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Federal Reserve hawkish turn tanks markets

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6 December 2021

Written by
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

Safe-havens like the Japanese yen and Swiss franc outperformed last week, as the unambiguously hawkish statements from Fed chair Powell added to the uncertainty over the impact of the omicron COVID variant and sent risk assets tumbling worldwide.

A
mixed jobs report out of the US did little to steady nerves in equity and credit markets, though moves among major currencies were of modest size. The dollar put in a mixed performance, and there was no clear theme among emerging market currencies, which ranged from a 2% gain by the Mexican peso to yet another weekly collapse of over 6% by the Turkish lira, slammed by Erdogan’s increasingly erratic policies.

In addition to any news regarding the virulence of the omicron variant, traders will be looking closely at the inflation report out of the US on Friday, where yet another increase in both headline and core indices to 30-year highs is expected. Aside from that, there is not a lot of first-tier economic information on tap, so markets will continue to hang onto every word coming out of central bank officials, in particular Bank of England‘s MPC member Boradbent’s speech on Monday.

GBP

Sterling tends to suffer during bouts of risk aversion in financial markets, and last week was no exception. Comments from MPC members suggesting they are taking a cautious approach to the omicron variant did not help matters either. Catherine Mann noted her view that it was premature to start thinking about raising interest rates, while one of the most hawkish members of the committee, Michael Saunders, also said that he wanted more information on the new variant before deciding on how to vote this month.

We still think that the decision on whether to hike in December will be finely balanced, and look to Broadbent’s speech on Monday for confirmation that he’s taking a more hawkish view. If so, we believe there is a lot of pent up potential for a pound rally, as it has been excessively punished over the past couple of weeks, particularly against the US dollar.

EUR

The common currency has held up surprisingly well through two weeks of risk aversion and hawkish noises from the Federal Reserve. The massive upward surprise in Eurozone November inflation last week should make President Lagarde’s extreme dovishness increasingly untenable.

In particular, the 21.9% print in producer price inflation all but guarantees that inflation levels will not be coming down anytime soon, as those price pressures bubble up through the supply chains to the final consumer. Of particular note should be the German inflation number of 6%. We expect some hawkish pushback against Lagarde’s dovish line to emerge soon in the wake of these ugly numbers, and remain of the view that ECB interest rate hikes cannot wait until 2023.

USD

Chair Powell’s hawkish turnaround last week is a remarkable development, albeit one we have long expected. He explicitly stated that the word “transitory” should be retired when discussing the current inflationary episode, and suggested he’s ready for a significant increase in the pace of the tapering of bond purchases at the December meeting.

The mixed US labour report for November is unlikely to have changed this view. While the job creation headline was disappointing, the household survey’s unemployment numbers all dropped sharply, suggesting that the US economy is at or very near full employment and that little relief on inflationary pressures will come from supply side expansion. The inflation report this week should be another one for the record books, going back to many decades and cementing the Federal Reserve’s newfound resolve to fight inflation pressures through monetary tightening.

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