Welcome to Forex Friday, a weekly report in which we discuss selected currency themes mainly from a macro viewpoint, but we also throw in a pinch of technical analysis here and there.

• Dollar rallies as inflation expectations jump
• USD/CHF holds above parity
• Gold drops as yields climb higher
• GBP/USD endures another volatile session
• Looking forward to the week ahead

In this week’s edition, we discuss the dollar, yen, franc, pound and gold, and look forward to the week ahead.

Dollar rallies on UoM inflation expectations jump

Another day, another rally for the dollar and another downward move for assets that tend to move inversely with bond yields. Gold, silver, Nasdaq - you name it. US 10-year bond yields bounced back to climb north of 4% on Friday.

After the strong CPI report further cemented expectations of more aggressive rate hikes from the Fed, attention was on the University of Michigan’s consumer confidence and inflation expectations indices. These are forward-looking macro pointers, arguably making them more relevant to the Fed policy than the slightly back-ward-looking CPI data.

And they didn’t disappoint. Well, unless you were short USD and long stocks. The UoM’s 1-year inflation expectations rose to 5.1% vs 4.7% prior, while the 5-10 year inflation expectations index climbed to 2.9% vs. 2.7% last, suggesting both short and long-term expectations are moving higher.

This is not exactly what the Fed wants right now. Nearly all the FOMC members agree that the US central bank still has a lot of work to do to bring inflation down and that a more restrictive policy is needed. But with inflation expectations now on the rise, their job will be even harder.

The US dollar rallied on the back of those numbers, while stocks and bonds sunk. US 10-year yields jumped to above 4% again. The USD/JPY starred as it surged to fresh multi-decade highs. Will the USD/JPY get to 150 in early next week? Will Japan intervene?

USD/CHF holds above parity

The Swiss franc was among a handful of major currencies not to turn positive after the publication of the US CPI report on Thursday. As a reminder, the CPI initial caused a rally in the dollar, which later faded and allowed the likes of EUR/USD, GBP/USD and CAD/USD all to turn positive. But the USD/CHF closed higher, holding above parity.

With the dollar remaining fundamentally support, watch out for a USDJPY-style breakout in the USD/CHF. The Swissy neds to close above the May high of 1.0065 in order to trigger further technical buying at higher levels. Key short-term support comes in at around 0.9965, which needs to hold to keep the bulls happy.

Gold drops as yields climb higher

After everything bounced back in a short-covering rally in the aftermath of a hotter US CPI inflation report on Thursday, gold still closed the session lower. That was a sign of things to come.

Indeed, on Friday, when this was written, the metal started the day lower, and it never really recovered. It was later hurt further by UoM data showing inflation expectations were on the rise. Bad news if you were hoping for a dovish pivot by the Fed.

Gold's inability to hold above the 2021 low at $1676 means the path of least resistance remains to the downside, which should encourage technical selling.

At the time of writing, the metal was trying to break short-term support around $1650 area. It looked like the metal was about to drop towards the recent lows at $1615ish.

GBP/USD endures volatile session

Another day of turmoil in UK politics saw the departure of the fourth Chancellor in as many months. Enough was enough as under-pressure UK Prime Minister Liz Truss sacked Chancellor Kwasi Kwarteng after his controversial mini-budget sent UK financial markets in turmoil. There were lots of rumours on Thursday that this would happen, which saw the cable and FTSE stage a relief rally. But now that the news has been confirmed, the GBP/USD has reacted in a very typical way: down. In other words, it was a case of buy the rumour, sell the news for the cable.

What’s next?

The market will be asking lots of questions. What changes will the new Chancellor, Jeremy Hunt, will bring to the table? The Prime Minister Liz Truss also decided to reverse her plan to scrap an increase in corporation tax. All these changes and the U-turns within the first month of the new PM’s reign raises serious question marks about her longevity in the job, and even raises the prospects of a general election.

So, in addition to everything else, there is the added political uncertainty hanging over the economy, which is not going to benefit anyone.

But there is arguably an even larger elephant in the room…

The Bank of England’s temporary bond buying is going to end today. What will this mean for borrowing costs, and mortgages… and by extension the pound and FTSE? In short, lots of uncertainty, which means more downward pressure for pound and FTSE. On Friday’s UK yields jumped back higher, now that the BoE is no longer intervening.

BoE, what you gonna do?

As mentioned, the Bank of England’s temporary bond buying ends on Friday. We have already seen renewed selling of the pound while the FTSE gave back its entire gains made earlier on Friday, after rallying sharply on Thursday.

With the BoE no longer going to be purchasing long-dated bonds, the rising yields will provide stiff pressure on UK assets.

The US dollar meanwhile is also continuing to apply pressure on the GBP/USD, after a stronger CPI report and UoM’s inflation expectations data raised calls for more aggressive rate increase from the Fed.

In the UK, the political turmoil and a near 10% inflation rate means consumer and business budgets will continue to get stretched as we head towards the winter months.

The BoE has to keep on hiking interest rates because of the very high inflation rate. This should keep bond prices under pressure and yields underpinned.

UK CPI in focus on Wednesday

After edging back below 10% in August, CPI is likely to have remained elevated in September due to the latest slump in the pound, which has surely boosted the price of imported goods further. If CPI doesn’t come down sharply, the pressure on the BoE will grow even more. Aggressive rate hikes to bring CPI down will only boost bond yields further, raising borrowing costs for the government and households alike.

What does it all mean for GBP?

Well, you can argue that much of the risks to the UK economy has already been priced in. But the political and economic situation keeps on going from bad to worse. Yields could rise alarmingly again if CPI beats and the BoE refuses to step in again to depress rising borrowing costs. Against this backdrop, the path of least resistance remains to the downside for GBP/USD.

Looking forward to the week ahead

With US CPI out of the way, macro data from the world’s largest economy will take a back seat in the week ahead. This will allow other global macro pointers to take centre stage.

Chinese GDP, retail sales and industrial production (Tuesday)

Chinese growth estimate for the third quarter will be released on Tuesday along with the latest data on retail sales and industrial production. Together, these macro pointers will provide us a snapshot of the health of the world’s second largest economy, which expanded by just 0.4% in Q2 compared to the same period in 2021. Judging by recent data, expect more disappointment.

UK CPI (Wednesday)

After edging back below 10% in August, CPI is likely to have remained elevated in September due to the latest slump in the pound, which has surely boosted the price of imported goods further. If CPI doesn’t come down sharply, the pressure on the BoE will grow even more. Aggressive rate hikes to bring CPI down will only boost bond yields further, raising borrowing costs for the government and households alike.

UK retail sales (Friday)

With the cost of living soaring to around 10% in the UK, interest rates on the rise and concerns about mortgage payments elevated, consumers are likely to continue cutting back on non-essential purchases for a while. In August, retail sales slumped 1.6% on the month. Did things get even worse in September?

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