Rally in risk assets and FX continues as investors await President Biden’s infrastructure plan in February

Rally in risk assets and FX continues as investors await President Biden’s infrastructure plan in February           

• USD: The rally in risk assets continues, driven by vaccine and economic recovery expectations for the most part in 2020 and more recently, from expectations about US President Biden’s 2-part fiscal spending plans. The first part of Biden’s fiscal strategy was delivered last week – a USD1.9tn COVID-19 relief plan. Investors now await the second part that includes a potential $2trn infrastructure stimulus plan to be announced in February. If passed by Congress, this $2tr in “accelerated investment” is meant to be deployed during Biden’s first 4-year term.      

• USD: The massive infrastructure spending bill has positive implications for commodity prices (such as iron ore and steel) and is probably partly behind the solid gains in commodity prices and commodity FX. But it also seems investors are paying scant attention to the risks that include – (1) Congress significantly watering down the stimulus, OR (2) higher US bonds yields if the entire stimulus program is passed especially as the additional supply of debt is met with a Fed Reserve buying less bonds due to its taper (Citi analysts expect the Fed to start QE tapering in October 2021).          

Data releases Friday – Focus is on the forward looking PMIs       

• USD: US Markit January (prelim) manufacturing PMI rises to 59.1 from 57.1 in December and vs consensus for 56.5, led by gains in output, new orders, employment and with input/ output prices at multi-year highs. Markit Services PMI rises to 57.5 in January from 54.8 in December with input prices also at multi-year highs – overall, increased inflationary pressures but with risk of volatility through Q1 as mkts navigate uncertainty around US fiscal discussions and global Covid developments.

• EUR: Euro area January (flash) manufacturing PMI declines to 54.7 from 55.2 in December, though well in expansionary territory while Services PMI goes deeper into contraction at 45.0 versus 46.4 in December. This leaves the January (flash) Composite PMI lower at 47.5 versus 49.1 in December. Markets though focus on resilience of manufacturing to take EURUSD modestly higher post data. 

• GBP: Flash UK services PMI for January prints at 38.8 (consensus 45.0) alongside introduction of new lockdown restrictions. This is sharply down on levels in December (49.4) and November (47.6) with Services PMI now having contracted for 3 consecutive months. Meanwhile, UK manufacturing PMI is relatively resilient at 52.9 (consensus 53.6). Citi analysts point to business failures accelerating which suggests more persistent weakness in services later in 2021.    

Understanding price action in EUR post last week’s ECB meeting   

• EUR: EURUSD gains some 40 pips post the ECB meeting last week to close the week at 1.2170. This is despite ECB President Lagarde explicitly mentioning EUR strength as a concern in her comments. But investors have dismissed her comments as “a light touch” and expect ECB to not stand in the way of market – driven EUR strength. ECB’s core strategy however centers around ensuring euro area financial conditions are sufficiently loose to support the economic recovery. The term “financial conditions” is a mix of both domestic and external drivers – the former is primarily interest rates driven that includes level of sovereign yields, corporate, bank lending and swap spreads, equity prices etc., while the latter includes strength/ weakness of the exchange rate.   

• EUR: Post ECB, Friday’s euro area PMI data shows the externally driven manufacturing sector (export driven) continues to expand while the domestic services sector continues to contract. Markets have reacted accordingly by rebalancing euro area financial conditions - driving EUR higher (tightening external financial conditions) but lowering euro rates (loosening domestic financial conditions).  However, there may be a limit to such rebalancing (and EUR’s gains in the short term) even if euro area manufacturing continues to improve. This is because the ECB also carries a sole mandate of price stability and with current euro area HICP running at 0.2% Y/Y and likely to remain at this level for many months (Citi analysts), ECB would likely be concerned about the current rapid pace of EUR appreciation and its dampening impact on euro area inflation. 

Week Ahead      

• USD: FOMC meeting - After significant market and policy-maker discussion of the potential for Fed to taper its QE program in 2021, Citi analysts expect little new for now as neither policy plans nor the outlook have substantially changed. Market reaction will consequently be to the nuances of how – if at all – Powell characterizes “well ahead” (3m, 6m, 9m?) regarding signaling of the start of QE taper.        

• EUR: German ifo Business Climate, Jan Forecast: 92.3 Prior: 92.1; ifo Expectations, Jan Forecast: 93.5 Prior: 92.8; ifo Current Assessment, Jan Forecast: 91.0 Prior: 91.3 - The continued lockdown probably does not allow any improvement in the German economy as a whole, even though manufacturers are likely to feel that it has improved.   

• GBP: UK Employment, Sep-Nov Forecast: -74k 3M/3M Prior: -144k 3M/3M; Unemployment Rate, Sep-Nov Forecast: 5.2% 3M Average Prior: 4.9% 3M Average; Average Weekly Earnings, Sep-Nov Forecast: 2.6% 3M YY Prior: 2.7% 3M YY; AWE Ex-Bonus, Sep-Nov Forecast: 3.0% 3M YY Prior: 2.8% 3M YY - The proportion of furloughed staff increased in November and Citi analysts expect this to weigh on headline earnings growth in the three months to November. The team also expects UK unemployment to increase to around 5.5%, driving the 3m average to 5.2%.

• AUD: Australia Q4 CPI: Citi headline CPI forecast; +0.9%, Previous; +1.6%; Citi trimmed-mean CPI forecast; +0.4, Previous; 0.4% - Citi analysts’ Q4 QoQ CPI forecast is 0.9% and would take the yearly inflation reading to 0.9%, while trimmed-mean inflation is expected to rise 0.4% QoQ, taking yearly growth to 1.3% with risks skewed to the upside.   

This is an extract from the Daily Currency Update, dated January 25, 2021. Please approach a Citigold Relationship Manager if you would like more information.