Inflation and central bank responses continued to dominate markets on Tuesday.

Inflation and central bank responses continued to dominate markets on Tuesday.

US and global bond yields moved higher amid less confidence that higher inflation would be transitory. Risk appetite was underpinned by expectations of reflation trades with global bourses at a 1-month high. Wall Street equities also posted limited net gains.

The dollar lost ground, especially with a lack of defensive demand, but did recover from 3-week lows. EUR/USD moved above 1.1650 before stabilising. The yen remained under pressure with USD/JPY posting 47-month highs. Sterling gained further support from expectations of a near-term Bank of England rate hike with GBP/USD above 1.3800. Commodity currencies drew support from strength in commodity prices with AUD/USD at 4-month highs.

ECB Council member Villeroy stated that there was no reason for the ECB to increase interest rates between now and the end of next year. He also reiterated that higher inflation is transitory, although there was slippage on the timeline with comments that inflation should fall back below 2% by the end of 2022.

In contrast, fellow member Vasle stated that there were early signs that wage pressures could become material which could pose inflation risks. There were still expectations that the majority would push for a very accommodative monetary policy.

The dollar overall continued to retreat ahead of the New York open with EUR/USD strengthening to highs at 1.1670. The US currency was hurt by speculation that more central banks would push ahead with interest rate hikes ahead of the Federal Reserve. There was also evidence of long liquidation after the sharp retracement.

Richmond Fed President Barkin stated that labour shortages might outlast the pandemic. Fed Governor Bowman stated that the central bank is looking at a situation where we may see inflation lasting longer than expected a few months ago. She added that a substantial number of older workers might not return to the labour market.

Fellow Governor Waller stated that he will favour an earlier lift-off in interest rates if inflation runs above 2% well into 2022 and there will be action if there is any sign of inflation expectations becoming unanchored. Fed commentary will continue to be watched closely in the short term.

The dollar regained some ground later in the day with increased interest in using the Euro as a funding currency curbing support as commodity currencies posted further gains against the single currency. The dollar overall, however, remained firmly on the defensive as defensive demand remained weak.

Overall, EUR/USD retreated back below the 1.1650 level, but the dollar was unable to secure a significant advance and the single currency traded just below 1.1650 on Wednesday.

The Chinese yuan maintained a strong tone ahead of Tuesday’s US open with the onshore rate posting the strongest close since mid-June amid wider dollar losses.

US housing starts slowed to an annual rate of 1.56mn for September from a revised 1.58mn previously and below consensus forecasts of 1.62mn. Building permits also declined sharply by 7.7% on the month to 1.59mn from 1.72mn previously and below expectations of 1.68mn. There was further evidence that supply constraints were having a negative impact on the construction sector which initially hampered the dollar.

USD/JPY dipped to lows near 113.80, but then recovered ground as Treasuries lost ground and US yields moved higher. The 10-year rate increased to highs 4-month highs above 1.62% while equity markets were in positive territory and USD/JPY recovered to around 114.25 at the European close.

In comments on Wednesday, Japanese cabinet minister Isozaki stated that there was the need for a stable currency given that a weak currency will raise input costs which suggests there is unease over the impact of currency weakness. The yen, however, remained out of favour with renewed losses on the crosses. USD/JPY also strengthened to 47-month highs above 114.50 with EUR/JPY at 4-month highs while the Chinese yuan maintained a stronger tone.

UK yields continued to move higher on Tuesday with further speculation that the Bank of England would look to raise interest rates at the November policy meeting.

Sterling was also supported by a wider move into risk assets during the day with strong demand for commodity currencies.

There were no significant comments on monetary policy from central bank officials during the day, but yields continued to move higher.

The latest UK inflation data recorded a slight decline in the headline rate to 3.1% from 3.2% and marginally below expectations while the core rate edged lower to 2.9% from 3.1%. Rampant expectations of a near-term Bank of England rate hike cooled slightly, but Sterling held a firm tone and GBP/USD traded just below 1.3800.

Economic Calendar

07:00GBP Core CPI (Y/Y)(SEP3.00%3.10%
07:00GBP CPI (Y/Y)(SEP)3.20%3.20%
07:00GBP CPI (M/M)(SEP)0.40%0.70%
07:00GBP PPI Core Output (Y/Y)(SEP)5.3
07:00GBP PPI Input (Y/Y)(SEP)11.60%11.00%
07:00GBP PPI Input (M/M)(SEP)1.00%0.40%
07:00GBP PPI Output (Y/Y)(SEP)6.80%6.00%
07:00EUR German PPI (Y/Y)(SEP)12.70%12.00%
07:00EUR German PPI (M/M)(SEP)1.00%1.50%
10:00Euro-Zone Core CPI (Y/Y)(SEP 01)1.60%1.90%
10:00Euro-Zone CPI (Y/Y)(SEP)3.00%3.40%
10:00Euro-Zone CPI (M/M)(SEP)0.40%0.40%
12:00USD MBA Mortgage Applications0.20%
13:30Bank of Canada Core CPI (M/M)(SEP)0.20%
13:30Bank of Canada Core CPI (Y/Y)(SEP)3.50%
13:30CAD CPI (M/M)(SEP)0.10% 0.20%
13:30CAD CPI (Y/Y)(SEP)3.90% 4.10%
16:00USD Crude Oil Inventories2.233M 6.088M
18:00FOMC Governor Keith Randal Quarles Speech

*All rates shown are indicative of interbank rates and should only be used for indication purposes only. It is important to note that foreign exchange rates fluctuate and that rates may vary depending on the amount and the base currency that is purchased or sold. Rates are correct as of 8:00am UK time. CentralFX are not responsible for the rates shown.