Post date: 20/12/2021 17:04

The Federal Reserve made it clear that it is increasingly concerned about inflationary pressures at its December meeting, and the dollar reacted accordingly. The greenback rose against every G10 currency last week, together with sterling, which joined the dollar rally, as the Bank of England whipsawed markets yet again by hiking rates unexpectedly. Emerging market currencies mostly held up better than G10 ones against the dollar, an interesting development that bears watching closely. The Turkish lira was yet again the exception, crashing by over 15% again as Erdogan’s policies threaten to unravel the Turkish financial system. There has been a massive turnaround in central bank priorities over the past few weeks, as shown by the Fed hawkishness, the Bank of England’s unexpected hiked rates, and the budding dissent within the ECB council. As the newsflow turns light into the holidays, traders will be paying close attention to the omicron variant news. Into the New Year, the different pace of central bank tightening will continue to be the key driver in currency markets.


UK November inflation delivered another nasty surprise, rising above expectations to 5.1% for the year. This may have been the catalyst for the surprise hike by the Bank of England, after a notably hawkish 8-1 vote. This completely dumbfounded expectations – an 8-1 vote in favour of no change in rates looked far more likely in the lead up to the meeting given the thoroughly dovish comments from a handful of MPC members in the past few weeks. The Bank mentioned specifically a tight labour market and inflationary pressures as justifications for the move. We think there is potential for a continued sterling rally into year end, given the paucity of data, the positive news from the central bank, and a market that is still very short the currency and may be forced to cover in the thin holiday season.


The ECB clearly will lag its global peers in this tightening cycle. However, we think there were subtle but clear signs that the institution is shifting its view on inflation and taking a more hawkish stance. The inflation forecasts were revised sharply higher. Also, the omicron variant was cited as a potential cause of additional inflation. Finally, President Lagarde suggested the existence of a hawkish dissenting faction within the Council, admitting the decision was not unanimous. For now, however, Lagarde insists that a 2022 hike remains “very unlikely”, and the euro struggled to find a footing all week long.


As expected, the Federal Reserve doubled the speed of the taper and will wrap up its bond purchases no later than March. However, Fed communications, notably the “dot plot”, were more hawkish than most expected. Fed members now expect to hike rates three times in 2022, and it’s clear that the March meeting is now a live one in terms of the possibility of a hike. Chair Powell suggested that the central bank is much more worried about inflation than at the previous meeting, and that it sees the labour market as close to full employment. While we retain our generally positive outlook on the US economy, one of the key uncertainties is what will happen to US rates once the Fed’s massive support for the Treasury market disappears, as bond purchases end on or before March of next year.