English Markets

Inflation, Interest Rates and Forex (Q2 2021)

Various forecasters have changed their view of the dollar and now expect a robust development rather than weakness due to a possible rise in interest rates.

The future of price developments (inflation) is causing a lot of nervousness in the currency markets. This is especially true for the dollar and, to a lesser extent, also for the euro.

In April, the Fed did not expect any interest rate hikes until 2024. However, Treasury Secretary Yellen would not nave ruled out an interest rate hike in May after inflation data was surprisingly stronger and some statements at the Fed’s June 16, 2021 meeting led traders to believe that the Fed might consider a faster increase in its key interest rate and sent the dollar soaring.

Euro interest rates were also little changed in May. Prior to that, the rise was smaller than in other currencies, which was due to the European Central Bank’s emergency program to buy government and corporate bonds. This program increased by another 500 billion euros to 1.85 trillion euros and extended to 2022. Rising bond yields are a concern for the ECB, so it has stepped up its bond purchases to bring down overall interest rates. The ECB will combat interest rate risk with significant monetary easing, although it also expects inflation to rise: Economic growth appears to be much more important than price stability to the ECB.

In Switzerland, on the other hand, inflation remains at a moderate level thanks to the strength of the Swiss franc. At 0.6% (May), inflation is significantly lower than in the US (5.0%) or Germany (2.5%). Inflation remained stable within the target range of 0 to 2%, which the Swiss National Bank (SNB) considers price stability.

In its quarterly review on June 17, 2021, the Swiss National Bank expects inflation to continue to rise during the year and sees it as a transitory phenomenon. The short-term effect is due to higher prices for petroleum products and tourism-related services as well as for goods affected by supply bottlenecks. Inflation shall then decline again due to the consequences of the pandemic, which will continue to weigh on demand for some time to come. However, given the SNB’s expanding balance sheet, pension funding problems and pandemic-induced debt, higher inflation in the longer term is a very plausible scenario that the SNB has not addressed. The SNB believes that long-term inflation expectations in Switzerland have not increased and that there should be no change in its expansionary monetary policy established in 2015: the negative interest rate of -0.75% and, secondly, the willingness to intervene in the currency market.

Overall, the Swiss franc remains “highly valued” in the SNB’s assessment, but various forecasters have changed their view of the dollar and now expect a robust development rather than weakness due to a possible rise in interest rates. The euro’s decline of more than 2% against the dollar after the Fed’s June 16, 2021 meeting (partially reversed a week later) may provide an interesting partial entry point for those who wish to gain more exposure to the Eurozone