Most of the time, investors are focused on two V’s: value and volatility. However, two other V’s will continue to dominate the month ahead of the investment climate: virus and vaccine. At the end of January, it seemed like many high-income countries had begun seeing leveling-off after the holiday-inspired surge. Economic-cramping restrictions will remain in place for the next several weeks, and many consider deepening and/or broadening restrictions.
The IMF boosted this year’s outlook and sees world growth at 5.5%, up from 5.2% in October. If accurate, it would be the strongest growth since 2010’s recovery from the Great Financial Crisis. The chief economist Gopinath commented as the new forecasts were published that “Much depends on the outcome of this race between a mutating virus and vaccines and the ability of policies to provide effective support until the pandemic ends.”
Fiscal stimulus from late last year by the US and Japan were taken on board by the IMF, and it revised 2021 growth higher its update. US 2021 GDP is now estimated to be 5.1% rather than the 3.1% it projected last October. The prospects for more stimulus mean that there is upside potential in the IMF’s next update. Japanese growth was revised up to 3.1% from 2.3%. Growth in the eurozone was downgrade to a still solid 4.2% from 5.2%.
The IMF seemed particularly optimistic about India. Last year’s contraction is now estimated to be around 8% of GDP rather than more than 10%. It is the 2021 forecast of 11.5% (from 8.8% in October) that grabbed attention. China’s growth prospects were shaved to 8.1% from 8.2%. In 2022, the IMF also projects India to grow faster than China (6.8% vs. 5.6%).
Most of the G7 are at risk of contracting in the first three months of 2021. The main exception is the United States, helped by the $900 bln fiscal package approved at the end of 2020. Although President Biden has proposed a new $1.9 trillion stimulus bill, it is best understood as an opening gambit that will most likely be negotiated down. The IMF estimated that the stimulus proposal if adopted, would boost growth by 1.25% this year and 5% over the next three years. Debating over the size and priorities of this package will likely dominate the month ahead. Ideally, it will be resolved before the extension of jobless benefits ends in the middle of March.
A new divergence appears to be opening between the US and other high-income countries. The preliminary Purchasing Managers Survey for January is a case in point. The composite reading for the eurozone was 47.5, the third month below the 50 boom/bust level. At the end of 2019, it was at 50.9. Japan’s preliminary January composite PMI stood at 46.7. It has not been above 50 since January 2020. In stark contrast, the US preliminary composite PMI rose to 58.0, and it was the fourth month above 55.0. In December 2019, the composite was at 52.7.
Although based on comments from the Governor of the Bank of Canada, a window appeared to open in favor of a mini-rate cut (10-15 bp), but for the most part, barring a new undesirable turn of the virus, we are probably near peak monetary policy in this cycle. In the US, several regional Fed presidents are open to the possibility of tapering the long-term asset purchases this year. Chairman Powell wants to stay focused and ensure a robust recovery and argues it is premature to. In the ECB, there seems to be an agreement that the full 1.85 trillion-euro Pandemic Emergency Purchase Program does not have to use if favorable financial conditions can be preserved with less.
In late January, ECB officials warned that investors were underestimating the risks that it reduces rates again. The ECB’s dual rate regime, whereby the deposit rate (minus 50 bp) is not functioning as the floor for money market rates because the central bank makes loans (TLTRO) at minus 100 bp if certain lending targets are reached. It is difficult to tell precisely what has been discounted, but we note that the key overnight benchmarks are six-eight basis points below the deposit rate. The implied interest rate on three-month Euribor futures contracts is below the deposit rate by as much as eight basis points until September 2023.
ECB President Lagarde has repeatedly indicated that its measures are scalable in numerous dimensions. The PEPP was symmetrical. The full authorization need not be drawn upon, but if more was needed, it would be provided. The risk of an ECB rate cut has not been more pronounced, maybe because it would likely be a 10 bp move, which may be too small to have much impact. And to think that it would have more than a short-term impact on the foreign exchange market or that it would boost CPI seems somewhat naïve.
None of the three G10 central banks that meet in February (Reserve Bank of Australia, Bank of England and Sweden’s Riksbank) are likely to change their stance. The BOE continues to say that it is studying the implications of negative rates, but implementation has not been discussed. The short-sterling (three-month deposit rate) futures strip implies a negative rate from April through December this year. Gilt yields out five years also have negative yields. Barring a new negative shock, we do not expect the BOE to adopt a negative policy rate.
While some emerging market countries are likely to begin raising rates this year, February is too soon. Turkey has turned back to monetary orthodox and has been rewarded by a firmer currency. In three steps, the central bank more than doubled the one-week repo rate to 17% in December (from 8.25% in August). In January, the Turkish lira led the few advancing emerging market currencies higher with around a 1.8% gain. It appreciated by 3.75% in Q4 20 to narrow the whole year decline to 20%.
Emerging market equities got hit hard in Q1 20 but have been trending higher since. The MSCI Emerging Market Index has been on a tear. It rose by around 10% in the first few weeks of the year before succumbing to profit-taking pressures. The 4.5% loss in the last week of the month still saw it finish its fourth monthly advance was about a 3% gain. And that weekly loss was only the fourth since the end of September. It rose 15.8% in all of 2020, a little more than in 2019
However, note what is being measured here. The index is heavily weighted toward a few large Asian markets. Nearly three-quarters of the benchmark is accounted for by China (~39%), South Korea (~13.5%), Taiwan (~12.75%), and India (~9.25%). Brazil is a distant fifth with about a 5% weight.
In contrast, the JP Morgan Emerging Market Currency Index, which is less heavily weighted toward Asia fell slightly in January. It had appreciated by 6.5% in November-December 2020 as part of a broad-based dollar decline. The four weakest emerging market currencies in January were in South America: Brazilian real (-5.6%), Colombian peso (-4.1%), Argentine peso (-3.6%), and the Mexican peso (-3.2%).
The Bannockburn World Currency Index, the GDP-weighted benchmark we launched last year with Bloomberg, snapped a three-month advance in January, slipping fractionally. As you can see in the chart here, it has been moving broadly sideways, going back to early December, after trending higher since late March. It captures the dollar’s depreciation after the initial rally in the early days of the pandemic. The leveling off added to our analysis anticipating a dollar bounce at the start of the year. It finished the month on its lows, suggesting the counter-trend dollar recovery can carry into February.
The $900 bln fiscal stimulus package approved at the end of last year will help underpin economic activity as herd immunity to Covid-19 is sought. Some of the jobless benefits were extended until mid-March, which now serves as the new Congress’s deadline as it debates another package. The first two years of the Biden administration may be shaped by that debate. Will, the Democrats, use their majority to push-through stimulus through the reconciliation route, or will it find a compromise a draw opposition support? Will the Democrats prevent the filibuster from blocking their agenda? Meanwhile, the Federal Reserve will continue to buy $80 bln of Treasuries and $40 bln of Agency mortgage-backed securities. The dollar appears to have been used extensively as a funding currency. If the correction in the equity market and many risk-assets in general continues, the greenback may recoup more of the losses suffered since the election.
The extended social restrictions will continue to hamper economic activity, and the EU has been slow to roll out the vaccines. The EU’s 750 bln-euro Recovery Fund is not expected to distribute money until closer to midyear. The ECB’s Pandemic Emergency Purchase Plan (1.85 trillion euros) is not the same as the Fed’s commitment to buy a fixed amount of Treasuries and Agencies. It gives officials flexibility. The goal is to ensure favorable financial conditions. It will use the PEPP as necessary to achieve the goals. The European Union appears galvanized by the US preoccupation with domestic issues. It seems to be on the move. Brexit, the dispute with Poland and Hungary over the EU budget, and the protracted negotiations with China on an investment pact successfully completed at the end of last year. It took the initiative on regulation in the digital space. Over US objections, it is proceeding with the Nord Stream 2 pipeline from Russia. In January, it released a paper outlining how it wants to boost the euro’s international use and regain the sovereignty it feels it has lost as the US enforces its sanction regime. Germany is reportedly contemplating sending a frigate to the disputed waters in the South China Sea.
(end of January 2021 indicative prices, previous in parentheses)
Spot: $1.2135 ($1.2215)
Median Bloomberg One-month Forecast: $1.2145 ($1.21)
One-month forward: $1.2140 ($1.2245)
One-month implied vol: 5.7% (6.8%)
The yen often seems driven by external factors, such as its use as a funding currency used to buy higher beta assets. When those higher beta assets sell-off, which they invariably do, the yen is repurchased. Japan’s fiscal stimulus prompted the IMF to revise up this year’s growth forecast to 3.1% from the 2.3% estimate made in October 2020, despite the formal state of emergency that covers about 60% of the economy. Talk that the Bank of Japan could reduce its ETF buying seemed to have dampened by the sharp drop in share prices at the end of January, which left the Nikkei up 0.8% on the month, the only G7 bourse to finish higher. Based on the minutes from the recent BOJ meeting, some thought a wider range of the 10-year yield may be tolerated. Under yield curve control, the BOJ targets the 10-year yield at zero and allows it to move in a 20 bp band around it. Yet, the generic 10-year yield has not been below zero since last May and has not been much above six basis points since last March. Prime Minister Suga’s honeymoon has not lasted long, and hopes to call an early election (due in October) have faded.
Spot: JPY104.70 (JPY103.20)
Median Bloomberg One-month Forecast: JPY104.50 (JPY104.00)
One-month forward: JPY104.75 (JPY103.25)
One-month implied vol: 6.3% (6.3%)
The rapid rollout of the vaccine in the UK and the cushion of inventories dampening the initial disruptions of Brexit has underpinned sterling. As the euro and yen fell around 1% against the dollar in January, sterling managed to eke out a small gain (~0.30%). Still, it was the fourth consecutive monthly appreciation, which matches the longest streak since 2009. At 4.5%, the IMF forecast is for the UK growth to exceed the eurozone (4.2%) and Germany (3.5%). While the US contemplates more stimulus this month, the UK Chancellor of the Exchequer Sunak will be preparing the budget for early March and is under political pressure to demonstrate that fiscal policy will return to a sustainable path. Meanwhile, the race between the drawing down inventories and implementing the technology and procedures of the new trade regime continues. The euro has fallen from a little more than GBP0.9200 in December to almost GBP0.8800 in January. This may have helped fuel sterling’s resilience against the dollar, but it may have largely run its course.
Spot: $1.3710 ($1.3660)
Median Bloomberg One-month Forecast: $1.3695 ($1.3540)
One-month forward: $1.3715 ($1.3670)
One-month implied vol: 7.8% (9.2%)
The US dollar slipped below CAD1.2600 on January 21 for the first time since April 2018 and reversed higher. It finished January at its best levels for the month and has appreciated three consecutive weeks, the longest advance since last September. The Canadian dollar’s 0.4% loss last month still made it the best performing within the dollar bloc. Although Bank of Canada Governor Macklem held out the possibility of a mini rate cut (presumably 10-15 bp), it appears in no hurry to use that space. The Bank of Canada sees the economy is flush with stimulus, and as confidence grows in a sustainable recovery and expansion, the policy will be adjusted. This seems to hint at a further reduction in bond purchases later this year, which have already been reduced from C$5 bln to C$4 bln a week. Biden canceled the Keystone XL pipeline project on his first day in office. However, it probably says little about the political or economic relationship. The Keystone pipeline would have carried as much as 830k bpd, and the expansion of existing pipelines is projected to boost capacity by 950k bpd. Canada accounts for a little more than half of the US oil imports. The Canadian dollar seemed more sensitive to the vagaries of equities than the 7.5% rally in crude prices in January.
Spot: CAD1.2780 (CAD 1.2730)
Median Bloomberg One-month Forecast: CAD1.2770 (CAD1.2800)
One-month forward: CAD1.2800 (CAD1.2700)
One-month implied vol: 7.0% (6.9%)
After gaining nearly 4.8% against the US dollar in December 2020, the Australian dollar slipped by about two-thirds of a percent. It peaked early in the month (~$0.7820), its highest level since March 2018. It choppily traded lower to approach $0.7600 at the end of January. The central bank is in a wait-and-see mode, and the focus is on the labor market. Stronger wage growth is necessary, but there is still too much slack. The government has yet to secure a rapprochement with China. Yet, Australia’s trade balance has held up well, and its surplus through the first 11-months of 2020 was a little larger than the same period in 2019. That is also true through the last three months (through November), as Beijing escalated its pressure. If being a military and security outpost for China’s chief rival is not provocation, Australia chose the timing of its confrontation with the internet giants by drafting legislation to force payment for the media service and be subject to mandatory arbitration. Google, which accounts for an estimated 85% of the internet searches in Australia, has threatened to pull out of the $4 bln markets to deter others. The Australian dollar is also vulnerable to the unwind of risk-appetites.
Spot: $0.7645 ($0.7695)
Median Bloomberg One-Month Forecast: $0.7640 ($0.7625)
One-month forward: $0.7650 ($0.7700)
One-month implied vol: 10.3% (10.3%)
The peso edged higher in the first few weeks of the New Year. It rose to its best level since last March before risk appetites reversed and send the peso lower. Through January 21, when the peso topped out, it had been one of the strongest of the emerging market currencies. The increase in volatility dampens the attractiveness of Mexico’s relatively high-interest rates. The peso also acts as a proxy for other emerging market currencies. The six-week decline in the JP Morgan Emerging Market Currency Index is the longest drop since July-August 201. Given the lack of strong fiscal support, the central bank is still under pressure to cut rates. Even though headline inflation, which spent August through November above the 4% ceiling, has eased back toward 3.0%, the core rate has firmed to 3.8% in December. Although there is some risk that the central bank delivers a 25 bp rate cut at its February 11 meeting, we suspect it may wait until after its inflation report in early March.
Spot: MXN20.5750 (MXN19.9050)
Median Bloomberg One-Month Forecast: MXN20.5050 (MXN19.8850)
One-month forward: MXN20.5854 (MXN19.97)
One-month implied vol: 15.3% (15.3%)
The dollar established a range against the yuan in the first two trading sessions (~CNY6.43-CNY6.5150) that it remained within until the waning hours of the month when it was pushed to about CNY6.4235 after the mainland’s official close. Month-end pressures, tax obligations, and a purposeful tightening of money market conditions, but shy of a rate cut, also may have helped underpin the yuan. The overnight repo rate rose to 3.33% at the end of January, its highest level in more than a decade, up from a low of 59 bp in December and above the Standing Loan Facility rate that acts as the funding ceiling. This squeeze in the domestic money markets has favored the onshore yuan (CNY) over the offshore yuan (CNH). The gap is the widest since last August. The PBOC does not have to hike rates. The fear of its action is itself useful. Officials may want to discourage the liquidity that it provides to cushion the New Year distortions (Year of the Ox, February 12) to be used for more extend levered positions. It does appear that the pace of the recovery is leveling off.
Spot: CNY6.4285 (CNY6.5270)
Median Bloomberg One-month Forecast: CNY6.4750 (CNY6.5175)
One-month forward: CNY6.4750 (CNY6.5310)
One-month implied vol: 5.1% (5.8%)
- Marc Chandler, Chief Market Strategist, BBGFX
Compliments of Bannockburn Global Forex – a member of the EACCNY.