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Despite the ongoing stalemate in the UK’s negotiations for the future trade relationship with the EU, the pound rallied against the dollar following a significant policy change from the Federal Reserve in the US.

The Fed last week announced that it will change the US inflation target policy from an approximate 2% target to an Average Inflation Target (AIT).

The result of adopting AIT is that the Fed will now be willing to allow inflation to run hotter than normal (i.e. more than the usual 2% target) in order to support the US labour market and broader economy.

This has had a significant effect on the value of the US dollar, leading to rallies for both the euro and the pound.

Inflation policy weakens dollar

According to corporate investment firm the Bank of New York (BNY) Mellon Corporation, the increased likelihood of the US increasing inflation – in combination with capping bond yields – could weaken US yields, weakening the value of the dollar.

As a result, the US Dollar Index (DXY) dropped from a weekly high of around 93.35 to a low of 91.80. It opened this morning only a few points above last week’s lows – the index’s poorest rating since April 2018.

Pound takes advantage 

The pound’s value against the dollar has therefore increased, rising from a low of 1.306 to break above the 1.34 level in early trade this morning.

UK markets continue to be pressured by concerns that the talks for the future trading relationship with the EU will fail, but with negotiations not scheduled for this week, the pound should continue to do well against the US dollar.

Euro rally dented by Covid-19

The euro also rallied against the dollar as a result of the AIT announcement, rising from just below the US$1.18 mark to over $1.20 this morning.

However, the rise in Covid-19 infection rates across Europe could weigh down this surge, with the FTSE 100 dipping this morning an indicator that fears of a second wave are having an impact.

Market could reposition

Anecdotal evidence suggests that the current downward trend for the dollar has left markets positioned short of the real value of US dollars and in excess of the true worth of the euro.

We expect some resistance for the euro in particular, which could support Sterling. Last week the pound rose from a low of 1.106 to 1.122 and is currently valued at around 1.12.

Chinese recovery

The Chinese Manufacturing PMI was released last night (31 August) and showed the strongest growth in the market in nearly a decade.

This, alongside the fall in value of the US dollar, has since the renminbi rise to above US$0.146 and to its highest value since January this year.

Equity markets remain firm

Equity markets remained firm last week, underpinned by the printing of money from global central banks, with several benchmarks at or near to all-time highs in the US.

Good week for Oil 

Oil was steady during the week, rising from a low of around US$42.30pb to heights of $43.75 as inventories in the US fell. It is trading just above the US$43 level this morning.

Gold regains ground

Gold regained some ground, in part due to the weakening US dollar. Its value increased from just below US$1910 to just above $1990 this morning.

Silver performed even better, rallying from a low of around US$26.13 to $28.80 per ounce this morning.

Week ahead 

The main UK economic releases this week are today’s Manufacturing and Thursday’s Services PMIs, with markets expecting a slight rise in the former and the latter to be largely unchanged from the preliminary figure.

The main international figures will be the US Employment data release on Friday with expectations of a further 1.4 million jobs created in the US and the unemployment rate falling from 10.2% to around 9.8%.

Change in focus

Economic releases have recently been overlooked in FX markets, with attention shifting onto central banks and interest rate decisions. This is due to the significant impact Covid-19 has had in unsettling economies around the world.

Comments from senior bankers – such as Fed chair Jerome Powell, BOE governor Andrew Bailey or ECB head Christine Lagarde – are therefore having a greater impact on currency rates than usual.

Highlights this week

Today (1 September)

• German Unemployment report
• UK Manufacturing PMI
• Eurozone Inflation and Unemployment reports
• US ISM Manufacturing PMI and Weekly Crude Oil stocks
• Speeches by ECB chief economist Philip Lane and Federal Open Market Committee member Lael Brainard

Wednesday   

• German Retail sales
• US ADP Nonfarm Employment change
• Factory Orders and Crude oil inventories
• Speeches US rate setters John Williams and Loretta Mester and the UK’s Ben Broadbent

Thursday   

• Services PMIs from the UK, Europe and US
• Weekly Jobless claims and Trade balance from the US
• Speeches from are BOE Governor Andrew Bailey, the ECB’s Isabel Schnabel and the Chicago Fed President Charles Evans

Friday     

• German Factory Orders
• UK Construction PMI
• US Employment Report for August
• Scheduled speech from Philip Lane (ECB)