FX Market View #37 Markets breakouts have subsided but inflation remains

During the first month of the year, the currency markets fed on optimism from lower global unemployment data that support a consensus for economic growth. This positive sentiment encouraged a number of breakout patterns in several of the major crosses. The Dollar rallied to five year highs against the Yen, whilst breaking out of an unrelenting range against the Euro. However, these near term spikes and dips eventually subsided with the Dollar returning to the range against the Yen which it was confined to four months earlier. Against the common currency the Dollar would have also returned to earlier range bound levels, if not for the hawkish signal from the ECB. A similar picture was seen in the EURCHF cross, with the Swiss Franc spiking to seven year highs on the back of geo-political tensions, eventually reversing to an earlier equilibrium.
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The currency markets therefore appear to remain in a range bound state, searching for the data that can support a sustainable broader move. Looking ahead, the global markets are forced to react to inflationary pressures. Central banks are responding by raising interest rates in order to stabilise economic growth, as parts of the world are relaxing COVID restrictions. If left improperly managed, rising prices driven by surging energy costs and increasing consumer demand will have a spill over effect onto risk assets. Across the financial markets the impact of the energy sector has taken a clear direction with the added volatility. US Oil is trading significantly higher with global equities also adjusting upwards following a brief selloff last month.
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To summarise the views of this past week, it appears that the world is coming to terms with Omicron and the key market theme is managing inflation. Looking back six months it would not have been a likely scenario that central banks will be raising rates, and on multiple occasions with the several high income nations. Last year markets were predicting the first US interest rate hike in 2024. So far the ECB is one of the only major central banks not to yet hike. A reason for this delay in normalising monetary policy can be partially explained. The fact that the Eurozone has only recently returned to its pre-crisis level at the end of last year, can indicate that the inflationary pressures are transitional. However, with inflation being the hot topic of the moment the ECB will need to speed up tapering and prepare the path for higher interest rates.