different dollar bills on marble surface

In our FX review for this week, we talk through the impact of the latest US inflation figures, the retracement of EUR gains, and what confirmation of strong GDP figures means for GBP.

Inflation putting pressure on the Fed

The main focus for the week was the US CPI inflation print put out on Wednesday. Jesse posted some quick thoughts on it at the time, which can be read here.

In short, inflation continues to move higher, with January YoY figure at 7.5%, up from 7% previously and expectations of 7.3%. Although the price action was extremely messy in the immediate aftermath, USD gains ultimately won out. For example, EUR/USD struggled to maintain levels in the mid 1.14’s, dropping to close the week a cent lower. 

Chatter following the bumper figure is that we could see the US Fed raise rates before the March meeting in an unscheduled hike. This isn’t without precedence (think back to 2020 when rates were cut outside of the usual meeting times). However, we think that this is unlikely to happen now. Firstly, we don’t think the period between now and the March meeting is long enough to really be able to move the needle much by raising early. Secondly, we think this would signal to the market that the Fed is starting to panic, and isn’t in control of monetary policy.

Rather, we think that the inflation number cements a 50bps hike for March, rather than 25bps. The larger step in the rate hike should allow the Fed to show that it’s taking strong action to counter inflation that is showing no signs of slowing down.

Finding value outside of USD

Even with some USD gains from the inflation print, a lot of optimism is built into the dollar at current levels. With the expectation of rate hikes already in the price, we struggle to see significant gains in coming weeks, even with a 50bps hike in March. Rather, we actually like using this dip to get long EUR/USD. 

Even with the retracement of EUR gains after the pivot from the ECB the previous week, we think for relative value the EUR wins out. There’s more room for investors to price in a more hawkish ECB than the Fed. 

As for GBP, GDP figures out on Friday showed growth in 2021 not seen since the second World War. Sterling wasn’t able to really push higher on this news, as again most are looking at it from a rates position. With expectations of potentially another 4 rate hikes this year from the Bank of England, GBP might struggle to appreciate until these are realized. 

As a team, we are actually turning more neutral on GBP crosses, as we think the bar is very high for the BoE. Any indication that the UK economy in 2022 isn’t performing as well as hoped could see the bank pause on rate hikes. Given that hiking is priced in, this could see GBP move lower, not higher.

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