When most of us think of an APP
It’s something on phones that we tap
But Madame Christine,
The ECB queen,
Fears PEPP’s end would be a mishap
So, word is next week when they meet
Expansion of APP they’ll complete
Thus, PEPP they’ll retire
But still, heading higher
Are PIGS debt on their balance sheet
Over the next seven days we will hear from the FOMC, ECB and BOE with respect to their policies as each meets next week. Expectations are for the Fed to increase the speed at which they are tapering their QE purchases, with most pundits looking for that to double, thus reducing QE by $30 billion/month until it is over. Rate hikes are assumed to follow shortly thereafter. However, if they sound quite hawkish, do not be surprised if the equity market sells off and all of our recent experience shows that the Fed will not allow too large a decline in stock prices before blinking. Do not be envious of Chairman Powell’s job at this point, it will be uncomfortable regardless of what the Fed does.
As to the ECB, recent commentary has been mixed with some members indicating they believe continued support for the economy is necessary once the PEPP expires in March, and that despite internal rules prohibiting the ECB from buying non IG debt, they should continue to support Greece via the Asset Purchase Program. The APP is their original QE tool, and has been running alongside the PEPP throughout the crisis. Both the doves on the ECB and the punditry believe that any unused capacity from the PEPP will simply be transferred to the APP so there is more buying power, and by extension more support for the PIGS. However, we are hearing more from the hawks recently about the fact that QE has been inflating asset prices and inflation, and perhaps it needs to be reined in. When considering ECB activity, though, one has to look at who is running the show, just like with the Fed. And Madame Christine Lagarde has never given any indication that she is considering reducing the amount of support the ECB is providing to the Eurozone economy. Rather, just last week she explained that inflation’s path is likely to be a “hump” which will fall back down to, and below, their 2.0% target in the near future, so there is no need to be concerned over recent data.
Finally, the BOE finds itself in a sticky situation because of the relatively larger impact of the omicron variant in the UK versus elsewhere. While Governor Bailey had indicated back in October that higher rates were on the way, the BOE’s failure to act last month was a shock to the markets and futures traders are now far less certain that UK interest rates will be rising in order to fight rapidly rising prices there. Instead, there is increased discussion of the negative impact of omicron and the fact that the Johnson government appears to be setting up for yet another nationwide lockdown, something that will clearly reduce demand pressure. So, there is now only a 20% probability priced into the BOE raising rates to 0.25% next week from the current 0.10% level. This is not helping the pound’s performance at all.
And lastly, the PBOC
Adjusted a rare policy
Was raised to a bar
Two points o’er its prior degree
One last piece of news this morning was the PBOC announcement that they were raising the FX Reserve Ratio Requirement from 7% to 9% effective the same day the RRR for bank capital is being cut. This little-known ratio is designed to help the PBOC in its currency management efforts by forcing banks to increase their FX liquidity. This is accomplished by local banks buying dollars and selling renminbi. It is a clear sign that the PBOC was getting uncomfortable with the renminbi’s recent strength. Today is the second time they have raised the FX RRR this year with the first occurring at the end of May. Prior to that, this tool had not been used since 2007! Also, if you look at the chart, following this move in May, USDCNH rose 2.25% in the ensuing three weeks. Since the announcement at 6:10 this morning, USDCNH is higher by 0.5% already. It can be no surprise that the Chinese are fighting the strength of the yuan as it remains a key outlet valve for economic pressures. And while Evergrande is officially in default, as well as several other Chinese property developers, the PBOC maintains that is not a problem. But it is a problem and they are trying to figure out how to resolve it without flooding the economy with additional liquidity and without losing face.
With all that in mind, let’s see how markets have behaved. Yesterday’s ongoing rebound in US equity markets only partially carried over to Asia with the Nikkei (-0.5%) failing to be inspired although the Hang Seng (+1.1%) and Shanghai (+1.0%) both benefitted from PBOC comments regarding the resolution of Evergrande. European bourses are in the red, but generally not by that much (DAX -0.35%, CAC -0.2%, FTSE 100 -0.2%). There was little in the way of data released in the Eurozone or UK, but Schnabel’s comments about PEPP purchases inflating assets have put a damper on things. US futures, too, are sliding this morning with all three major indices lower by about -0.4% or so.
One cannot be surprised that bonds are rallying a bit, between the large declines seen yesterday and the growing risk-off sentiment, so Treasuries (-2.2bps) are actually lagging the move in Europe (Bunds -3.6bps, OATs -3.8bps, Gilts -4.7bps) and even PIGS bond yields have slipped. Clearly bonds feel like a better investment this morning.
After a 1-week rally of real significance, oil (-0.7%) is consolidating some of those gains and a bit softer on the day. NatGas (-0.7%) is also lower and we are seeing weakness in metals prices, both precious (Au -0.2%. Ag -0.7%) and industrial (Cu -1.4%). Foodstuffs are also under pressure this morning, but at this time of year that is far more weather related than anything else.
As to the dollar, it is broadly stronger this morning with the only G10 currency to gain being the yen (+0.1%) and the rest of the bloc under pressure led by NOK (-1.0%) and AUD (-0.45%) feeling the heat of weaker commodity prices. I must mention the euro (-0.3%) which seems to be adjusting based on the slight change in tone of the relative views of FOMC and ECB policies, with the ECB dovishness back to the fore.
EMG currencies are also mostly softer although there are a few outliers the other way. The laggards are ZAR (-1.0%) on the back of softer commodity prices and TRY (-0.9%) which continues to suffer from its current monetary policy stance and should continue to do so until that changes. We’ve already discussed CNY/CNH and see HUF (-0.5%) also under pressure as the 0.2% rise in the deposit rate was not seen as sufficient by the market to fight ongoing inflation pressures. On the plus side, the noteworthy gainer is CLP (+0.5%) which seems to be responding to the latest polls showing strength in the conservative candidate’s showing. Also, I would be remiss if I did not highlight BRL’s 1.5% gain since yesterday as the BCB raised rates by the expected 1.50% and hawkish commentary indicating another 1.50% rate rise in February.
On the data front, Initial (exp 220K) and Continuing (1910K) Claims are really all we see this morning, neither of which seem likely to have an FX impact. Tomorrow’s CPI data, on the other hand, will be closely watched.
The current narrative remains the Fed is quickening the pace of tapering QE in order to give themselves the flexibility to raise rates sooner given inflation’s intractable rise. As long as that remains the story, the dollar should remain well supported, and I think that can be the case right up until the equity markets respond negatively. Any sharp decline will be met with a dovish Fed response and the dollar will suffer at that point. Be prepared.
Good luck and stay safe