Post date: 13/12/2021 14:08
Early data on the omicron variant suggests that it’s no more virulent than previous variants, and may in fact be less severe. Risk assets worldwide understandably rejoiced. Stocks, commodities and credit all rallied, helped along by the extremely stimulative settings in both monetary and fiscal policy. Currencies mostly followed suit, with emerging market currencies putting in an excellent performance, and safe-havens underperforming. The dollar fell against most of its peers, somewhat surprisingly. As central banks in developed countries prepare to dial back the enormous monetary stimulus that is fuelling inflation, there remains large uncertainties over the timing and extent of the removal. The Federal Reserve (Wednesday), the European Central Bank and the Bank of England (Thursday) all meet this week. The Fed is expected to sound hawkish, the ECB dovish and no one knows for certain about the BoE. The interplay between these three institutions decisions, their communications and market expectations for those should be key in what is shaping up to be a decisive week for currency markets.
With little economic news of any note last week, traders were content to trade sterling in a very tight range against both the euro and the US dollar, awaiting this week’s central bank meetings. Omicron headlines probably rule out any policy moves this week, but we expect both the actual vote and the bank’s communications to leave the door open for a hike at the next meeting in February, should information on the Omicron variant confirm its relative mildness. The reaction in sterling in the immediate aftermath of Thursday’s decision is likely to be largely dependent on the MPC’s vote on interest rates. We think that the most likely scenario is for the vote to remain split 7-2 in favour of no change. A unanimous vote, or one in which either of the two hawks vote in favour of no change, would be a significant disappointment for markets and could trigger a sharp move lower in the pound.
Strong industrial production data out of Germany last week may have helped the euro stabilise against the US dollar last week, but traders remain focused on the ECB meeting this Thursday. Market expectations are for a very dovish central bank that expresses its willingness to continue buying bonds well into 2022, even as others, particularly the Fed, taper their purchases much faster. There is, however, some hope for the euro. Any disappointment of these expectations, either through a more aggressive tapering schedule or perhaps the development of hawkish dissent within the ECB, could lead to a sharp short covering rally.
Inflation in November registered yet another record high, jumping to 6.8% and 4.9% after stripping food and energy components, both fresh multi-decade records. The market had, however, braced itself for these numbers, and currencies did not move much in the aftermath. A hawkish turn by the Fed this Wednesday is universally expected, with market consensus expecting an end to bond purchases by March and a first hike before the summer. Another key to the meeting will be the “dot plot” in which officials record their expectations for future hikes. Markets are already pricing in three hikes in 2022. If the median Fed member comes in over or under that, it will likely have a significant impact in the dollar.