COVID-19 continues to largely dictate the moves across the major global markets—for better or worse. While some countries work on introducing stimulus packages and spending programmes, others are left fighting the problems influenced by the pandemic. In the short term, markets may consolidate and seek to assess the impact of the vaccination. The real economic situation, however, will become clear in the second half of the year.
Biden’s stimulus package
In just a short period of time, the markets have already been priced in the US President Joe Biden’s $1.9 trillion stimulus package. This stimulus (equivalent to 10% of GDP) will start at a time when the federal debt-to-GDP ratio already tops 105%—a highest level since the end of the Second World War. What’s important to notice, though, is that Bidens’ proposed amount is two times the share of the economy budgeted to the Marshall Plan.
Meantime, FED head Jerome Powell mentioned that quantitative easing is here to stay, at least for a little while. He stressed that the “economic recovery remains uneven and far from complete,” while the path ahead is highly uncertain.
In this scenario, the adaptive monetary policy will be here as long as employment and inflation recover to the expected levels. Powell emphasized that the real unemployment is more or less about 10%—making a point that there’s a lot of work to do in order to reach a full employment.
But yields are what matters the most to the markets at the moment. Powell knows it as well; he is not concerned about it though, as it’s closely tied to optimistic expectations about the outlook. The yield on the 10-year Treasury reached 1.64%, its highest since February 2020, and US analysts believe an economic comeback will come in the next half of the year.
Euro inflation
The current deposit rate of −0.5% leaves little room for maneuver, although ECB president Christine Lagarde has said that all options are considerable. But keeping in mind the ongoing struggle, the complicated situation regarding COVID-19 vaccination, and the inflation target difficulties, there are a lot of doubts in the market.
The latest report on 12-month headline inflation in the Eurozone represented it at 0.9%—a significant increase from the −0.3% of previous numbers. Although likely to be transitory, this spike could alleviate concerns about deflationary pressure coming from the exchange rate. So ‘Japanisation’ looks like a good scenario, far from the worst as it was speculated before.
A wide range of different technical indicators lie behind the recent jump in euro inflation. But these will largely fade with the turn of the year, leaving the outlook for core inflation still muted and too low to allow the ECB to embark on policy tightening for years to come. After peaking at 1.7% in Q4 21, we see core inflation drop back and fluctuate around 1.0% in 2022.
Brexit
The key driver for the pound the past four years has been developments in Brexit negotiations with the EU, a huge and important impact on the UK’s economy. Compared with other pools of currencies, the pound is fundamentally supported by gross domestic product, employment, inflation, industrial production—all of these felt the strong touch of Brexit.
Major concerns, not only from the financial markets, come from the new mutation of the COVID-19 virus, which was identified in the UK in December. More aggressive and easier to spread, it resulted in a spike of infection numbers and another round of government-ordered lockdowns.
A few of the key risks to the pound over the upcoming 6-12 months appear to be tied with the UK’s vaccine advantage and its likeliness to disappear relatively quickly as more of the world’s developed economies engage in a more aggressive programme and will reach the top rates. The pound’s advantage could weaken as early as the second quarter and its future depends only on the COVID-19.
There are a lot of financial analysts which consider that the Bank of England will look to lean against a tightening in financial conditions and probably will extend the bond-purchase programme for a foreseeable future. It is worth considering labour market trends, where the risk of a spike in unemployment after job support measures end, will most likely trigger a weaker than expected economic recovery.
What’s interesting to look out for are the Scottish elections in May, which most probably will fuel expectations of a second independence referendum.
Strong support for Norway
The energy price collapse in 2020 weakened Norway’s terms of trade, but NOK is still a high beta derivative of the global reflation—economy stimulation process—theme. So, having in mind near-term vaccine news, NOK buying program, higher NOK rates and high oil price, strong support to the currency is expected.
Meanwhile, the further potential is limited by a turn in the industrial cycle, a stronger USD and US shale oil re-entering the market. What’s important to watch out for is the impact on risk appetite from higher USD real rates.
Sweden enters open market
Weak domestic inflation dynamics remain a huge problem for the Central Bank of Sweden, as it is even more enhanced by recent SEK appreciation. The Central Bank itself acknowledges that a worsened economic outlook might warrant a rate cut or QE expansion—or even both.
A strong rebound in Swedish exports has reversed the previous worsening of the current account which implies an underlying demand for SEK. The Central Bank of Sweden has started selling SEK in the open market, but the market impact has been limited.
Building inflation pressure on Polish zloty
Poland is expected to maintain the current stance—unless there is a sudden sharp plunge in economic activity. Financial markets think that the country will drop the exchange rate focus as the Polish economy recovers in full over the summer. Meanwhile, inflation pressures continue to be notable with core inflation remaining at 3.7%, above the Central Bank’s target.
The FX intervention announced before Christmas (4,50 EUR/PLN was mentioned as a target level) together with dovish signals from the governor and other members of the Central Bank of Poland policy committee before the new year, sent EUR/PLN to 4.60. Going forward, the Central Bank will stick to its new signal and prevent a sharp strengthening of the exchange rate in the short term.
Expectation is that EUR/PLN will trade in a range of 4.48–4.60 in coming months, but the recovery in Poland, as well as globally, will strengthen in the spring; the Central Bank will be more open in case of the stronger PLN.
Uncertain path to recovery for Canadian dollar
There is a very close connection between the US and the Canadian economies that fosters the strong relationship between CAD and USD. Thus, a lower EUR/USD in the medium-to-long term creates expectations that USD/CAD could move lower in the coming quarter as well. Further recovery will depend on commodity prices cycle and oil demand.
The Bank of Canada made a decision to leave its QE program at a current level of “$4 billion per week”—worth to notice that the easing program is much more aggressive as a share of GDP than that of the FED. The overall strength of the USD against the currencies of the major economies fuels speculations on CAD and strong expectations on it as well.
However, it is important to stress that the Canadian economy has been hit as hard by COVID-19 as other economies. All these employment programmes, which are to encourage people to stay in work, have so far worked unexpectedly well. This is supported by the participation rate of prime aged workers, which is back to its pre-COVID-19 levels. Housing is another important example. In December 2020, 65% of the 32 urban markets reported 12M home price inflation of 10%.
Having in mind all these factors it is hard to agree with the Bank’s current decisions of quantitative easing program.
AUD’s strong recovery
Since March, the AUD has rebounded strongly in line with risk sentiment as well as prices of industrial and especially precious metals. The changing terms of trade (the ratio between the index of export prices and the index of import prices) have been strongly AUD positive.
Australian labour market has shown a steadfast recovery, since seeing the worst crisis in 20 years. In fact, the labour market is more or less back to the pre-COVID employment level. Activity indicators also suggest continued improvement.
Wrap up
As the pandemic maintains its grip on the major markets, the world economies continue taking steps to try to lessen the impact as much as possible. Unemployment crisis still remains an issue to be solved, but major undertakings, like the US’ stimulus package or Canada’s unemployment programmes, are feeding the optimistic outlook for the foreseeable future. In turn, it looks like most of the economies are headed for a rebound.
