12 January 2021: Virus to get worse before recovery

Virus to get worse before recovery

12th January: Highlights

  • MPC member sets out case for negative rate
  • Dollar bounce to continue
  • Investor confidence in positive territory

Retail footfall fell by 27% in the most recent week

Data for like-for-like retail sales was published overnight. It showed just how bad 2020 was for the sector.

There was a slump in demand for fashion and homeware products while sales of foodstuffs grew by 5.4% over 2020. This perfectly illustrates the effect of the lockdowns that took place during the year. Overall, sales fell by 0.3%, the worst outcome since records began twenty-five years ago.

Silvana Tenreyro, a member of the Bank of England’s Monetary Policy Committee spoke yesterday of the possibility that the Bank will need to add more stimulus to the economy This view was backed by U.S. investment bank Goldman Sachs which, in a report on the UK economy, said it expects a move as early as next month.

Tenreyro went on to discuss negative interest rates in the UK. While most analysts expect stimulus to be delivered in the shape of increased or faster purchases of bonds, she said that it was important that the Bank maintained the weapon of another interest rate cut and retained the possibility of taking rates into negative territory.

Work on the effect on the economy continues but not all members of the MPC are convinced.

Overall, interest rate futures predict a cut to zero for rates in the second half of the year and a further cut early next year.

The pound has entered a corrective phase as the increase in cases of Covid-19, seemingly out of control in some areas of the country, offsets the positivity generated by the first couple of weeks of Brexit and the rollout of the Coronavirus vaccines.

Moderna, the third vaccine to be approved is expected to be delivered for use by March. This will increase the UK’s capability to have the entire population who are willing to be vaccinated to be offered a jab by the Autumn.

Versus the dollar, Sterling fell to a low of 1.3451 but recovered to close at 1.3520.

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Fears of double dip hit risk appetite

Companies who import or export goods who have to hedge their currency exposure and investors who wish to overlay a hedge to their foreign currency investments are facing an increasing dilemma in the shape of the new unpredictability of the path of the dollar.

While it has always been a fact that the greenback is a safe haven currency which tends to perform best in turbulent times, changes in risk appetite have now become the primary driver for the currency.

Overall, despite the changes to risk appetite, the dollar, and other major or G7 currencies have historically fluctuated mostly when driven by the underlying strength of their respective economies.

If there was ever an example of a sea-change in market attitudes, it was the reaction of the dollar to truly abysmal employment data released last Friday.

It began a correction to its recent falls, which has continued into this week. Analysts now expect that correction to continue in the short term and it will take an improvement in the rollout and take up of the vaccines in the U.S. to turn risk appetite positive and stop the dollar’s advance.

Inflation is receiving several inches of column space in the U.S. financial press currently with concerns growing that the country could see a rapid increase in prices over the medium term.

The two main drivers of this view are the fall of the dollar over 2020 which has dropped by close to 15% since March, and pent-up retail demand which awaits the end of lockdown.

Inflation has not challenged the Fed’s target of 2% for some time now, but several analysts expected a break higher which has already been headed off, to a certain extent by FOMC Chairman Jerome Powell as he discusses a change to an average level of inflation of 2%.

Yesterday, the dollar index reached a high of 90.73, closing at 90.74.

ECB to provide further stimulus

Central Bank meetings are at something of a premium in the early part of the month. The ECB Governing Council will meet next week with the FOMC the following week, as monetary policy and stimulus efforts continue to dominate traders and investors.

With interest rates at historic lows, it is likely to be any change in the direction of rates, which currently remain firmly lower that drives risk appetite and therefore FX markets (as discussed above)

Papers released recently under the thirty-year rule in the UK show that Prime Minister Margaret Thatcher was firm in her belief that a single currency could not survive if there was a monetary union but not fiscal union.

While that has clearly been a millstone around the currency’s neck during any major upheaval, the financial crisis and the Pandemic are prime examples, the Union has managed to pull a rabbit from the hat at the last minute to ensure its survival.

That situation remains and is exacerbated by the underlying socialist principle of joint responsibility for every decision and majority rule. Such a policy only works with strong leadership which is not something the EU Commission has enjoyed (the jury is still out on Ursula von der Leyen) over the entirety of its existence.

Strong national leaders like Angela Merkel, Giuseppe Conte and Viktor Orban undermine whether by intention or personality the ability of the Commission, Council, and Parliament to do their jobs, ably backed by a high level of bureaucracy.

Once the vaccination of the population of the region is well under way, the Union would do well begin to consider its long-term future particularly with Angela Merkel about to depart and no obvious popular leader to replace her, despite what Emmanuel Macron may think.

The euro fell versus a correcting dollar yesterday. It reached a low of 1.2132, closing at 1.2153. A test of the 1.20 level cannot be ruled out and given the impetus the currency received when that level was finally breached on the way up, should it break below, the correction could easily become a trend.

Have a great day!
About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”