that a March interest rate hike is a foregone conclusion, and sent US yields to new year highs. The Dollar followed higher, ending the week up against every other G10 currency. Last week's loser was the Swedish Krona, down sharply on disappointing inflation data that delay the prospects for Riksbank policy normalisation.
This week is relatively light in terms of macroeconomics releases. European politics should be the main factor driving markets. In addition to the run-up to the Italian elections next weekend, German social democrats will hold a vote of whether to join Angela Merkel's grand coalition government.
Major currencies in detail
Sterling had a rather good week, finishing as the second best performer in the G10, right behind the US Dollar, and gaining 1% against the Euro. It drew support from hawkish Bank of England comments at the parliamentary Treasury Committee, and also news that the Cabinet is closer to a unified position on Brexit.
In addition to the business activity survey for manufacturing out Thursday, the key event for the Pound will be Bank of England Deputy Governor Cunliffe's speech on Monday. We are looking for hawkish confirmation that the MPC will hike rates as early as May, in line with our forecasts.
The weak tone on most of last week's economic releases combined with the general Dollar rally sent the common currency sharply down against the greenback. The business activity PMI surveys all came in weaker than expected, though they remain at high levels. The minutes from the last ECB meeting proved to be mostly a non event. In this context, the fresh widening of short term rate differentials with the US to new cycle highs pressured the Euro lower.
Politics will be the focus in the Eurozone this week. The parliamentary elections in Italy will likely result in a muddled, inconclusive parliament. On the same date, the German SPD membership votes on whether to join a Grand Coalition with Angela Merkel's Christian Democrats. While polls are consistent with a slim majority voting yes, uncertainty remains high. Sunday night FX trading on 4th March should be interesting and volatile.
The hawkish minutes from the FOMC’s January meeting set the Dollar on a positive course early in the week. It needs to be noted that since that meeting, US data has become even more supportive of Federal Reserve hikes. Inflation and wages have generally surprised to the upside. A March hike is now a near certainty, and the market is coming ever closer to our view that there will be four rate hikes in 2018.
This week we look to the personal consumption deflator to provide another positive surprise on Wednesday, which should continue to buoy the Dollar towards the higher levels of its recent range.