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  • EUR/USD has slipped back from Asia Pacific levels around 1.2100 to range around 1.2050.
  • Market commentators are attributing euro underperformance on Fed/ECB divergence.
  • Eurozone and US data both sent inflationary signals but were both mostly ignored by FX markets.

It’s not been a great day for the euro, which has weakened against the majority of its major G10 FX counterparts aside from the yen and Swiss franc. Against the euro, it is down about 0.1% or about 15 pips, having slipped back from Asia Pacific levels around the 1.2100 level, with resistance in the form of the 21-day moving average at 1.20956 not helping. At present and for the last few hours, EUR/USD has traded close to the 1.2050 mark, finding support when it fell as far as 1.2030 but struggling the closer it got to 1.2070.

Driving the day

Market commentators have attributed euro weakness versus the US dollar to divergent views from Fed and ECB members regarding recent bond market moves; Fed officials continue to not show any concern about recent upside in bond yields, with FOMC Member Thomas Barkin going as far as saying that the Fed would be disappointed not to see yields rise when the economic outlook improves. Such commentary is in stark contrast to commentary from ECB members who at the very minimum have indicated that the bank is “closely monitoring” long-term bond yields (President Christine Lagarde and a number of other officials said this last week). Other ECB members have gone further, with one calling outright for an acceleration in the pace of weekly asset purchases in order to drive yields lower, a sentiment which ECB Governing Council Member Francois Villeroy de Galhau seemed to sympathise with when giving comments on Monday; de Galhau essentially said that to the degree to which rising bond yields constitute an “unwarranted” tightening of financial conditions, the ECB should “act” to counter this.

Eurozone and US data has for the most part been ignored by markets, but rising German (and Eurozone-wide) inflation poses a problem for an ECB that remains intent on staying dovish. Headline German Consumer Price Inflation rose at a MoM pace of 0.7% (versus forecasts for 0.5%) and a YoY pace of 1.3% (versus forecasts for 1.2%). HICP (the measure relevant to the ECB) was also firmer than expected, with the YoY rate coming in at 1.6%. ING attributes the further acceleration in German inflation to higher energy prices, although they caveat that “these numbers are still distorted by lockdowns and imputed prices as many goods and services are simply not available”.

According to ING, “there will be a series of one-off factors pushing up headline inflation”. In the short run, the bank thinks it will mainly be higher energy prices driving up inflation but, in the longer-term when economies reopen, “price mark-ups in sectors most hit by the lockdowns will also add to upward pressure on inflation”. Moreover, “the full swing of the German VAT reversal will only unfold in the second half of the year”. As such, ING are forecasting German headline inflation to rise to somewhere between 3% to 4% and that eurozone inflation could rise above the 2% level this year. Still, the bank (and most other analysts) expect the ECB to turn a blind eye to what they are likely to call a transitory pick up in inflation.

US Data

In terms of US data, the final Markit Manufacturing PMI headline index number for February saw a slight revision higher to 58.6 from 58.5 and Construction Spending in January grew at a slightly faster MoM pace of 1.7% versus expectations for a MoM growth rate of 0.8%. These data points have largely been ignored however, with market participants much more focused on the February ISM manufacturing survey.

The headline ISM Manufacturing PMI number came in above expectations at 60.8 (expected was 58.8), its highest since September 2018. The employment subindex rose to 54.4, boding well for this week’s official US labour market report. New Orders rose to 64.8 from 61.1, in a sign of strong demand ahead. But the Prices Paid subindex shot higher to 86.0, its highest level since 2008. According to Capital Economics, “higher oil prices and the depreciation of the dollar are putting some upward pressure on US prices this time around too, but the scale of the rise in the ISM prices paid index goes well beyond what can be explained by those factors alone”. The economic consultancy continues that “the comments in the report also make it crystal clear that these shortages go well beyond just semiconductors, with firms in every sector reporting shortages and problems with suppliers keeping up with demand”.

Amid further evidence of the build-up of inflationary pressures following this latest ISM report, ING comment that they now “expect inflation to rise above 3.5% in the second quarter”. Though the Fed has said that this expected increase in inflation will not be sustained and thus does not warrant a policy response, ING thinks “there is a growing risk inflation could end up being a little stickier around the 3% mark given the prospect of vibrant, stimulus fueled demand coming up against a supply-constrained economy and businesses taking advantage to rebuild margins.” Thus, concludes the bank, though “the Federal Reserve tells us that they don’t think they will raise interest rates before 2024… we feel that this will be increasingly difficult to reconcile with the data… (and) mid-2023 looks increasingly likely to be the starting point for higher US interest rates”.


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