The dollar stole the show yet again this week as the DXY index climbed to near 2-month highs. US economic outperformance remains the dominating theme as economically damaging lockdown measures persist in most G10 economies.
This time around, the near-term headwinds to the global economic recovery aren’t being offset by vaccine optimism either, which previously gave markets a reason to look through lockdown measures and continue selling the dollar on an improved medium-term growth outlook. It isn’t just the availability of vaccines that is concerning for markets either, as Covid-19 mutations are seen to reduce the effectiveness of vaccinations by leading pharmaceutical companies. While the dollar rally has been broad based against the G10, both sterling and the loonie have suffered the smallest losses for different reasons. For the pound, a hawkish Bank of England meeting on Thursday resulted in sterling rallying as expectations of negative interest rates evaporated. Meanwhile, the loonie benefitted from falling oil stockpiles in China and the US as WTI crude pushed above $56 per barrel.
Next week, central bank meetings in Sweden and Mexico are set to be less dramatic than that from the Bank of England on Thursday. Meanwhile, political developments in Italy and the US will remain in scope. Former ECB President Mario Draghi will continue talks over the weekend with party leaders in an attempt to form a new coalition government and divert the Italian electorate from heading to the polls. Meanwhile, Donald Trump’s impeachment trial is set to begin at noon on Tuesday 9th. While it is unlikely that Trump will be convicted of his actions that led to the storm on the Capitol on January 6th, the Senate will likely pass a vote that will bar the former President from holding office in the future – a vote that needs only a simple majority.
Monday – 08/02
The week starts with early figures from Germany’s Industrial production at 07:00 GMT. November saw a 0.9% gain in industrial output for Germany, following a 3.4% jump in October, leaving the level of industrial output in Q4 just above the Q3 MoM average of 2.06%. In December however, German factory orders fell for the first time in eight months after Germany’s tighter lockdown measures forced curbs on activity.
Despite the decent run in October and November, we expect output to slow down in December.
Bloomberg’s median of forecasts sees a 0.1% increase in output. Eurozone Sentix Investor Confidence at 09:30 GMT will likely have risks tilted to the downside following the current lockdown situation in the euro area’s largest economies and the unrelenting divergences in vaccine distributions between the UK/US and the EU. Bloomberg’s consensus foresees a 4.5 increase from last month’s 1.3 reading, but this is likely a reversal of last month’s unwind rather than an actual improvement in investor confidence.
Tuesday – 09/02
Mexico headline inflation is released at noon on Tuesday, with investors hanging on the balance for the Banxico announcement later in the week. After two months of softening inflation dynamics following settling food prices and overall slack conditions, markets sit on the edge of a stable path in prices within Banxico’s target. Offsetting factors are meant to support this trajectory, while Banxico decides on the timing for additional monetary accommodation and its stance on potential inflation overshooting. With medium forecasters expecting a modest uptick in headline inflation in January, markets are likely to take a wait-and-see approach for the ensuing Banxico announcement.
Brazil follows with IBGE Inflation figures an hour later, with MoM numbers expected to print at 0.33% vs the prior reading of 1.35%, while the YoY figure is set to have increased in January from 4.52 to 4.63%.
Brazil’s inflation in December was not only above target but also the highest reading in four years, indicating that any downtick from December’s figure may be an unwind rather than a reversal in trend.
Food prices accounted for more than half of the overall annual increase and rose to a nearly two-decade high. The central bank has insisted the spike in inflation is only temporary and will soon pass when the jump in food and commodity prices fades, but January’s inflation figures will still be key for any forward guidance of the central bank following their latest comments that the guidance may be removed earlier than previously anticipated.
Australia Westpac Consumer confidence is on the agenda for 23:30 GMT. Last month’s reading saw the first negative print since August last year when the return of the virus spread caused the Perth metropolitan area and other regions of Western Australia to enter a five-day lockdown after a single Covid-19 case was identified. The lockdown is to be lifted on Friday February 5th already, however, as no new local cases have been discovered since. Japan’s Producer Price Index of January is scheduled for release at 23:50 GMT. At this point, markets view a negative print as a given and investors will pay attention to the extent at which the emergency state declared in January has slowed economic recovery in Japan.
UK manufacturing production and Q4 GDP are scheduled for release at 07:00 GMT. The Bank of England, which released its forecasts on Wednesday, expects GDP to have dropped 8% over 2020, while Bloomberg’s forecasters expect an even larger decrease of 8.2%. Markets can expect the figure to be ugly given the stringent lockdown measures, however, if the reading surprises to the upside, this may lead forecasters to think differently about the Q1 2021 outlook as well. Norway CPI is also released at 07:00 GMT before Friday’s calendar shows the GDP figures for December. Headline inflation will likely be pushed up, driven by higher electricity and fuel prices. At 09:30 GMT, the Riksbank will come out with its first monetary policy decision of the year including fresh forecasts. A separate primer is included below.
Thursday – 11/02
Thursday’s data calendar is light, with most of the focus resting on Mexico’s Central Bank policy meeting. Even though policy accommodation was not a major factor in MXN volatility over the last months, broad uncertainty over the potential resumption of rate cuts might make markets more nervous this time around. Details to what to expect in the February meeting and later in the year can be found below in a separate primer. Shortly after Banxico’s announcement, US initial jobless claims data is released at 13:30 GMT but is unlikely to move the needle too much seeing as the data point comes so soon after January’s NonFarm payrolls data.
Friday – 12/02
Norway GDP is up at 07:00 GMT on Friday. The Norges Bank expects GDP to end up at 2.5% YoY down from the previous 3.0%, while Bloomberg forecasters estimate a 1.3% QoQ increase. Higher electricity and crude oil prices may pose an upside risk to the Norges Bank growth outlook if CPI growth is higher than expected. With the Norges Bank having taken a more hawkish stance than other central banks, indicating a rate hike in 2022H1 already, a high CPI growth and a potential swift vaccine roll-out may be enough for the NB to sound more hawkish going forward. Later in the afternoon, focus turns to the University of Michigan Sentiment at 15:00 GMT which is set to print at 80.8 in February, just above January’s 79.0 reading.
BETTER THAN EXPECTED DATA SHOULD BE NO GAME CHANGER FOR THE RIKSBANK ON WEDNESDAY
The Riksbank will release its first monetary policy decision of the year on Wednesday February 10th after announcing a three-year plan to buy roughly SEK5bn worth of FX per month as an alternate means of funding its FX reserves on January 13th. While this may be taken as a sign of currency intervention in order to strengthen the impact of monetary policy, thus sending a dovish signal to markets, Swedish policymakers emphasised this was not a move aimed at weakening the Swedish krona – FX intervention would be against the agreement of G20 countries. Instead, it is all about eliminating the need for the central bank to borrow from the Swedish debt office to finance its FX reserves.
The communication from the central bank regarding their three-year plan is key for assessing the next moves at the policy meeting on Wednesday. Since the November meeting, economic data has shown improved conditions: Q3 2020 GDP data has been upwardly revised from 4.3% to 4.9%, while preliminary Q4 2020 readings showed the hit to Swedish resource utilisation was far smaller than the Riksbank had forecasted. Beyond that, the labour market showed resilience even after the tightening of lockdown measures in October.
Unemployment averaged 8.7% in Q4 2020, which is again better than the forecast of 9.1% by the Riksbank back in November.
The improvement in data lessens the need for the central bank to take additional dovish measures during Wednesday’s meeting.
Although the data contains improvements, the Riksbank will still be in no rush to send any signs of policy normalisation on Wednesday. This will be most visible in its latest rate projections that now cover Q1 2024, which we expect to show rates on hold at 0%. Stricter containment measures both domestically and in Sweden’s largest trading partners will likely keep the Riksbank cautious over the first half of the 2021 outlook. However, 2021 H1 inflation forecasts will likely be revised upwards following the better-than-expected data, which proved Sweden’s resilience to this crisis. That being said, the mild recovery in inflation and output, and the relatively resilient labour market should not move the needle for the Riksbank to change course, as the bank will likely maintain its somewhat pessimistic tone and emphasise that the pandemic is not over. This will be evident in the level of risk that surrounds their inflation forecasts. The path of price growth still remains a challenge for the Riksbank due to Sweden’s reliance on the eurozone as a trading partner given the nation’s status as a small and open economy. With eurozone inflation remaining very low, this poses a risk to Sweden’s imported inflation, especially if EURSEK drives lower, but Riksbank’s First Deputy Governor Cecilia Skingsley played down the notion that a strong currency and low inflation are worrying the central bank and reiterated the Riksbank’s stance on the FX reserve policies not being due to import inflation.
EURSEK driving lower despite Swedish lockdown as data shows Sweden’s resilience
In terms of vaccine distribution, the Swedish vaccination programme started in late December, but as the rollout remains dependent on an EU-wide programme, downside risks to the rollout remain. The EU programme had a rocky start to begin with, and faced delivery issues with Pfizer and AstraZeneca in Q1 2021 as well. Still, the Swedish government has pledged that the entire adult population will be given access to a shot by mid-2021.
EXPECTATIONS ARE DIVIDED AHEAD OF THE NEXT BANXICO MEETING
The Central Bank of Mexico meets on February 11th, with consensus among analysts strongly divided on whether the bank will resume its easing cycle as soon as next week or defer it for later in the year. More importantly, it remains unclear what Banxico’s reaction function and forward guidance will look like given the level of uncertainty around the economic recovery and vaccine distribution. While the broad consensus is built on expectations for an additional 25 basis point rate cut somewhere this year, markets and analysts place the move at different points in time, raising the bar for surprises surrounding scheduled announcements. Moreover, speculation on a softer tone towards overshooting inflation, similar to the Fed´s renewed approach, has started to cement expectations of protracted policy normalisation. While Banxico has so far eluded to entering negative territory with respect to real yields, increasing inflation expectations will put the Central Bank to the test in the near-term should they cut rates and keep them low while inflation rises in the future.
After an 18-month period that saw 400bps of easing, Banxico decided to take a pause to evaluate inflation dynamics while leaving the door open for a resumption.
With softening prices in place, conditions are prime for timely additional support amid a challenging near-term outlook and a still severe pandemic situation.
Analysts are fond of this view, with the Bloomberg consensus signalling a final rate cut at next week’s meeting. As a novelty to the February decision, the governing council is being renovated, with the replacement of the hawkish deputy governor Javier Guzman by the new director Galia Borja, who is expected to lean towards the dovish side. This could tilt the majority decision towards striking a softer tone, even as Banxico pledges to maintain their conservative stance towards policy relaxation.
Markets sit on a different page for the time being, with implied expectations of a sole rate cut in six months’ time as per fixed-income pricing. Recent comments by director Jonathan Heath signalled that the Bank would be studying the viability of cutting interest rates from the April meeting onwards, watering down expectations of any policy move shortly. Heath tempered those comments indicating that overwhelming inflation wouldn’t be as concerning for Banxico looking forward, leaving little excuse for keeping rates on hold in the current climate. With such mixed signals exacerbating confusion over the timing of the next policy step, markets will be in frantic search of any additional hints ahead of the meeting.
Clarity may be found in the upcoming inflation data prior to the Banxico meeting…
Headline inflation slightly broke Banxico’s 2-4% target range in Q3 and early Q4, prompting a prudent pause in the last two meetings in 2020. After that, however, the headline annual rate fell back within the target range, to 3.3% in November and 3.2% in December, mainly driven by the unwinding of an earlier spike in food inflation. This trend in food prices is poised to run further as favourable base effects causes the core component to decline in the coming months, with roughly a quarter of the core CPI basket made up of food items. The strong rebound in the peso will also weigh on inflation, as over 20% of currency appreciation since April gradually filters through into domestic prices. One offsetting factor will be rising fuel inflation, as oil markets catch up with the pace of raising global demand and decreasing inventories. Moreover, unfavourable base effects will temporarily push fuel inflation above target in late Q1 and for most of Q2. Taking into account this expected trajectory of prices and a potentially reduced need for additional stimulus later in the year, we favour a prompt rate cute sooner than later.
Simon Harvey, Senior FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, FX Market Analyst