22 July 2021: Sterling under pressure

Sterling under pressure

22nd July: Highlights

  • Self-isolation now its own epidemic
  • Delta Variant a minor disruption
  • Can Lagarde convince the market she isn’t a dove?

Yet another Brexit rethink on offer

The pound has begun to suffer as the UK enters a new phase of the Pandemic.

The supposed effectiveness of the Government’s track and trace app has led to ten so thousands of people being forced to self-isolate. It has become such a widespread issue that it is affecting the economy.

Two more obvious signs of the issue are the empty shelves in supermarkets that are reminiscent of the first weeks of the Pandemic, and garages running out of fuel.

The risks attached to the economy of these issues are spooking investors and concerns are growing that the issue could become so serious as to derail, or certainly slow, the recovery.

The final withdrawal of Coronavirus restrictions has caused traders to adopt a half glass empty attitude to the country’s recovery. Boris Johnson, himself self-isolating, has been forced into several decisions that appear to be rushed and not thought through.

The travel and entertainment industries have been most badly hit, with quarantine and self-isolation rules for travellers changing almost daily. New rules have also been introduced that will hit nightclub owners, in what has been one of the most severely hit sectors of the economy.

Tomorrow will see the release of data that, if predictions are correct, could arrest the pound’s recent slide.

Retail sales data for June and July’s flash PMI figures for activity are expected to continue the strong recent trend. If that is proven to be the case, the market may consider the pingdemic something of a blip, with the underlying economy remaining well into a recovery mode which can survive a bump in the road.

Yesterday, the pound fell to a low of 1.3591, but recovered strongly as traders took profit on short positions ahead of tomorrow’s data. It closed at 1.3711, still at the bottom end of its recent range.

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Market confusion over future policy grows

Jerome Powell will have had one of the most confusing periods as Chairman of the Federal Reserve of his predecessors in living memory.

Having passed three years in charge last February since he replaced now Treasury Secretary Janet Yellen, Powell has had to contend first with a boss about whom one of the kinder comments labelled him a megalomaniac.

Rumours of his departure from the role occurred almost daily as he refused to comply with the instructions of Donald Trump, insisting on the independence of the Central Bank.

He has now faced one of the shortest but most devastating recessions in history, with the economy shedding around twenty-two million jobs over a two-month period last year.

He has held his nerve, surrounded by FOMC members who largely agree with his policies.

Now, he faces the recovery with the same degree of personal certainty. It is fairly clear that he eschews labels, and no one right now could label him a dove or hawk.

He is, however, dovish about inflation, which has now trended well above 5%, a level not seen since the period ahead of the financial crisis.

5% inflation is of course dwarfed by the rate of 15% seen in 1980 but the world and the U.S. economy were beasts of a different kind forty plus years ago.

The transitory nature of the current level of inflation is a term that has been picked up by financial journalists, and the fact that it is considered a different type of inflation has also attracted their attention.

The question remains inflation is inflation however it arrives. It is probably true that no two inflationary periods in economic history have been created or arrived in the same manner.

Powell now faces the dilemma of having to react to rising inflation without damaging the nascent recovery, and it looks like these decisions will be taken against the backdrop of a rise in infections.

Hawk or dove makes very little difference in the current environment. If, as is likely, the FOMC hangs on until the end of the year, is that to be considered dovish? Possibly so given the current level of inflation, but Powell will be happy to be considered a dovish hawk or even a hawkish dove as long as he achieves his goals in the end.

The rise in the dollar index will have had a marginally positive effect on inflation but given the pace at which prices have been rising, that benefit may get lost in the mix.

Yesterday, the index hit a high of 93.20 but still looks a little fragile. If it is unable to maintain upwards momentum it may well retrace as the rally is considered a reaction of a fall in risk appetite and little more.

Hawks hope, doves expect

Today’s the day! It seems a very long time since Christine Lagarde announced that there will be a significant announcement following today’s ECB rate setting meeting. Getting the boring stuff out of the way first, there is not expected to be any change in either interest rates or the Bank’s level of asset purchases.

There has been a high degree of speculation following Lagarde’s release of the news that the ECB is changing its inflation reference to 2%, but that would be treated symmetrically.

That comment was swiftly followed by comments from the more hawkish council members who wished to reiterate that while this may be a more dovish measure, it doesn’t give the bank carte blanche to allow inflation to rise simply because it has been at historic lows for some time.

The meaning of symmetry in this case is that the Bank will be tasked with keeping inflation as near to 2% as possible, and to take low inflation as seriously as high inflation.

Today, we will see Lagarde add some meat to the bones and also let the market know what is expected to happen once the current round of asset purchase ends. That is believed to be next March, although, if inflation is considered controlled, and the economy failing to grow at the desired (or expected) rate, it may be longer.

A further takeaway from today will be the first time that the ECB President has been in a position to really exert her will over future policy.

Of course, she will be providing further detail over a strategy that was agreed upon by all members of the Eurozone, some perhaps more grudgingly than others, but she will also be able to use the slightly more dovish outlook to keep control of those nations that see their own agenda as being what should be followed by the entire group.

Today may also see the single currency rise again to exert itself across the financial markets. It has remained driven by the dollar almost for the entirety of the Pandemic and beyond, but a clear understanding of the bank’s goals, targets and expectations may push the market to see it as more than a makeweight in the index.

Yesterday, the euro rose to a high of1.1804 as the recent fall in risk appetite abated somewhat. It closed at 1.1794 but today could/should provide some kind of watershed.

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.”