Dollar falls sharply as emerging market currencies rally hard, Brexit troubles sink Pound

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24 September 2018

thomasdodds

A broad-based rally of risk assets in general slammed safe haven currencies and the Dollar in particular last week.

S
harp rebounds in emerging market currencies and the most battered G10 ones meant the Dollar underperformed every major peer except for the Japanese Yen. However, Sterling failed to benefit from Dollar weakness, as news that Brexit negotiations were stalled by the EU rejection of the “Chequers plan” slammed the Pound on Friday, and caused it to give up all of the week’s gains in just a few hours.

We are now into the fourth week of this US Dollar downturn. The key question now is whether this is just temporary weakness or a sustained trend brought about by the convergence in monetary policies in G10 countries, as more and more central banks follow the Federal Reserve’s lead and begin to tighten their stance.

This week’s meeting of the Federal Reserve, complete with press conference and staff forecasts, will provide critical information to answer the question. Any political developments from Brexit will also be closely followed by Pound traders after last week’s dismal news and performance.

Major currencies in detail

GBP

Sterling experienced one of its most volatile weeks of the year. An upside surprise in inflation data brought forward the prospects for Bank of England rate increases and buoyed the Pound. However, the news that the EU had flatly rejected Prime Minister May’s so-called “Checkers plan” and that the Brexit negotiations were in risk of collapse hit markets and Sterling experienced its worst one-day performance since the referendum crash.

With little news on tap out of the UK, we expect Sterling to continue trading in response to Brexit negotiation rumors or headlines.

EUR

A very quiet week for Eurozone news meant the Euro mostly traded in reaction to news elsewhere. It dutifully followed the general rally against the US Dollar, but gave up some of its gains in reaction to the bad Brexit news on Friday.

We are increasingly focusing on inflation as the key to future ECB tightening, and hence the future direction of the EUR/USD cross rate. This week we get the preliminary inflation data for September. For the timetable for Q3 2019 hikes to remain on track, we need to see a clear upward trend on core Eurozone inflation soon. Forecasts for this week’s number on Friday are subdued at 1%. Even a modest upward surprise would have a positive impact on the common currency.

USD

This week’s Federal Reserve meeting is shaping up to be particularly important. Though another hike in the overnight rate is universally expected, substantial uncertainty surrounds the communications from the Fed. It seems that markets are expecting a noticeable upward revision in Fed forecasts for growth, inflation and perhaps future rates in the the famous “dot plot”. Yet, in spite of this, the Dollar has now been falling for three straight weeks. We think that risks for the greenback may be tilted to the downside if the Fed maintains essentially unchanged its guidance from the previous meeting.