Munix Weekly 21st July
Time to watch the currency markets
In recent months, central bankers have been paying considerable attention to leading indicators of economic recession and inflationary pressures rippling through commodity, product and labour markets. To add to that assessment, they need to start examining the movements in currency markets too.
This year has seen a noticeable appreciation of the US dollar by over 10% against other major currencies. This has partly related to the shift towards a more aggressive stance by the Federal Reserve, widely expected to raise interest rates by another 0.75% next week. In addition, concerns about the Russia-Ukraine war have had much more of an impact on Europe than Asia or America; indeed speculation has grown that Russia might switch off more natural gas supplies to Europe in coming months, which could push that region into an unpleasant recession. Political concerns have also reared their ugly heads, with worries about a collapse in the Italian government. The end result has been the Euro declining towards parity versus the US dollar; it is not alone of course as the Pound has fallen below 1.20 to the dollar. Such concerns will feed through into higher import prices, especially commodities such as oil denominated in dollars.
Accordingly, the ECB was widely expected to begin its hiking process this week, and duly obliged with a move of 0.5%, albeit only bringing headline rates back to zero, whist hinting at more to come into the autumn. This news was matched with the creation of a new programme of bond purchases, the TPI or “transmission protection instrument”. Such an ‘anti-fragmentation’ tool is intended to restrain the widening bond spreads between, say, German and Italian bond yields, which could in theory cripple Italian fiscal policy if allowed to expand too much.
The Monetary Policy Committee is in a similar position. The depreciation of sterling against the dollar will reinforce the signs of domestic inflationary pressure shown in the latest labour market report. Continued job creation kept unemployment at a trough of 3.8%, whilst the backdrop remains a series of strikes across different sectors as workers strive for wage increases to match high headline inflation. The June CPI report was also a little worse than expected. Headline CPI reached 9.4% pa in June due to food and fuel with 11.5% forecast for October when the energy price cap is lifted. Against this backdrop, the MPC is widely expected to raise interest rates by 0.5% at its August meeting. A looming danger for the Bank would being drawn into the political tensions surrounding the election of a new Conservative Party leader and Prime Minister, with very different views about the direction of fiscal and monetary policy from Sunak and Truss.
Bond markets also had the standard array of economic and corporate news to take into this week. On balance business surveys and the reports from senior company management still suggest weaker rather than stronger global economic activity into the second half of the year – albeit recession is not definitely on the cards. The net result was little major change in most bond yields, although central bankers will remain wary that volatility in currency markets might spill over into fixed income markets if their decision making looks to be leading to any major policy errors.
Bond yields at the time of writing this week
% 2 year 5 year 10 year
USA 3.16 3.07 2.96
UK 2.00 1.85 2.05
Germany 0.62 1.01 1.23
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making