Dollar rally pauses amid emerging market volatility

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11 June 2018

thomasdodds

The relatively modest weekly move in the Dollar against most major currencies masked the enormous volatility experienced by key emerging markets currencies, primarily, the Brazilian Real. G10 currency moves were mild by comparison, and the Euro led European currencies in staging a modest bounce against the Dollar, as markets become more confident on an end-of-year taper to the ECB’s QE programme.

T
his week is shaping up as a critical one for currency markets. The Federal Reserve is meeting on Wednesday and the ECB on Thursday. In addition, the House of Commons vote on the EU withdrawal Bill on Tuesday will provide political headlines. Finally, key inflation data in the US is due Tuesday and in the UK on Wednesday. In parallel with these developments, headlines from the US-North Korea summit have the potential to add some serious volatility to the mix in the coming week.

Major currencies in detail

GBP

Sterling is trading almost tick-by-tick with the Euro, torn between a somewhat better tone in economic data and mostly bad news regarding the state of Brexit negotiations. It is somewhat remarkable that Sterling has failed to benefit from Euro weakness and is still trading close to the 0.88-0.89 level, but we think there is a good chance this will change as soon as Brexit headlines take a turn for the better. This week’s debate in the House of Commons on the EU Withdrawal Bill will provide less substantive information than the crucial labour and inflation data, set for release on Wednesday.

EUR

There is more uncertainty than usual around the key ECB meeting this week. It is not clear to us what reaction the Council will have to the political and market turmoil caused by the new the Italian populist government, and also the unrelated slowdown in economic data out of the Euro-area. We think these twin worries are sufficient to delay the announcement of an end to QE for later this year, until the July meeting. On a longer time frame, however, the strong bounceback in inflation data we saw in May provides the first tentative evidence for an uptrend in this critical economic indicator and that the Dollar rally against the Euro may be nearing its end.

USD

With the Federal Reserve set to hike rates next week, and US inflation data likely to show yet another uptick, the only thing keeping the US 10 year Treasury rate below 3.0% has been the bout of market volatility which started in Italian bonds and spilled over to more vulnerable emerging markets. The latter showed positive signs in the second half of last week, seen in the strong bounce back in the Brazilian Real from its panic Wednesday lows. If this resilience continues, US rates should resume a modest march upwards. However, we are starting to think that Dollar levels against most currencies already price in these developments and we do not necessarily expect the US Dollar to follow this upward path in the short term.