The pound has hit a fresh multi-year high today; the dollar has weakened further ahead of US CPI; stocks have opened on the backfoot in Europe despite US index futures extending their gains, and Brent crude oil has reached its best level since January last year.
In other words, nothing has changed, with sentiment towards risk remaining overall positive. With the lack of any major macro news this week, any dips in risk-sensitive assets are likely to be supported – not least the pound.
Pound continues good run of form
The GBP/USD has today risen its best levels since April 2018 as investors continue to pile into the racier pound and out of the US dollars amid ongoing “reflationary” and “risk-on” trades. The pound has been pushing up across the board since the turn of the year due to a no-deal Brexit being avoided and the UK is currently well ahead of many countries in the race to vaccinate its population. Together, these developments have boosted expectations that the UK economy could potentially recover quicker and stronger once lockdowns end.
Stronger pound holding FTSE back – for now
The above expectations have helped to push the pound to repeated new multi-year highs, but this has been slightly negative news for the FTSE whose constituents earn big portions of their profits abroad – in euros and dollars, etc. Thus, when foreign earnings from these multinational corporations are exchanged for the pound, their profits appear less rosy than they do in dollars or euros. The stronger pound is also negative for UK exports, as it makes UK goods and services appear dearer overseas.
However, with expectations of a strong recovery in UK economy growing, the potential for stronger domestic demand recovery should help UK-listed stocks offset the negative impact of the ongoing exchange rate appreciation. And with UK and global monetary conditions remaining very loose, while fiscal spending is also expansionary, conditions remain favourable for UK stocks. So, the FTSE should, in my view, go higher over time and catch up with the other European indices.
Future pickup in inflation is the key risk for stock markets
There has been a lot of talks about inflation rising due to pent up demand, significant government spending, extremely loose monetary conditions and rising oil prices. While the latest US CPI reading is likely to be tepid, and the Fed has said it will allow prices to rise above average for a while, this could come back to haunt investors at a later point in time. If in a couple of quarters down the line the market starts to believe inflation is going to accelerate sharply, requiring tighter monetary conditions, that’s when we are mostly likely to see stocks dropping back from their all-time highs in the US, if not before.
US CPI, central bank speeches
The macro calendar is quite quiet but will have latest US CPI and speeches by Fed Chair Powell and BoE Governor Baily all coming up later. For what it is worth, US CPI for the month of January is expected to come in at +0.3% month-over-month following a +0.4% increase the month before. Year-over-year, CPI is expected to print 1.5%, up from 1.4% y/y previously.
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