Ebury: Looking at central banks

By Enrique Diaz – Alvarez

The first data on the Omicron variant show that it is not more contagious than previous variant, and may in fact be less severe. Understandably, this brought euphoria around risk assets. Shares, commodities and credit have risen due to extremely supportive reforms in both monetary and fiscal policy. The currencies for the most part followed the same path, with emerging market currencies performing exceptionally well and safe havens underperforming. The dollar fell against most of its bonds, somewhat surprisingly.

As central banks in developed countries prepare to lift the huge monetary stimulus that fuels inflation, much uncertainty remains about the timing and extent of the lift. The central banks are meeting this week: the US Federal Reserve on Wednesday, the European Central Bank and the Bank of England on Thursday. The first is expected to appear boldly, the second moderately, and no one knows for sure about the third. The interaction between the decisions of these three institutions, their communication messages and the market expectations for them should be the key to what is shaping up in a crucial week for the foreign exchange markets.

Sterling

With little financial news from anywhere last week, traders have been content to trade sterling very narrowly against the euro and the US dollar, in anticipation of the Bank of England’s meetings this week. News of the Omicron paralysis is likely to rule out any political moves this week. However, we expect that both the vote and the Bank’s announcements will leave the door open for an increase at the next meeting, if the information on the Omicron variant confirms its relative leniency.

Euro

Strong industrial production from Germany last week may have helped stabilize the euro against the dollar last week, but traders remain focused on the ECB meeting on Thursday. Market expectations are for a very modest stance by the Central Bank, which expresses its willingness to continue buying bonds until 2022, even when others, particularly the US Federal Reserve, are restricting their purchases much sooner. However, there is hope for the euro. Any frustration with these expectations, either through a more aggressive downturn or perhaps a dispute over growth within the ECB, could lead to a sharp and short rally.

Dollar

Inflation hit a record high in November, jumping to 6.8% and 4.9% following the results of food and energy forecasts, setting a multi-decade record for both. However, the market was prepared for these numbers and the currencies did not move long after the announcement. The Federal Reserve is expected to take a bold turn internationally on Wednesday, with the market expecting an end to bond markets by March and a first rate hike before the summer. Another key factor of the meeting will be the “dot plot”, ie the recording of the Bank officials’ expectations for future interest rate increases. Markets are already anticipating three increases in 2022. If the Fed officials’ average dot plot moves above or below it, it is likely to have a significant impact on the dollar.

* Enrique Diaz – Alvarez, is Chief Risk Officer of the international payment company Ebury. The company’s analysts were named by Bloomberg in the first place of the most successful forecasts for the EUR / USD exchange rate in the fourth quarter of 2020.