Morning Brief – Knock-On 

Charles Porter
Thu 16 Feb 2023


As we have covered, the US Dollar has remained well supported. The bond rally that has been observed over the past few weeks has been reversed in the face of strong US economic data and a hawkish rhetoric coming from Federal Reserve Officials. What is also worth noting is that the presence of a stronger Dollar is having some strong displacement effects across the market, and not just within the emerging market FX basket as we discussed earlier this week. Following Tuesday’s inflation data which showed an above-forecast presence of inflation year-on-year in January and yesterday’s retail sales data, the Dollar is bid, and bond prices are softer. 

Whilst this Dollar resurgence has taken place, the Japanese Yen and Chinese Yuan have slipped to rival their respective year-to-date lows. The Pound Sterling has also taken a hit trading down almost 1.5% during yesterday’s session and pushing the GBPUSD pair into the red year-to-date. The pair challenged the psychological level of 1.20 yesterday with some intraday breaks of this level being recorded. With the UK reporting inflation data only one day after the US, it is the opportunity for contrast between the two inflation figures that is driving opposing forces within yields on their respective fixed income contracts and currencies. 

UK inflation today came in at 10.1% year-on-year versus an expectation of 10.3% and a previous figure of 10.5%. Similarly, Core inflation showed a 5.8% rise versus 6.2% forecast and 6.3% prior reading. This is still astronomically high and well above target, however, the image received by the market thanks to the direct contrast to US data released only yesterday is that UK inflation has taken a more tangible turn lower and much faster than that in the US. Furthermore, the more concerning component of inflation, services inflation, was also seen to show more significant moderation than otherwise expected. 

Due to the seasonality behind data, it is possible that the sell-off in GBP correcting the recent rally in bond prices could be overplayed for now. It is more likely that as a result of the simultaneous readings of the transatlantic data points, GBPUSD has taken an exaggerated step downwards. What is likely a more credible move is the sell-off in the Chinese Yuan and Japanese Yen given the US inflation data. China’s Yuan has been sensitive to higher US rate expectations due to the Chinese central bank’s liquidity infections to simulate economic activity lately. The contrasting monetary policies between China and the United States has left currency volatility high. 

Given the handover of power at the Bank of Japan, the Yen has also experienced relatively high levels of currency volatility. The moves seen throughout last year within JPY crosses have more often than not reflected the ultra-accommodative policy adopted by the central bank despite rising global inflation. Stronger US inflation readings and therefore US rate expectations is creating vulnerability within lower yielding currencies and those beginning to exhibit normalising inflation patterns. 

Discussion and Analysis by Charles Porter

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