FX Matters August 2021 | Article – HSBC VisionGo

Fed to taper this year; BOE to tighten modestly in three years
Finance  ·    ·  17 mins read

  • The FOMC minutes for July flag a taper in 2021
  • The USD softens on Fed Chair Powell’s rather neutral comments at Jackson Hole
  • The BOE minutes show the MPC expects “some modest tightening” over a three-year forecast period

Summary – Powell’s speech disappoints

The US Dollar Index (DXY) rallied 0.5%[1] this month as risk appetite slumped on the widening spread of the COVID-19 Delta variant and markets saw the Federal Reserve (Fed) edging closer to tapering. On 6 August, US non-farm payrolls for July rose 943k, the largest gain so far this year, which saw the DXY jumping 0.6% as markets began to price in earlier monetary policy normalisation. The USD continued to clamber higher, before moderate gains in US core and headline CPI for July halted its ascent. Another obstacle arose as the University of Michigan’s consumer sentiment index for August plunged to its lowest level since 2011, on 13 August, dragging the USD down with it. The USD resumed its rally in the middle of the month as risk appetite sank on COVID-19 fears and the July Federal Open Markets Committee (FOMC) minutes flagged a 2021 taper. That said, a recovery in risk sentiment saw the USD relinquish some of its gains as markets awaited the Federal Reserve (Fed) Chair Powell’s Jackson Hole speech. The DXY slipped 0.4% on Powell’s speech which dashed hopes for any indication taper may begin sooner than laid out in the July minutes, before firming into the end of the month.

The EUR weakened 0.5% against the USD in August. The month saw the EUR fluctuating in line with US data surprises and was dragged lower by deteriorating risk sentiment amid signs the Fed was gearing up for a September taper prior to Powell’s Jackson Hole speech. Generally underwhelming economic data this month provided further resistance to the EUR in August, although EUR-USD recovered some losses towards month-end as risk appetite improved and the USD softened following Powell’s speech.

The GBP fared worse, sliding 1.1% against the USD this month. The currency was driven lower by a broad weakness in activity data against a backdrop of USD strength as COVID-19 fears escalated. The Bank of England (BOE) kept rates on hold this month and voted 7:1 to maintain the current asset purchase programme on 5 August. That said, the minutes of the August meeting showed that the Monetary Policy Committee (MPC) expects “some modest tightening” over the next three years, which temporarily spared the GBP from the USD’s rally. Even with a weak domestic picture, the GBP managed to pare some losses going into the month-end as risk sentiment recovered and it ultimately fared better than some of its G10 peers.

Elsewhere: Brief pain in commodities

August was a rocky month for gold, mainly hit by broader USD strength and increased expectations around Fed tapering, before ending the month flat. Oil also faced turbulence, with prices falling 6.6% in the first week, before ending the month down 4.4%. Brent crude price’s volatile climb was largely due to concerns focused on slowing global demand amid signs of waning economic momentum.

[1] This report uses Bloomberg prices.

US: On a roll

The US Dollar Index (DXY) was mostly on a roll in August, with the highest US non-farm payrolls of 2021 fuelling the start of its 0.5% climb over the month. On 6 August, non-farm payrolls for July rose by 943k, topping estimates for 870k. Likewise, the unemployment rate beat expectations, falling half a percentage point to 5.4% from 5.9% last month. The DXY rose 0.6% on the day for its best one-day performance this month, as the job report showed headway had been made towards the Federal Reserve’s (Fed) goals of “substantial further progress” needed for tapering to begin.

That said, on 13 August, US consumer sentiment took a nosedive. The University of Michigan’s consumer sentiment index plunged to 70.2 in August, the lowest reading since 2011, as fears around rising COVID-19 Delta variant infections mounted and the DXY faltered on the day, slipping 0.6%. However, its fall was short-lived, and the USD pared its losses on 17 August, as US industrial production for July posted the largest gain in four months, rising 0.9% from a month ago, beating expectations.

Over the next few days, the USD continued to rally on the back of a slump in risk appetite amid concerns over China’s slowing growth and the spread of the Delta variant, signs the Fed is edging closer towards policy tightening, and improving weekly employment data. Minutes from the July Federal Open Market Committee (FOMC) meeting showed most members agreed “it could be appropriate to start reducing the pace of asset purchases this year” and US initial jobless claims declined on 19 August for the fourth consecutive week to 348k. The USD climbed to a new year-to-date high on 20 August, but it ultimately reversed some gains as risk sentiment recovered and markets settled in anticipation for Fed Chair Powell’s speech at the annual Jackson Hole Economic symposium on 27 August.

Powell stuck to a dovish inflation narrative and affirmed the economy had met the Fed's pre-condition of making “substantial further progress” needed for tapering to begin at Jackson Hole. However, he did not suggest tapering would begin any sooner than, before year-end, as laid out earlier in the July FOMC minutes. Powell also cautioned investors against reading into a 2022 rate hike from a taper announcement this year. The USD softened on Powell’s tone which stood in contrast to hawkish comments from other Fed policymakers the days prior. Notably, St. Louis Federal Reserve President James Bullard stated the Fed should “get going on taper” (CNBC, 26 August 2021) and Dallas Federal Reserve Bank President Robert Kaplan mentioned tapering should “start as soon as possible” (Bloomberg, 27 August 2021).

Eurozone: Dragged lower by stronger USD

August saw the EUR fall 0.5% against a backdrop of broad USD strength. The month started with the currency mostly trading sideways. However, on 6 August, the EUR slid 0.6% for its worst one-day performance of the month as the USD rose on the back of stronger-than-expected US non-farm payrolls for July. EUR-USD remained soft over the next few trading sessions as risk appetite soured on COVID-19 fears, propelling the USD to a two-week high.

A two-week rally in the Euro Stoxx 50 Index, together with US consumer sentiment taking a nosedive on 13 August, helped to temporarily buoy the EUR, which rose 0.6% against the USD on the day. That said, the currency failed to hold onto its gains, drifting lower before slipping 0.6% on 17 August, as US Treasury yields rose despite disappointing US retail sales data for July. There was no reprieve for the currency as EUR-USD dropped to a nine-month low, below 1.17, the next day amid broad USD strength following the release of the Federal Reserve’s (Fed) minutes for July.

EUR-USD managed to stage a comeback going into the final week as the USD slid on improving risk sentiment. The EUR’s climb higher was further supported as Eurozone Purchasing Managers’ Indices (PMI) in August generally held up 23 August with a beat in services and a slight easing in the composite and manufacturing readings. Following Fed Chair Powell’s rather neutral tone at Jackson Hole, EUR-USD continued to extend gains, paring earlier losses to end the month down 0.5%.

Eurozone economic data generally showed a mixed picture this month. Manufacturing and composite PMIs for August eased slightly, with the former slipping from estimates of 62.0 to 61.5. In contrast, the services PMI came in at 59.7, just topping consensus for 59.5. Eurozone inflation also accelerated faster than expected in August as headline CPI for August rose 0.4% from a month ago, compared to consensus estimates for a 0.2% increase. Whereas, Eurozone aggregate GDP held up in 2Q21, posting a seasonally adjusted sequential growth of 2%, in line with expectations.

UK: Back of the pack

The GBP struggled in August, erasing its gains from July as it fell 1.1% against the USD. The first half of the month saw GBP-USD mostly drifting lower as economic data generally missed the mark and the currency pair was challenged by broad USD strength.

On 5 August, the Bank of England (BOE) kept rates at 0.1%, and voted 7:1 to maintain the current asset purchase programme. However, it proved unexpectedly hawkish as the minutes showed that the Monetary Policy Committee (MPC) expects “some modest tightening”, over its three-year forecast period, “is likely to be necessary” to meet its inflation target, as it now expects inflation to peak higher at 4% in 4Q21. The BOE also clarified it plans to start unwinding its asset purchase programme once the benchmark rate hits 0.5%. GBP-USD ended the day up 0.3% on the BOE’s mildly hawkish tone. These gains were relinquished the next day upon a strong US non-farm payrolls print for July.

On 17 August, GBP-USD slipped 0.7% amid concerns the upcoming withdrawal of the UK government-funded job retention schemes for COVID-19 lockdowns (known as furlough schemes) may moderate the recovery of the UK labour market. Despite a brief recovery the next day, the GBP tumbled 0.9% lower on 19 August for its worst one-day performance as risk sentiment slumped. Broad USD strength after the Federal Open Market Committee (FOMC) minutes for July signalled that a taper announcement this year may be on the cards contributed to downwards pressure for the GBP. However, as risk appetite recovered in the final week, the GBP managed to pare some of its losses. GBP-USD climbed a further 0.5% on broad USD weakness following the Federal Reserve (Fed) Chair Powell’s rather neutral tone at the Jackson Hole economic summit, before steadying going into the month-end.

UK economic data was generally worse than expected. Industrial and manufacturing production for June both disappointed with the former falling 0.7% from a month ago against expectations for a 0.3% gain. Headline CPI for July stayed the same from that a month ago, below consensus estimates for a 0.2% increase. That said, preliminary estimates showed the UK economy for 2Q21 expanded by a hefty 4.8% from the previous quarter, in line with expectations, compared to a 1.6% contraction in 1Q21. However, UK retail sales for July severely disappointed, with a sharp monthly fall of 2.5% against consensus for a 0.2% gain, which suggested the UK recovery may be losing momentum.

Japan: Rather average

The JPY slipped 0.3% in August. Despite initially strengthening against the USD, after the ADP national employment report showed US firms added 330k jobs in July, far fewer than consensus of 683k, USD-JPY rallied over the next few days. The USD was bolstered by the July non-farm payrolls beat, on 6 August, which stirred excitement around the Federal Reserve (Fed) edging closer to a taper announcement.

On 13 August, as US consumer sentiment slumped, the JPY benefited from increased risk aversion, which saw USD-JPY fall 0.7%, relinquishing any gains thus far. The JPY advanced a further 0.3% against the USD on 16 August, as US equities slipped amid increasing COVID-19 concerns which triggered a loss of risk appetite. However, as US industrial production posted the largest gain in four months the following day, USD-JPY changed course. Over the next few days, against a backdrop of USD strength, bolstered by a recovery in US equities and market speculation over a Fed taper following the July Federal Open Market Committee (FOMC) minutes, USD-JPY edged higher. The currency pair then mostly traded sideways going into the month-end as markets awaited Fed Chair Powell’s Jackson Hole speech.

A worsening COVID-19 outbreak continued to weigh on Japan’s economic activity in August. Japan’s Prime Minister Suga extended the COVID-19 state of emergency (where the serving of alcohol in restaurants and bars is banned) in Tokyo and several prefectures through to mid-September amid a continued surge in cases. Despite this, retail sales for July beat expectations, rising 1.1% from a month ago versus consensus estimates for a 0.4% gain. Industrial production for July also held up better than expected, declining 1.5% from a month ago against expectations for a 2.5% fall.

China: Under pressure

August saw a steady weakening of the CNY against the USD until a retracement in the final week saw the CNY end the month flat. Expectations for an earlier taper from the Federal Reserve (Fed) fuelled broad USD strength and, along with bearish domestic factors, put downward pressure on the CNY. USD-CNY began its grind higher on 6 August on the back of a strong US non-farm payrolls print. As concerns around the recent COVID-19 outbreak in Nanjing weighed on China’s economic outlook, the CNY continued to weaken against the USD. However, after US CPI showed moderate gains for July, the CNY’s three-day slide came to an end on USD weakness. After this brief reprieve, a steep sell-off in Chinese technology stocks on 17 August in response to tighter regulations saw USD-CNY rise again. Foreign equity outflows caused by concerns over China’s regulatory uncertainties led USD-CNY back on its path higher, with the pair breaking above 6.50 on 20 August. Downside pressure on the CNY eventually eased in the final week as risk appetite recovered with markets waiting for Fed Chair Powell’s Jackson Hole speech. USD-CNY continued to slide lower going into the month-end as the USD softened following Powell’s rather neutral comments at Jackson Hole.

Canada: Sliding on oi

The CAD fell 1.2% against the USD in August, but most of the price action was seen in the second half of the month, when the commodities sell-off intensified before rebounding in the final week. USD-CAD began its ascent on 13 August, as oil prices started a seven-day slide, after the International Energy Agency’s (IEA) latest report slashed China’s fuel demand outlook. The pair’s climb was supported by broad USD strength amid sinking risk appetite, after the July Federal Open Market Committee (FOMC) minutes on 19 August flagged a potential 2021 taper, with USD-CAD rising 1.3%. That said, the next day a strong rebound in Canadian retail sales for June, which rose 4.2% from a month ago, compared to a monthly decline of 2.1% in May, ended USD-CAD’s rally, which had seen the pair reach a six-month high earlier that day. The CAD pared most of its losses going into the month-end amidst a hefty surge in oil prices and a revival in risk sentiment.

Australia: Plagued by COVID-19 woes

The AUD fell 0.4% against the USD in August. AUD-USD started on the front foot, rallying 0.5% on 3 August, as the Reserve Bank of Australia (RBA) held rates and announced it would stick with its September taper. However, the AUD’s strong start halted the next day, when the USD strengthened after the Federal Reserve (Fed) Vice Chair Clarida stated that the pre-conditions for a rate hike would be met “by year-end 2022”. On 17 August, the RBA minutes showed the board considered “delaying the tapering of bond purchases to AUD4bn a week currently scheduled for September 2021” as the COVID-19 and lockdown restrictions continued to weigh on the economy; AUD-USD plunged 1.2% on the day. The currency pair slid a further 1.2%, two days later, as markets looked past the strong beat in July employment data, focusing instead on broad USD strength and a new record in daily COVID-19 cases in New South Wales. AUD-USD ultimately pared some losses in the final week amid a recovery in risk-on sentiment.

New Zealand: Status quo on rates, albeit with a hawkish tone

The NZD was the second best performer in the G10, rising 1.0% against the USD. The NZD rallied 0.4% on 4 August after New Zealand’s unemployment rate fell more than expected to 4% in 2Q21, fuelling expectations the Reserve Bank of New Zealand (RBNZ) would hike rates this month. However, these gains were relinquished when NZD-USD slid 0.7% on the US July non-farm payrolls beat. On 17 August, the NZD dropped 1.4% against the USD after the first COVID-19 case in six months was discovered, lowering the expected likelihood of an August rate hike from over 100% to around 60% based on rate market pricing. The NZD slipped 0.5% the next day as the RBNZ held rates at 0.25%, but its hawkish tone and aggressive policy rate forecast provided stiff resistance against further drops. As the July Federal Open Market Committee (FOMC) flagged a 2021 taper in the US and domestic lockdowns were extended, the NZD continued to slide lower. However, a recovery in risk appetite in the final week saw NZD-USD pare earlier losses before finishing the month higher.

Norway and Sweden: Polar opposites

In contrast to its lacklustre performance the past two months, the NOK rose 1.6% against the USD in August. As COVID-19 woes dampened risk appetite early in the month, the NOK came under pressure. This intensified as oil started to feel the pain of the commodities sell-off on 9 August, plunging 2.3% on the day, which dragged NOK-USD 0.6% lower. However, the tide turned when headline CPI for July remained strong at 3% from a year ago, indicating support for a rate hike as soon as September. NOK-USD climbed 0.5% on the day. On 19 August, the Norges Bank held rates whilst flagging its first rate hike will “most likely” come in September as the economy has seen a “marked” rebound after re-opening. The NOK faced stiff resistance from the July Federal Open Market Committee (FOMC) flagging a 2021 taper amidst sinking oil prices, leading NOK-USD to fall 1.5% on the day. Nonetheless, a recovery in risk sentiment and oil prices allowed the NOK to pare losses going into the month-end.

Meanwhile, the SEK fell 0.4% this month coming in third place amongst its G10 peers. The krona began the month sliding lower first on the US July non-farm payrolls beat, then on tumbling Brent crude prices. The currency’s worst one-day performance came on 17 August, as US industrial production for July rose by the most in four months, fuelling broad USD strength, with the SEK falling 1.2% on the day. On the data front, Sweden’s economic releases generally underwhelmed. Industrial orders for June rose 1.1%, significantly less than the 6.1% gain the month prior, and retail sales for July also missed consensus expectations for a 0.5% gain, sliding 1.2% from a month ago.

Oil: Turbulent ride

It was a rocky month for Brent crude prices, due to oil demand concerns and a stronger USD. Oil fell 6.6% in the first week alone before ending the month down 4.4%. With both China and US manufacturing Purchasing Managers’ Indices (PMIs) for July missing the mark, fears of a slowdown in oil demand took hold. Rising supply by the Organization of the Petroleum Exporting Countries (OPEC) and its allies (known as “OPEC+”) added further pressure and the announcement of new COVID-19 restrictions on 9 August in Asia, and China in particular, intensified pandemic-related demand concerns, leading oil prices to slide 2.4%. Thereafter, oil staged a rebound, clambering higher the next three days, bolstered by the Energy Information Administration’s (EIA) upward revisions to its 2021 US demand outlook, which outweighed concerns over new COVID-19 curbs in Asia. However, Brent prices soon tumbled again for seven consecutive days as the International Energy Agency’s (IEA) latest forecast showed a sharp slowdown in China’s oil demand growth in 3Q21 and attention turned to a potentially oversupplied market in 2022. Oil dipped to its lowest level since May, on 19 August, as rapidly rising cases globally heightened fears of weaker global demand, amidst broad USD strength as the July Federal Open Market Committee (FOMC) minutes raised expectations of an earlier taper in the US. That said, oil staged a comeback in the final week with prices jumping 5.5% and 3.4% on 23 and 24 August, respectively, driven by a weaker USD, further inventory declines and a production outage in Mexico.

Gold: Rockier than it seems

Gold was flat in August, but this masked the swings seen early on in the month. The precious metal began the month mostly trading sideways until 6 August, when it tumbled 2.3% for the largest fall in seven weeks, after US non-farm payrolls for July topped estimates. Following the strong US employment report for July, which bolstered expectations for an earlier taper by the Federal Reserve, gold temporarily plunged to a four-month low on 9 August, before steadying to end the day down 1.9%. However, as US. inflation for July showed only moderate gains, tapering concerns eased, ending the precious metal’s four-day slide. Gold continued to extend its gains as the US University of Michigan’s consumer sentiment tanked on 13 August. That said, gold steadied over the next few days as it battled the USD, as risk appetite deteriorated amid COVID-19 fears, before marching higher back above USD1800 per ounce on 23 August on a revival in risk sentiment. Gold eventually closed the month at around USD1,814 per ounce.

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