Inflation fears everywhere

The EUR/USD pair has remained stable over the last five days. The single currency is still under pressure and is trading at its lowest point of the year as it looks the conflict in Ukraine will continue, with no end in sight. With no developments on the ground, the market is now looking to fundamentals, particularly the one metric that has been making headlines for some time: inflation.

The Fed’s released its monetary policy meeting minutes last week. It indicated that one or more 50–basis point hikes might be appropriate in future meetings, especially if inflationary pressures remain high or intensify. Figures released yesterday show the CPI climbing an annualised 8.5%, the highest increase since 1981, supporting the Fed’s hawks in their position. James Bullard of the St. Louis Fed is in favour of taking rates to 3% to 3.25% by the end of the year. Mr Bullard believes the situation is urgent, and that the Fed is ‘behind the curve’ with its actions.  Lael Brainard, the central bank’s number two – and one of the most, if not the most, doveish Fed governors  has really thrown a spanner in the works by stating that the Fed now intends to tackle the size of its balance sheet more aggressively (known as quantitative tightening, or QT). The simultaneous launching of QT and the numerous rate hikes signalled in the dot plots and anticipated by the markets are pushing Treasury yields higher. The 10-year rate reached 2.82%, a level not seen since December 2018. The Fed’s stated intention to act more aggressively on rates and cash withdrawals in the coming months in an attempt to regain control over inflation has not gone unnoticed on Wall Street. The New York Stock Exchange has been falling in recent days amid nervousness about rising yields.

The single currency is also under pressure against the Swiss franc. Demand deposits with the SNB rose to CHF 739.4 billion at the end of last week, compared with CHF 737.2 billion the previous week. This increase suggests that the SNB has intervened in the markets to curb the appreciation of our currency. By remaining very cautious about raising interest rates, the European Central Bank is maintaining pressure on the franc. With the expected slowdown in growth in Europe in the first half of the year and the ECB’s monetary policy stance, there is little reason to believe the trend will reverse in the short or medium term. The minutes of the last ECB meeting show that while some members are in favour of normalising monetary policy to deal with inflation, many fear the impact of the war in Ukraine on the economy and use it to justify the status quo.

But in the market, one currency has gone against all expectations. At the end of February and beginning of March, the rouble plummeted to unprecedented levels against the dollar: 100 roubles, then 120 to over 140 roubles per dollar on 7 March. Since then, however, the Russian currency has only strengthened and on Thursday returned to the level it had on 23 February, on the eve of the invasion of Ukraine, despite international sanctions. Still, analysts consider this strong comeback to be disconnected from reality and ascribe it solely to the capital controls put in place which prevent Russian residents from selling their roubles for dollars or euros. Individuals have thus been limited to monthly purchases of USD 10,000. In addition, there have been interventions by the Central Bank of Russia.  The combination of interventions and capital controls has worked so well to prop up the rouble that, on Friday, the central bank surprised everyone by slashing its rate to 17% without warning, after having doubled it to 20% on 28 February.  It has done so in spite of the soaring inflation in Russia Prices jumped 16.7% on an annual basis in March, which the first month to see the impact of Western sanctions on prices. Food prices rose by 19.5%.

The Central Bank of New Zealand raised its rate by 0.50% to 1.5%, although only a 0.25% hike had been expected. It is the biggest increase in 22 years. The bank justified the move by its fear that, otherwise, inflation may soar and no longer be under control.

Oil prices have fallen back below $100 a barrel after the decision to tap into strategic reserves to increase supply. The US will bring at least 180 million barrels onto the market, while the other IEA member countries have committed to 60 million, i.e. 240 million barrels in total. The new COVID wave in China has also raised fears of a drop in oil demand, even though China has announced a relaxation of its lockdown measures. The price of US crude oil fell to below $93 a barrel on Monday, before recovering to around $100.