GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
They did it again! After leading markets to believe that a Dec rate hike was unlikely, the BoE wrong footed markets again by announcing a 15bsp hike. Recall we had external member Saunders (who voted for a hike in Nov) suggest there could be benefits in waiting before moving on rates BoE’s Mann a few days before the meeting saying it was premature to even talk about the timing of hikes let alone the magnitude, but of course both of them ended up voting for a hike in the end with a surprising 8-1 vote split (BoE’s Tenreyro the only dissenter). The bank lost even more of the little credibility it had left, but in the end, they did the right thing (in my opinion at least) as they stayed data dependent and hiked given a flurry of much better-than-expected econ data in the run up to the meeting. The consensus view among the MPC was that current price pressures warranted tighter policy in the near-term, with inflation expected to peak close to 6% in April (up from previous projections). One negative was of course growth, which is expected to push lower given the new Omicron wave. The Dec decision was a hawkish development for the GBP, but of course Omicron and incoming econ data will be key considerations for the rate outlook going forward (25bsp hike fully priced for March).
2. Economic & Health Developments
Even though activity data has been slowing, the economy is not expected to fall off a cliff by any means. Growth expectations by the IMF/OECB still sees solid growth differentials, but not everyone shares that optimism (as polling data from Refinitiv reveals). Even though we think the solid economic data running into Dec were enough to convince the BoE to hike, the overall rate trajectory already priced into money markets seem very overambitious. As long as the incoming data remains firm it should keep the odds of additional tightening on the table, but we should be mindful of potential unwinding if data starts painting a bleaker picture.
3. Political Developments
Even though Brexit isn’t the focus it used to be, some issues, such as the Northern Ireland protocol, remains in the loop with neither side willing to budge. As usual, we’ve had heated rhetoric from both sides with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have ignored this as political posturing, but of course any actual escalation (such as an actual triggering of Article 16) could drastically see some sharp risk premium built into the GBP. Furthermore, political uncertainty surrounding PM Johnson opens up another can of worms as GBP usually doesn’t like domestic political uncertainty. That means the upcoming Sue Gray report this week will be a key focus, where damaging results for the PM could prove GBP negative and vice versa if it shows the PM was not at fault. Apart from the report, the question remains on whether there will be enough MP’s who opt for a vote of no-confidence (if so that could see short-term downside), but after that the question will be on whether the PM can survive an actual vote of no-confidence, where a win for the PM is expected to the GBP positive and negative if he loses.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +28919 with a net non-commercial position of -247. Short bets continue to be unwound for Sterling as large speculators have seen a huge reduction in net-shorts and pushing GBP to neutral. Even though that’s a positive, this week’s political developments will be front of mind and close to neutral positioning means it’s a fair fight higher and lower depending on the outcome.
5. The Week Ahead
As always, the FOMC will be in focus for most major currencies given its potential impact on global asset classes and will thus be in focus for Sterling. Apart from that, the biggest focus point will be the political developments, which means attention will be placed on the findings of the Sue Gray report, and after that any subsequent actions against the PM (whether he has to face a vote of no confidence, and of course if he does whether he will have enough support to survive it). As Sterling is usually sensitive to domestic pollical uncertainty, any quick resolution will arguably be the best outcome for Sterling, while a messy and uncertain outcome could see some risk premium built into the Pound.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation , and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook for the US and the globe will be key for the USD. The USD is often inversely correlated to global growth & inflation , doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, incoming data will also be important to see how the Fed responds to it, where a worsening outlook that deteriorates much faster than expected could see a dovish pivot from the Fed which could mean downside for the USD if money markets start pricing out hikes (especially with markets now expected just over 4 hikes for 2022).
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1458 with a net non-commercial position of +36434. The shortterm unwinding of stretched USD longs played out exactly as expected but was also short-lived in the midst of the recent strong risk off moves in certain parts of the market. Surprisingly, the big flush lower in the USD has not showed up in the CFTC data as expected with very little change to the overall positioning. In the current context, the stretched long positioning makes the USD vulnerable in the event that the Fed does not deliver the very hawkish tone expected of them in this week’s upcoming FOMC meeting.
4. The Week Ahead
For the USD the big focus this week will be overall risk sentiment and the first FOMC meeting for 2022 on Wednesday, followed by Friday’s Core PCE and Employment Cost index prints. The latter will of course be important given the inflation outlook with more emphasis recently on the odds of a possible wage spiral affect. However, the main event will be the FOMC, where the meeting is expected to serve as a signalling meeting to pave the way for a 25bsp hike in March and to provide more clarity on the bank’s balance sheet plans. With a March hike sitting close to a 90% probability, and markets already fully pricing in 4 hikes this year, the bar has been set quite high for a hawkish surprise. However, there are also some participants that think the recent econ data ( CPI YY >7% and Unemployment <4%) justifies an early end to the Fed’s QE program instead of allowing tapering to run it’s planned course until March. That would certainly give a more hawkish feel to the meeting and could see markets pricing in an even earlier and faster pace of QT if confirmed. But, if the Fed does not deliver on an early end to QE , and does not offer a strong enough signal that the 4 hikes priced by the market is justified, we could be in store for some moderation in the rise in yields and the USD and could also prove to be supportive for equities which ended last week in quite bad shape.
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
They did it again! After leading markets to believe that a Dec rate hike was unlikely, the BoE wrong footed markets again by announcing a 15bsp hike. Recall we had external member Saunders (who voted for a hike in Nov) suggest there could be benefits in waiting before moving on rates BoE’s Mann a few days before the meeting saying it was premature to even talk about the timing of hikes let alone the magnitude, but of course both of them ended up voting for a hike in the end with a surprising 8-1 vote split (BoE’s Tenreyro the only dissenter). The bank lost even more of the little credibility it had left, but in the end, they did the right thing (in my opinion at least) as they stayed data dependent and hiked given a flurry of much better-than-expected econ data in the run up to the meeting. The consensus view among the MPC was that current price pressures warranted tighter policy in the near-term, with inflation expected to peak close to 6% in April (up from previous projections). One negative was of course growth, which is expected to push lower given the new Omicron wave. The Dec decision was a hawkish development for the GBP, but of course Omicron and incoming econ data will be key considerations for the rate outlook going forward (25bsp hike fully priced for March).
2. Economic & Health Developments
Even though activity data has been slowing, the economy is not expected to fall off a cliff by any means. Growth expectations by the IMF/OECB still sees solid growth differentials, but not everyone shares that optimism (as polling data from Refinitiv reveals). Even though we think the solid economic data running into Dec were enough to convince the BoE to hike, the overall rate trajectory already priced into money markets seem very overambitious. As long as the incoming data remains firm it should keep the odds of additional tightening on the table, but we should be mindful of potential unwinding if data starts painting a bleaker picture.
3. Political Developments
Even though Brexit isn’t the focus it used to be, some issues, such as the Northern Ireland protocol, remains in the loop with neither side willing to budge. As usual, we’ve had heated rhetoric from both sides with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have ignored this as political posturing, but of course any actual escalation (such as an actual triggering of Article 16) could drastically see some sharp risk premium built into the GBP. Furthermore, political uncertainty surrounding PM Johnson opens up another can of worms as GBP usually doesn’t like domestic political uncertainty. That means the upcoming Sue Gray report this week will be a key focus, where damaging results for the PM could prove GBP negative and vice versa if it shows the PM was not at fault. Apart from the report, the question remains on whether there will be enough MP’s who opt for a vote of no-confidence (if so that could see short-term downside), but after that the question will be on whether the PM can survive an actual vote of no-confidence, where a win for the PM is expected to the GBP positive and negative if he loses.
4. CFTC Analysis
Latest CFTC data showed a positioning change of +28919 with a net non-commercial position of -247. Short bets continue to be unwound for Sterling as large speculators have seen a huge reduction in net-shorts and pushing GBP to neutral. Even though that’s a positive, this week’s political developments will be front of mind and close to neutral positioning means it’s a fair fight higher and lower depending on the outcome.
5. The Week Ahead
As always, the FOMC will be in focus for most major currencies given its potential impact on global asset classes and will thus be in focus for Sterling. Apart from that, the biggest focus point will be the political developments, which means attention will be placed on the findings of the Sue Gray report, and after that any subsequent actions against the PM (whether he has to face a vote of no confidence, and of course if he does whether he will have enough support to survive it). As Sterling is usually sensitive to domestic pollical uncertainty, any quick resolution will arguably be the best outcome for Sterling, while a messy and uncertain outcome could see some risk premium built into the Pound.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Fed turned a lot more hawkish than expected in Dec. They doubled the pace of tapering to $30 billion per month which will see QE concluded by March 2022 as was widely expected. Surprisingly though the Summary of Econ Projections showed the median dot plot pencilled in 3 hikes for 2022 (up from the previous 1), confirming Fed Fund Future expectations. Fed Chair Powell explained they hadn’t decided whether to pause between the end of tapering and a first hike but reiterated that rates will likely only rise when QE has concluded. Another positive shift was Powell’s comments that they could raise rates before full employment has been met due to high inflation , and stated that with inflation above target, they cannot wait too long to get to maximum employment as current inflation levels is seen as a threat to max employment. The hawkish tilt went further to note that the bank started discussing the balance sheet but said no decisions were made on when QT might commence. Even though the dots projected 3 hikes for 2022, the updated rate trajectory only showed 1 additional hike over the forecast horizon, which combined with a lower terminal rate was less hawkish than some had feared. Nonetheless, the meeting marked a material hawkish shift from the Fed, putting it on par with the likes of the RBNZ. The meeting minutes also revealed that the QT discussion saw majority of members thinking it appropriate to start QT soon after rate lift off and another more hawkish tilt than expected from the Fed.
2. Global Risk Outlook
The growth & inflation outlook for the US and the globe will be key for the USD. The USD is often inversely correlated to global growth & inflation , doing bad during reflationary environments (growth and inflation accelerating), while the USD usually does well in disinflationary environments (growth and inflation decelerating). Thus, with expectations that both growth and inflation will decelerate this year, both in the US and the globe, that should be a positive input for the USD in the med-term . However, incoming data will also be important to see how the Fed responds to it, where a worsening outlook that deteriorates much faster than expected could see a dovish pivot from the Fed which could mean downside for the USD if money markets start pricing out hikes (especially with markets now expected just over 4 hikes for 2022).
3. CFTC Analysis
Latest CFTC data showed a positioning change of -1458 with a net non-commercial position of +36434. The shortterm unwinding of stretched USD longs played out exactly as expected but was also short-lived in the midst of the recent strong risk off moves in certain parts of the market. Surprisingly, the big flush lower in the USD has not showed up in the CFTC data as expected with very little change to the overall positioning. In the current context, the stretched long positioning makes the USD vulnerable in the event that the Fed does not deliver the very hawkish tone expected of them in this week’s upcoming FOMC meeting.
4. The Week Ahead
For the USD the big focus this week will be overall risk sentiment and the first FOMC meeting for 2022 on Wednesday, followed by Friday’s Core PCE and Employment Cost index prints. The latter will of course be important given the inflation outlook with more emphasis recently on the odds of a possible wage spiral affect. However, the main event will be the FOMC, where the meeting is expected to serve as a signalling meeting to pave the way for a 25bsp hike in March and to provide more clarity on the bank’s balance sheet plans. With a March hike sitting close to a 90% probability, and markets already fully pricing in 4 hikes this year, the bar has been set quite high for a hawkish surprise. However, there are also some participants that think the recent econ data ( CPI YY >7% and Unemployment <4%) justifies an early end to the Fed’s QE program instead of allowing tapering to run it’s planned course until March. That would certainly give a more hawkish feel to the meeting and could see markets pricing in an even earlier and faster pace of QT if confirmed. But, if the Fed does not deliver on an early end to QE , and does not offer a strong enough signal that the 4 hikes priced by the market is justified, we could be in store for some moderation in the rise in yields and the USD and could also prove to be supportive for equities which ended last week in quite bad shape.