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Dollar struggles in spite of positive US inflation surprise

We saw some volatile trading in currency markets last week. The upward surprise in US inflation had a counterintuitive effect on the Dollar, which fell hard to new multi-year lows, before rallying equally sharply to end the week down 1.5% versus European currencies.

Currency markets have turned less predictable of late, as some well-worn correlations between currencies and asset classes appear to have broken down - most notably, the one between US bond yields and the US Dollar. This apparent breakdown needs to be carefully watched and confirmed. The minutes of the Federal Reserve January meeting on Wednesday and those of the last ECB meeting on Thursday should be the focus for FX traders in an otherwise data-light week.

Major currencies in detail

GBP Economic data out of the UK was mixed last week. Inflation stayed high, and at 3% this is the only major economy where inflation remains consistently above the central bank target. On the other hand, retail sales for the month of January rose 1.5% from the previous year, disappointing expectations. We think the inflation data is considerably more relevant than the volatile retail sales number, and our call for a Bank of England interest rate hike at its May meeting is unchanged. This week is relatively busy for Sterling. In addition to the labour report on Wednesday, several Bank of England officials will testify in front of Parliament's Treasury Committee.

EUR In the absence of any key data releases, political news, or monetary policy developments, the Euro traded largely flat against all other European currencies, and rallied in a volatile fashion against the Dollar in line with all other major world currencies. The minutes from the ECB meeting and the flash business activity PMI indicators for February on Thursday should not significantly change the view of strong Eurozone growth and a very cautious future exit from negative rates policy.

USD Inflation data for January must have provided further comfort to Federal Reserve policymakers last week, confirming the view from the payrolls report that the tight labour market is finally filtering its way through to wages and prices. The Dollar did not benefit from the news, as markets were driven more by technical factors and the relief from the rebound in equity prices after the previous week’s sell-off. The calendar is relatively light in the US this week. We expect the relationship between the US Dollar and US interest rates to reassert itself, pushing the greenback higher in continuation of Friday's rally.


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