After a bright start for stocks and some of the other risk assets, sentiment deteriorated as we approached the US open, leading to a weaker open on Wall Street. US indices were near their lows of the day at the time of writing. Crude
oil was down. Bitcoin had given back entire gains made over the weekend, falling through $48K.
Source: ThinkMarkets and TradingView.com
The heightened volatility and investor hesitation are understandable. After all, it going to be a massive week for global monetary policy, with some 20 central banks set to decide on interest rates and QE. What’s more, the rapidly-spreading Omicron variant has raised some concerns over the global economy as countries go back in partial or full lockdown. Even milder restrictions such as working from home has some negative impact on the economy. The only positive thing about Omicron I suppose is that there hasn’t been much in the way of evidence that it is causing severe illness. That is keeping investors confident that we hopefully won’t see similar lockdowns like we did in 2020.
Still, with global inflation so high, central banks will be less keen to keep current monetary policy settings intact for much longer. Some policy tightening should be expected.
Here are some of this week’s central bank highlights:
Federal Reserve (Wednesday)
The Federal Reserve is likely to announce it will wrap up bond purchases sooner than expected at its meeting next week, especially in light of another strong inflation print on Friday, which showed consumer prices rose to their highest level since 1982. Although the data was more or less in line with what analysts were expecting, the fact that dollar sold off and stock index futures rose in the immediate aftermath of the report suggests investors were relieved prices ‘only’ rose 0.8% on the month to take the headline CPI to 6.8% year-over-year from 6.2% previously.
Still, this does little to change the outlook for interest rates in the US and it was the last major release for the FOMC to take into account before their meeting on Tuesday-Wednesday. In that meeting, the Fed is widely expected to announce the end of its asset purchases by March. This would then open the door to a rate rise around the middle of the year.
With the Fed likely to speed up the pace of taper, while most other major central banks are relatively less hawkish – not least the ECB and BOJ – this should keep the dollar’s uptrend intact for a little longer at least. But it could also be bad news for overvalued markets, as taper tantrums potentially return at a time when the economy is likely to be weighed down at least moderately by the latest omicron-linked restrictions and lockdowns.
Bank of England (Thursday)
The market has been pricing out the probability of a rate hike by the BoE, amid the latest Covid restrictions under the “Covid Plan B” strategy being implemented in the UK. This explains why the pound has struggled recently. The No. 10 party row is also weighing on sentiment, with Labour calling for Boris Johnson to resign if the prime minister is found to have misled MPs about the three parties that took place last year, which are being investigated for Covid rule breaches. But the pound’s recent weakness is more to do with worries about the economic impact of the steps the government has taken to stem the spread of omicron, even though there’s growing optimism that the variant is not as bad as first feared. That being said, although vaccine makers have provided us with some good news in recent days, the World Health Organisation (WHO) will likely wait until a couple of weeks for some detailed findings before providing its view. Once we hear from the WHO then the UK, and governments elsewhere, will probably respond appropriately.
But for as long as restrictions remain in place, this should weigh moderately on economic activity – and rate hike expectations. Some analysts, such as those at Goldman Sachs, now think that the BoE will delay its first rate hike to February. As such, the GBP/USD could be heading towards the next psychological level at 1.30 soon. But if the pound manages to halt its decline, its best bet would be against currencies where the central bank is less hawkish than the BoE – such as the euro or franc.
European Central Bank (Thursday)
The European Central Bank, like the Fed and BoE, is also faced with rising inflation rates in the Eurozone. But the ongoing spread of Delta, couple with the new threat of the Omicron variant, means it will most likely do nothing at this meeting as policymakers assess the potential economic damage of tighter restrictions that have been introduced in parts of the region to combat the spread of coronavirus.
The ECB has already indicated it is phasing out its Pandemic Emergency Purchase Programme (PEPP) in March. The question as to whether it will then simultaneously boost its existing Asset Purchases Programme (APP) remains unanswered. The ECB will not want to create a cliff edge effect by abruptly reducing total QE by €60bn per month. So, instead, what we might see is a rise in APP purchases to provide a buffer, which will then likely be tapered later in the year.
In so far as Thursday’s decision is concerned, well it will probably use the excuse of coronavirus to keep current settings unchanged. The ECB may choose to postpone a decision on officially ending PEPP, and what other measures it will take, until its February meeting. By the time the ECB meets, the EUR/USD may have already dropped to 1.10, if the Fed was indeed hawkish the day before.
Swiss National Bank (Thursday)
The world’s most boring central bank, otherwise known as the SNB, is again highly unlikely to make changes to its monetary policy when its policy meeting concludes first thing Thursday morning. Switzerland is likely to face more pain in the coming months and quarters as supply chain bottlenecks, inflation and pandemic restrictions persist in many parts of the world. But the rising franc against the euro is making an SNB intervention in the FX markets more likely than any tweaking of monetary policy.
CBRT (Thursday)
The CBRT might catch the headlines on Thursday, but for all the wrong reasons. The Turkish lira slumped to yet another record low at the start of this week, as investors prepared for another rate cut. They were probably spooked further by a decision from the S&P Global Ratings which reduced its outlook on Turkey’s sovereign rating – due to the “extreme currency volatility.” Unfortunately, the outlook on the lira is unlikely to improve any time soon. If the CBRT cuts rates sharply again on Thursday, we could be talking about USD/TRY 15.00.
Bank of Japan (Friday)
The Bank of Japan will be the last of the major central banks to make a decision on monetary policy on Friday. However, Japan’s benign inflation outlook means the central bank won’t have a decision to make. I can almost guarantee that it will leave policy settings on hold. This should keep the yen under pressure.
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