News & Analysis

This week proved to be another dominated by broad US dollar dynamics as markets trade on global risk appetite. The dollar took on water for much of the week, with sterling being the notable FX pair in the G10 space as GBPUSD hit fresh two-year highs. However, the greenback showed a flurry of strength on Friday before markets broke in North America for a long weekend, as position squaring favoured buying back the dollar. This week, the Riksbank was the only central bank in the G10 space to update its policy, while Banxico met analysts’ expectations and delivered a 25bps cut. On the data front, the calendar was relatively light, with UK GDP for December being the most notable release.

Markets are set to be quiet next week, especially on Monday with the combination of Lunar New Year celebrations in Asia and a federal holiday in North America.

However, the European session could open quite choppy given the limited liquidity in markets and expectations that Italy could approve Mario Draghi as the next Prime Minister over the weekend. If the former ECB Governor fails to pass the vote of confidence in both houses, forcing the Italian electorate to head to the polls, FX volatility is highly likely as markets widen Bund-BTP spreads again on renewed political risk. Outside of this, we look towards the CBRT’s latest decision on Thursday and take a look at inflation dynamics in the US after recent commentary by Fed Chair Powell and Treasury Secretary Yellen.


Monday – 15/02

Amid Lunar New Year celebrations in Asian markets on Monday, Japan releases its GDP figures for Q4 at ten minutes to midnight. Japanese real GDP towards the end of the year likely slowed from the sharp 5.3% rebound in Q3 on quarterly basis. Consensus stands around a 2,4% QoQ growth in Q4, consistent with an annual pandemic-induced collapse over 5% in 2020. Even so, the expansion in Q4 might offer a glimmer of hope for Japan, with all the major components excluding inventories expected to contribute to growth. Along with Japanese data, Singapore and Thailand´s GDP prints are due on the same day, also pointing at a slow but solid economic recovery by the year-end.

In Europe, the session might start on the back foot, with December industrial production in the Eurozone, released at 10:00 GMT, contracting for the first time since April. Later in the day, most of the attention will be centred around European Finance Ministers, who meet at 14:00 GMT to discuss macroeconomic developments and policy prospects in the euro-area. The Eurogroup discussion will be based on the Commission’s Winter Forecast and latest health developments presented by the World Health Organisation. The international role of the euro will be also addressed as part of the agenda, with ministers set to monitor “the opportunities but also the risks” of an enhanced participation of the single currency in global financial markets. The solvency of the corporate sector amid the pandemic will also be a centrepiece of the event, with ministers called to exchange views on how to best support the sector.

Tuesday – 16/02

Germany´s ZEW survey for February is released on Tuesday at 10:00 GMT. Despite the slow easing of curbs announced by the government for early March, remaining restrictions on travel and public life coupled with a sluggish rollout of vaccines will put sentiment to the test once again. While the survey is poised to depict a continued gap between the current assessment and future expectations, the outlook might seem mildly brighter with prospects of a strong recovery boosted by pent-up demand. The index might also find some support from the recent surge in equity markets, but this is unlikely to offset the extension of lockdown restrictions. Also at 10:00 GMT is eurozone GDP growth for Q4, with median estimates pointing at a 0.7% contraction on a quarterly basis.

Risks to this forecast are tilted to the upside after major European economies surprised with their better-than-expected readings. Any positive reaction in the single currency upon the news might be limited, as continued curbs in 2021 warn of a double-dip recession by the end of Q1.

Wednesday – 17/02

Intense debate on spiking inflation will continue on Wednesday, with the release of Consumer Price Index for the UK and Canada in January. In the UK, inflation is likely to remain subdued alongside the first quarter, with median estimates pinpointing the January reading at 0,6%. The downside effect of a sales tax cut for the hospitality sector and the temporary influence of weak energy prices will weigh on prices for some part of the first semester, followed by a likely spike in inflation data towards the end of the year. Meanwhile, in Canada at 13:30 GMT, inflation is expected to remain below 1% YoY in January as lockdown restrictions limit demand-pull forces. However, base effects and the gradual easing of lockdown conditions towards the end of the month suggest CPI will pick up in annual terms from March onwards.

US retail sales are expected to increase for the first time since September, likely from a boost from the second round of stimulus checks. The data will be released at 13:30 GMT, with median consensus looking at 0.8% monthly growth. Retail sales are meant to be a key data input in the current debate for the next round of stimulus, with democrats firming on the delivery of $1400 aid-checks to a broad proportion of Americans while also pushing for the hike of the minimum hourly wage to $15.

Thursday – 18./02

The Central Bank of Turkey will likely stay put on its policy decision on Thursday at 11:00 GMT, as real rates remain positive and the lira recovery continues. A separate primer is included below on this matter. ECB minutes from the January policy meeting will be thoroughly scrutinised in search for keys on what the Central Bank broadly refers to as “financial conditions”. Depicted by Lagarde as a wide set of indicators beyond sovereign bond spreads, markets will look for clues in the ECB’s economic assessment of the Eurozone economy looking forward. However insightful, however, European markets are fairly more sensitive to the slow-going vaccine distribution in the area, which will be central in the ECB´s balance of risks and forward guidance in the months to come. With the baseline scenario still unchanged and Mario Draghi´s return to the scene boosting european bond markets, the ECB might not hold too much protagonism in the European landscape.

Labour market data will be the spotlight in Thursday´s economic agenda…

With Australia’s unemployment rate and US initial jobless claims scheduled for 00:30 and 13:30 GMT respectively. Australia’s labour market recovery is set to continue in January after the end of the lockdown in Victoria was only partially dampened by curbs in New South Wales. The rebound in participation, job gains and positive employment outlook boosts prospects of a speedy labour market recoery. In contrast, recent comments from Jay Powell on a protracted recovery of the US labour market frame the weekly release of initial jobless claims. Following a rise of 793K additional submissions in early February, Bloomberg estimates point at another 760K increase in claims in the week ending on February 13th. The data, however, could serve as a fact-check reality of the need to push for big fiscal support.

Friday – 19/02

The economic calendar picks up on Friday, with the release of UK, EU and US flash Markit PMIs scheduled throughout the day. The agenda kickstarts with eurozone prints,  with the composite indicator probably stabilising in February close to the January reading of 47.8. Data is set to remain broadly in line as restrictions stood with little change, although disruptions to the supply of semi-conductors to auto-makers after Brexit might have weighed on manufacturing output. In the UK, the survey is poised to show a similarly grim outlook after the severe plunge in January, since the country kept lockdown restrictions in place into February. Technically, these “unchanged” conditions could force the figures to reflect a “stable” 50 reading as per the way the survey is constructed, but a similar situation during the first lockdown in spring indicates the ensuing indicators will remain depressed. In the US, figures should reveal a sound economic recovery both in manufacturing and services activity, although a mild slowdown compared with previous readings should be of note.

Wrapping up the agenda of the week, UK retail sales published at 07:00 GMT will serve as a thermometer of the damage inflicted by lockdown measures in January.

With the hit to the sector expected to be somehow milder than in the first wave of infections, restrictions in January are deemed to be more severe than in the partial November lockdown. Data on credit and debit card spending also suggest the retail e-commerce wasn’t as supported as expected, adding to the sector drop. Pent-up demand from nearly two months in lockdowns should lead to a sharp rebound once the curbs are eased, but a challenging race on vaccination is still in the way.


CBRT preview


The Central Bank of the Republic of Turkey has become somewhat predictable since the introduction of Governor Naci Ağbal back in November. After switching back to the framework of the one-week repo rate being a clear policy rate, and raising it from 10.25% to 17.0%, the CBRT now looks as if it is aiming to meet market expectations and avoid raising the terminal rate any more than it has to.

With inflation printing just over 2 percentage points below the one-week repo rate in January, markets don’t expect further rate hikes to be forthcoming.

This is especially the case given the CBRT has shown relative comfort in the markets’ assessment of where rates should be. With higher interest rates proving politically sensitive, and the lira recovery being supported by positive real rates and the return to an orthodox monetary policy framework, we expect the CBRT to hold rates at 17% next week like it did back in January’s meeting. This is despite the Governor’s recent comments that rates could rise further should inflation deviate from the medium-term outlook.

Meanwhile, de-dollarisation takes place in Turkey

With interest rates elevated, inflation set to ease back into single digits by year-end, and the lira regaining purchasing power with a 17% rally from last year’s low, domestic deposits of FX and precious metals have begun to decline. After reaching a record high of $236bn last month, data from the CBRT shows that domestic FX holdings have declined for the first two successive weeks since September. With them now sitting at $232.93bn, the de-dollarisation trend looks to have begun, but remains highly conditional on the CBRT’s good work in rebuilding locals’ trust in Turkish assets continuing.

Meanwhile, the CBRT’s FX reserves have only been rising by small increments. Governor Ağbal’s comments that Turkey would not seek swap lines with other central banks now, and instead opt to rebuild FX reserves via auctions, is a positive for investor confidence. The slower rebuilding of FX reserves suggests the orthodox monetary policy regime will remain in place for some time to help recoup the lira’s purchasing power as officials now don’t have the ammunition to rebut market forces due to depleted FX reserves.


CBRT FX reserves begin to recover but at a snail’s pace. Coupled with the decision to stop seeking swap lines with other central banks, this is a positive sign for the lira and the de-dollarisation trend


US inflation


With the Fed being more dovish than ever and the White House being brushed in blue, market expectations of US economic growth have picked up over the last few months as the massive monetary and fiscal injections breed hopes for a strong reflationary environment. US inflation expectations are at the highest since 2014, with the US 10-year breakeven sitting comfortably above 2% (chart 1), while growth is expected to be aggressive in 2021. The median forecast of household consumption, for example, sits at 4.85% for 2021 and has been increasing incrementally with the prospect of more fiscal stimulus. While markets price inflation and growth expectations, the Federal Reserve clearly stated it will only start considering scaling back stimulus when maximum employment is met, inflation reaches the 2% target and comfortably floats above target for quite some time. The last condition, which is known to markets at Average Inflation Targeting (AIT), sent a message that interest rates will not be hiked for some time and that real rates will stay negative. This is confirmed by the real yield on 10-year Treasury bonds, which remains flat in negative territory despite the recent bear steepening in the US yield curve (chart 2). However, a dilemma could soon arise should inflation pick up substantially while the economic recovery, and thus tightening of the labour market, takes longer.

While inflation readings are set to rise in YoY terms in the coming months due to base effects, underlying drivers suggest inflation in the US could come back with a vengeance, creating another episode of markets vs the Federal Reserve.


Chart 1: US 10-year breakeven shows inflation expectations are near 2014 highs


Chart 2: Nominal vs real yield on US 10Y Treasury




Markets tend to look at YoY inflationary figures as a rule of thumb as central banks usually target annual inflation. Annual inflation figures compare price levels in a specific month of 2021 to the same month in 2020, which means that if last year’s inflation figures were distorted – for example by the stringent lockdown effects – this year’s figures will be erratic as well. This effect, the “base” effect, will cause inflation to move higher in the months ahead as the base level of inflation from last year was low to begin with, especially throughout Q2.

As the economy gradually reopens in the next half of the year with containment measures lifted and demand returning, prices will recover and this will be evident in the month-on-month figures. If price levels would remain unchanged for the next four months, the depressed inflationary figures from last year will push up year-on-year figures, leading to an annual increase of headline inflation by as much as 2.5% at current prices (chart 3). As economic conditions are only expected to improve going forward, the 1.6-2.5% YoY range is set to become a strict minimum from March onwards. MoM figures will therefore be the way to go for markets, however, these figures also come with risks.

Monthly figures have risks tilted to the upside with many of the underlying inflation drivers set to pick up. This may include a big spike in consumer spending after consumers have piled up cash throughout the pandemic. The pandemic lifted savings rates across the globe to all-time highs, and while the peak from March has passed, US personal saving as a percentage of disposable income still floats around levels not seen since the late 1970s.  The question will then not be if, but by how much demand for consumer services will outstrip supply as the services sector may struggle to keep up with the high pace of demand that returns after a long state of hibernation. Beyond this, the pressure on rent growth will likely increase. The rate of increase in rents, which accounts for 40% of the core inflation figure, printed almost flat at +0.13% in January. However, when considering year-on-year prices, apartment prices are up 10% while the YoY change in the median rent asked by landlords printed at 18% in Q4 2020. These underlying drivers suggest a near-term rise in rent prices is incoming.

Next to the inevitable demand shock, there will likely be effects from the supply side as well…

Crude oil prices have recovered to pre-pandemic levels again due to a sustained drawdown in US and Chinese oil stockpiles and restricted supply due to the production cuts implemented by OPEC+. These higher input prices were reflected in the January ISM prices paid index, which printed at highs not seen since early 2011. Higher input prices, partly due to higher energy costs and partly due to a pandemic induced period of de-globalisation, will eventually filter through into the CPI basket, putting further upwards pressure on inflation.


Chart 3: Base effects mean May 2021’s CPI reading is coming in at 2.5% YoY already at current prices



At the time of writing, Democrats are using a legislative procedure called reconciliation to provide them with their best shot of passing something approximating President Joe Biden’s $1.9tn fiscal stimulus plan without needing bipartisan support. With reconciliation, the proposal would only require a simple majority of 51 Senate votes to be approved, including Kamala Harris’ tie-breaking vote, while regular longer-term fiscal legislation would require 60 votes through negotiations. If they succeed with the reconciliation process, the final fiscal stimulus package would be significantly closer to the $1.9tn plan than what would have been achieved under bipartisan support. Many have argued the fiscal package is too aggressive and may lead to overheating the economy. Treasury Secretary Janet Yellen and Fed Chair Jerome Powell, however, voiced no concerns around overheating the economy, with Janet Yellen stating that the risk of underdelivering in the current climate is higher than the risk of overdelivering. Yellen stated the US could reach full employment – which is one of the three conditions for the Fed to start tapering QE – next year if Congress manages to pass the $1.9tn bill. Without it, markets would be looking at full employment in 2025. Powell also downplayed the risk of runaway inflation and stated in a speech on Wednesday he does not expect a large nor sustained increase in inflation right now, and instead focuses to look through inflation volatility as it will be averaged out, and aims for a recovery in unemployment instead.

As much as Yellen and Powell seem to not care about inflation, markets have every reason to do.

Spill over effects from inflation may lead to the average target being met quicker than what the Federal Reserve suggests. This could lead to QE tapering as long as economic growth keeps up with the pace of inflation, and begs the question of what could happen if the Fed starts tapering before other central banks – are we looking at another risk of a taper tantrum and expectations of a normalisation cycle by the Fed before 2024? Alternatively, a risk remains that inflation could outpace the other metrics the Fed bases its forward guidance on. If the labour market and economic growth fail to keep up with the fast pace of inflation, depending on the underlying drivers of inflation, the Fed’s hands are more or less tied. Chances of the output gap recovering may be slim, but markets are aware of the high economic risks and will therefore be watching both the path of inflation and fiscal stimulus in the coming period to estimate the direction the Fed will take in the quarters to come.


Simon Harvey, Senior FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, FX Market Analyst



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