News & Analysis

Markets have focused on the wedge of central bank announcements this week, with notable meetings from the Bank of Canada, the Bank of Japan and the European Central Bank. In Canada, Governor Macklem’s optimistic tone resonated with markets and led the loonie to notch a fresh 33-month high against the dollar, while it also brought forward our expectation of QE tapering to the end of the year.

Meanwhile, the Bank of Japan stood by its last policy decision despite short-term risks to the economic outlook, while acknowledging the need to assess the effectiveness and sustainability of its policy tools in the March review. President Lagarde did her utmost to avoid signalling that the ECB uses its PEPP facility to keep sovereign spreads within a defined range, highlighting that the central bank takes a “holistic” view on financial conditions when determining the pace of purchases. Meetings in Norway and South Africa were less eventful, noting the mixed risks to the economic outlook. Alongside this, markets continued to keep an eye on events in Washington as President Biden hit the ground running on his first few days in office. While the new administration’s Covid response was swiftly laid out in new executive orders, markets await signs of progress with the additional fiscal stimulus package. Given this, and the upcoming FOMC meeting, the focus will remain on US dynamics on the whole next week, with QE tapering the topic on everyone’s lips.

Calendar

Monday – 25/01

At 09:00 GMT, the German IFO survey will provide insight on how the German economy is handling the extension of lockdown measures to February 2021 and further tightening of restrictions since December. Similar to the previous couple of releases, the current situation index is set to fall while the expectations index is expected to grow further after December marked the first monthly increase since Q3 2020. The data points may surprise to the downside given that the economy is likely to contract in Q1 2021 and it may not be until well in Q2 before economic recovery gets back on track.

Monday also marks the start of the virtual Davos Forum which will run from Jan 25 to Jan 29.

The annual meeting is typically held each January in the Swiss ski resort of Davos but will be online this year instead due to obvious reasons. French President Emmanuel Macron, German Chancellor Angela Merkel and Chinese President Xi Jinping will be among the speakers at the online event.

Tuesday – 26/01

UK labour market statistics are on the agenda at 07:00 GMT. The 3-month unemployment rate ending in November is set to have increased towards the end of 2020 as the one-month lockdown in the UK likely saw further job losses. Considering the extension of the furlough scheme in October was announced late on, the unemployment rate may etch up as additional redundancies are captured in the November sampling period. Expectations envisage a marginal increase from October’s 4.9% reading to 5.2% in November. Attention will then shift to the release of the Confederation of British Industry’s reported sales data for January at 11:00 GMT. After retail sales data for December showed weak levels of consumption, and the Bank of England’s CHAPS data also evidenced the reduced use of household debit and credit cards in early January, the CBI release will give markets a flash estimate of the damage the national lockdown has inflicted on consumption and the retail sector.

Wednesday – 27/01

December’s US durable goods data will be released at 13:30 GMT and is expected to increase another 1.0% on top of November’s 1.0% increase, marking eight months of consecutive growth. Any surprise to the downside may affect the dollar harder than an upward surprise considering another positive figure is priced in after seven months of increases. The FOMC is set to keep monetary policy unchanged on Wednesday evening at 19:00 GMT, however markets will closely watch any references to changes in economic conditions since December’s projections and QE taper talk. A separate primer on the FOMC decision is included below.

Thursday – 28/01

Norway and Sweden come out with unemployment figures at 07:00 and 08:30 GMT respectively. Both nations’ labour market has shown resilience in Q4 2020 despite the announced lockdown measures in October, and the very same may be true for the December figures. At 10:00 GMT, the eurozone will publish several confidence indicators for January including the consumer, economic, industrial and services indexes. The consumer confidence index is a final reading and therefore is not expected to be much different from the preliminary reading of -15.5, whereas the other three are flash readings and are set to decrease, according to the median forecast submitted to Bloomberg. With fears of a deteriorating short term economic outlook for the eurozone dominating markets in the past week following Pfizer’s supply delay and the divergence between the vaccine rollout of the UK and EU, a downturn in confidence indicators is likely. US annualised QoQ GDP for Q4 2020 will be released at 13:30 GMT and is expected to come in at 4.5%. This is a big difference from the prior reading of 33.4%, and follows as the US economic rebound found itself dissipating in the final quarter of the year, not only because of deteriorating virus conditions, but because lengthy negotiations regarding the coronavirus relief bill and government funding likely obstructed economic activity. Consumer confidence declined in Q4 while virus numbers and deaths continued to surge. The Q4 GDP reading will be an important one for markets, especially as it is released shortly after the Federal Reserve’s latest decision. Germany’s HICP inflation is on the agenda at 12:00 GMT and will be an interesting one as the VAT cut enacted in July to support spending will unwind this month. On top of this, energy prices have risen sharply since the recent rally in crude oil markets, which will likely cause inflation figures to jump.  

Friday – 29/01

A raft of preliminary GDP figures for Q4 in major eurozone economies will be out on Friday, with numbers for France, Germany and Spain published at 06:30, 07:00 and 08:00 GMT respectively. An aggregate collapse in the region’s economic activity is already priced in, as stringent restrictions were put in place across the area by year-end. France is expected to take the biggest hit, as an early national lockdown imposed in November and lingering restrictions in December shocked services. Consensus estimates pinpoint a decline of 4% in GDP on a quarterly basis, from the short-lived 18.7% sequential recovery in Q3. These numbers would be consistent with an annual decline of 9% in 2020 overall. The hit in the Spanish economy in Q4 should be relatively limited, since targeted measures proved successful to contain the virus spread compared to neighbour countries. Even so, Spain is poised to reflect a 1.5% contraction of real activity QoQ from a 16.4% rebound previously, pointing to an 11.4% collapse of GDP in 2020 as a whole. Germany will likely show a stagnation in activity in the last quarter of the year, with strong industrial production offsetting much of the impact of a national lockdown in services. All in all, the biggest eurozone economy is expected to show a slump of 5% YoY inflicted by the pandemic in 2020. The extension of restrictions into the New Year may result in a further contraction in Q1, which is broadly expected.

Mexico will release preliminary figures for GDP growth in Q4 at 12:00 GMT, with the YoY print expected at -7.4%. Such a decline would compare with the sharp collapse of 18.7% and 8.6% in Q2 and Q3 respectively, pointing to a slow recovery from the pandemic’s shock in 2020. Median expectations forecast an annual decline of 9% of GDP over the course of the year, the worst recession documented in Mexico’s history. The previous record was -6.30%, registered in the 1995 Tequila Crisis. Although private demand has beaten expectations by a small margin at the end of the year, we don’t expect significant upside surprises to the GDP figures next week. Moreover, we continue to expect ample economic slack to drive a flat inflation path going forward, prescribing limited monetary policy action in 2021.  Expectations for Canada’s November GDP reading on Friday at 13:30 GMT are bleak, sitting at 0% month-on-month growth. This comes in spite of Statistics Canada’s preliminary estimate of a 0.4% increase back in December. The preliminary reading is subject to a high degree of uncertainty, but Statistics Canada expects manufacturing, wholesale trade, finance and insurance to lead growth, while construction and services tempered growth. The GDP reading gives investors a glimpse into the impact the latest measures had on the economy, although the effects of the lockdown in the Toronto and Peel region are unlikely to be fully captured as they were only implemented on November 23rd. Finally, US Personal income & spending at 13:30 GMT are set to show a 0.2% and -0.5% change respectively, with the personal income index holding the largest difference between the consensus and prior reading.

 

FOMC

UPWARD SURPRISE TO DECEMBER’S PROJECTIONS BUT POWELL TO THROW COLD WATER OVER TAPER TALK

The Federal Reserve’s Open Market Committee concludes its two-day meeting on Wednesday 27th, with the monetary policy statement released at 19:00 GMT and a press conference held by Chairman Jerome Powell shortly after. With no fresh economic projections, we expect the FOMC’s monetary policy statement to remain largely unchanged, although references to weak incoming data may be eluded to. Beyond that, markets will have to wait for Jerome Powell’s press conference and the subsequent release of the FOMC’s meeting minutes on February 17th for additional details. Despite the weak data since December’s meeting, developments in the fiscal space along with vaccine distribution pose upside risks to previous forecasts. The Senate has since passed a $900bn fiscal stimulus package, while the Democrat wins in the Georgia elections suggest additional stimulus will be announced before the Fed’s next meeting in March. Moreover, Biden’s more aggressive stance on tackling the pandemic and his commitments to vaccine distribution bode well for the reopening of the US economy, however many hope that the plan to administer 100m vaccines in 100 days is a low hurdle as opposed to a realistic goal. On net, however, the developments since December are likely enough to see Chair Powell strike a cautiously optimistic tone in Wednesday’s meeting, similar to that struck by central bank governors in Europe and Canada last week. But, Jerome Powell will have to tread carefully in doing so to not embolden claims for earlier policy normalisation.

 

Economists’ GDP forecasts shift higher after $900bn stimulus package passed, and are likely to again once Congress agrees on the final sum of the $1.9trn proposal 

Source: Bloomberg Survey of Economists, Federal Reserve December Summary of Economic Projections

 

Attention will be particularly centred on the discussion of QE tapering. Previous comments by regional Fed members Bostic and Kaplan stoked markets into pricing in the possibility of bond market support fading by year-end. When combined with news of an additional $1.9trn fiscal stimulus package being floated in Washington, this resulted in rising 10-year yields, which has been one driver of the USD rebound witnessed at the beginning of this year. A quicker vaccination campaign being rolled out since December has also added to a brighter economic outlook, bringing the discussion of policy normalisation to the table.

 

Increased fiscal support and expectations of tapering have triggered early bear steepening in the US Treasury curve

Despite signals from regional Fed members that the central bank could slow down its role in bond markets ahead of expectations, Chairman Jerome Powell has promptly assured investors this isn´t happening any time soon. The Federal Reserve is drawing on lessons learned from the “taper tantrum” of 2013 to avoid stoking market expectations prematurely. Such an act would only result in tighter financial conditions, which will ultimately undermine efforts to support the economic recovery. Powell will endeavour to make sure 2013’s mistakes aren’t repeated this time around, reinforcing expectations of sustained support throughout the year.

The Fed’s official response is likely to be built around Powell’s previous statement that “now is not the time to be talking about exit” earlier on in the month.

Although the Fed has also indicated that any reduction in the pace of asset purchases will be communicated well ahead of time, this isn’t likely until the latter part of 2021 in our view. Even when the Fed does start reducing its monthly purchases, it will only gradually ease them, while staying on standby should economic conditions deteriorate or bond market dynamics undermine the recovery.

 

An uncertain economic outlook leaves the Fed’s balance sheet in expansionary territory for now

 

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

 

 

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