Caution: Strong Dollar Ahead

DOLLAR HEADING HIGHER

The US dollar has once again been at the fore as it recorded further gains against both Sterling and the Euro. The pound at one point slipped to its lowest level of the year against the greenback despite the support provided by rising interest rate expectations. However, after an early wobble it seems to be ending the week little changed against the Euro.

The past week has been another volatile one in markets with equity prices falling. Concerns about rising inflation and weakening growth, both seemingly linked to supply-side disruptions reflecting the ongoing impact of the pandemic, have been the key drivers. Meanwhile, commodity prices are rising again and the Brent crude oil price touched above $80bbl this week for the first time in three years. Other issues such as the outlook for Chinese property company Evergrande also remain of concern.

Markets are now discounting around 60 basis points of interest rate hikes by the end of next year from the Bank of England despite ongoing uncertainties about the growth outlook.

POLICY SHIFTS EXPECTED FROM CENTRAL BANKS

Where next for central banks remains a key focus for markets. After last week’s policy updates from the Bank of England and the US Federal Reserve, which seemed to suggest that policy changes may not be far away, this week’s follow up speeches from policymakers did little to dampen speculation. We noted earlier that UK rate expectations have hardened despite comments in the minutes of the BoE’s September meeting noting that a highly uncertain situation made a strong case for a wait-and-see approach. In the US, an announcement on tapering of its asset purchases after its 3rd November meeting seems to be now regarded by markets as a done deal. There is also growing speculation of a Fed rate hike in 2022, although markets still seem to regard that as less likely than a BoE rate rise. The rapid rise in Eurozone inflation will also complicate the policy discussion at the European Central Bank although a significant early change to Eurozone monetary policy is still seen as less likely than moves elsewhere. Next week’s central bank speaker schedule is less busy. However, markets will still look for clues on what to expect from what may be some potentially highly significant policy reviews in late October and early November.

LABOUR MARKET TO BE EYED WITH TAPERING IN MIND

Friday’s monthly US labour market report stands out in what is otherwise a light week for economic data. It is always seen as a key bellwether of economic conditions but as September is the only employment report before the next Fed meeting it takes on extra significance. Fed Chair Powell has set the bar low saying that even moderate employment growth would still be consistent with a tapering announcement at the November meeting. Consensus expectations are for a 500k monthly rise, what should be more than enough to meet Powell’s criteria. We are forecasting a slightly stronger increase of around 550k and a further decline in the unemployment rate to 5.0% (from 5.2% in August).

There may be some downside risks due to that forecast due to the rise in Covid cases in the US over the summer, which probably lay behind the much weaker-than-expected August rise in payrolls of 235k (the smallest rise for 8 months). Some economists at the Fed, using a model based on high frequency data, are predicting a fall in September payrolls. However, that model has only a very limited historic record and more traditional indicators do not point to such a weak outturn.

The wage data in the labour market will also be watched with particular interest given ongoing reports of labour shortages and recruitment difficulties. We expect annual growth to have risen modestly. However, any underlying message in the data continues to be swamped by distortions due to the pandemic, which makes the situation hard to assess. The September ISM services measure will provide a further indication whether near-term growth is slowing. It was down last month with supply constraints mentioned as a key factor although the level of the index is still elevated.

UK FOCUSES ON SUPPLY CHAIN CONSTRAINTS

Outside the US, the data calendar is very light. In the UK, the September services PMI report is a second reading that is not expected to be revised from the first estimate. However, the construction PMI is new data and we look for a modest rise in activity, although reports of supply issues are again likely to be to the fore. The Eurozone services PMI is also a final reading that is not forecast to be revised. Given the lack of data, markets may also give a high weight to anecdotal reports of UK supply issues particularly the latest updates on delivery issues including to petrol forecourts. Any news on the immediate impact of the end to the government’s furlough scheme will also be of interest although it will take some time for that to show up in the official UK labour market data.

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