21 May 2021: Variant unlikely to halt full reopening

Variant unlikely to halt full reopening

21st May: Highlights

  • Variant concerns slowing recovery
  • Powell’s Transitory inflation may last longer than expected
  • In the Eurozone, it’s inflation but not as we know it

Indoor hospitality delivering a boost despite concerns

The success of the UK’s vaccination programme has allowed the country to proceed without any problem along the path towards a full reopening of the economy.

There are clearly still several bumps in the road to be negotiated and having come so far, there is genuine concern that the Indian Variant that has been seen in several areas of the country could delay the whole process.

Prime Minister Boris Johnson remains cautious, saying all the right things about maintaining social distancing etc., so unless there is a major change to the current data the full removal of restrictions remains on schedule.

Inflation was always known to be the likely outcome of the measures that have been put in place to help economies survive the Pandemic. The rate at which price increases will take place appears to be varied according to how the stimulus has been applied.

In the UK, there has been a mix of direct support and ongoing measures that have seen the inflation rate start to rise. This week’s data shows that the issues of demand outstripping supply, logistical delays and continuing Brexit concerns will see prices rise significantly over the next few months.

The Bank of England will almost certainly choose to remain vigilant without taking any action since the economy is not yet sufficiently self-propelled to stand higher rates.

The big test for the recovery will come in September when the Government’s furlough scheme is wound down.

The degree of uncertainty in financial markets perfectly illustrates the current state of the economy. Investors are concerned that inflation will become such a concern to the Central Bank that it will be forced to act.

This is countered by those who see inflation as a temporary phenomenon that will even out over a relatively short period as the country catches up with itself.

Both scenarios are almost equally possible, and this has seen the pound dragged along in decreasing ranges that will continue until there is a positive outcome one way or the other.

A singular feature of the FX market over the past few months has been the almost complete dominance of the dollar over other G7 currency values.

Yesterday, the pound rallied to a high of 1.4192 versus the dollar. It has been threatening to break above recent highs over the past week but so far support for the dollar has held it back.

Versus the euro, Sterling remains in a broad 1.1480/1.1640 range for now. With expectations that the growth differential will favour the UK going forward, a break to the topside is the most likely scenario in the medium-term.

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FOMC boost wears off as index returns to recent lows

The FOMC is being driven to undertake the one thing it really doesn’t want to do.

That is, reveal its plans.

The data releases over the past six weeks or so have been demanding that Fed Chairman Jerome Powell appraise the market of the Fed’s plans to deal with rising inflation.

Powell continues to use the word transitory to describe the rise in inflation but needs to add some parameters to what that means and when transitory turns into permanent.

Inflation hasn’t been an issue for the global economy since before the financial crisis. Tales of 10% inflation and interest rates rising almost monthly have been consigned to history.

The introduction of quantitative easing, another name for printing money, was supposed to drive runaway inflation a decade ago but since that didn’t happen, the practice has now become a legitimate monetary policy tool.

However, the latest measures that have been taken will drive up inflation as the basic economic principles cannot be ignored and are exacerbated by the Pandemic and how it has been dealt with.

The change of emphasis in the U.S. driven by the lurch to the left as a result of the election means that now Janet Yellen and Jerome Powell have joined forces to ensure that the economy recovers. But their sledgehammer approach relies on the acceptance of the country’s creditors to play ball as Government debt continues to grow.

China needs the U.S. as the main buyer of its goods and this uneasy relationship is a little tenuous to be considered a secure bond of mutual benefit.

Of course, If China were to demand higher interest rates for its continued and increasing buying of U.S. debt, it could bring the entire edifice crashing down.

Yellen is well aware that China may make tough demands but, in the end, the two need each other and the rest of the global economy lives off the crumbs from the two giant economies’ table.

The boost the dollar received from the rather more hawkish than expected FOMC minutes dissipated quickly as it emerged that the Fed continues to hold fire on any change to monetary policy.

The dollar index fell back to support around the 89.80 level, closing at 89.76. The past three days have seen the index trade in an almost identical range. This will create a degree of pressure where whichever side is broken, the reaction will be volatile but short-lived.

Central banks desperate to remain in supportive mood

One thing that has been a constant in the ECB’s battle to ensure the Eurozone economy survives the Pandemic is inertia.

The President of the Central Bank, Christine Lagarde has used virtually the same speech at her post monetary policy meeting all year as the ECB clings on and hopes.

Now however, the Bank’s Chief Economist Philip Lane has found a new idea to deal with rising inflation.

His new notion is to say that what is being seen as prices rise across the Union isn’t inflation at all but a bottleneck.

Unfortunately, if it waddles like a duck, swims like a duck and quacks like a duck, it’s a duck.

Simply failing to recognise what is in front of his face, won’t save Lane from being forced to suggest what will need to be done.

In some ham-fisted way, Lane was trying to emulate Jerome Powell in trying to say inflation is transitory without using Powell’s copyright word.

Inflation is unlikely to rise as frantically in the Eurozone as it does elsewhere due, as mentioned above, to the way support has been applied.

Across the board the support payments have been used to prop up economies rather than stimulate them.

Yesterday, Italy approved a further Eur 40billion of bond issuance to help the recovery that is beginning to take place in the country due to the rapid improvement in vaccine distribution.

Italian Prime Minister Mario Draghi commented that while the funds will be used prudently, the release of the Eur200 billion in relief due from Brussels will be vital to the economy.

The euro remains well supported close to 1.20 versus the dollar but has no upside momentum as it reaches towards 1.2250. It reached 1.2229 yesterday and closed at 1.2227.

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.”