Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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FX Update: GBP rally stronger than BoE signal, USD surge continues
John J. Hardy
Global Head of Macro Strategy
Summary: The Bank of England decision was to the marginally hawkish side of the spectrum of likely outcomes in that no haste for a negative rate policy was mentioned, but neither was the idea entirely eliminated. Sterling relief rally shows strong bid for the currency. Elsewhere, the USD surge continues as the longest US yields rose to new highs for the cycle and after a couple of strong data points and as stimulus progress expected soon.
FX Trading focus: GBP rally stronger than BoE signal
More than a bit of relief in sterling as the reaction to the Bank of England meeting today saw a slow reaction at first. The Bank of England statement release was nothing to write home about and the cautious wording around the negative rate guidance did not immediately trigger much beyond a tepid strengthening, but the subsequent strong bid suggests that the market was ready to snap up sterling as long as the BoE failed to come out markedly dovish.
On the “dovish” side, the Bank revised its forecast for 2021 GDP down to 5% from 7.25%, no doubt due to the forecast that this quarter will see a large growth hit from the comprehensive lockdowns (worth noting that UK Covid hospitalization numbers are collapsing at a tremendous rate – down some 38% in just two weeks for a data series through February 1 and it will be tough to justify restrictions if the pace continues to fall and the vaccination roll-out rate is maintained).
The discussion of negative rates was the key focus and the result here was on the marginally hawkish side of expectations, as the Bank of England made it clear that they didn’t want to signal negative rates at this time and that implementing negative rates any time in the next six months would carry with it operational risks for banks. The unanimous vote in favour of the decision reads a bit more hawkish than one might have expected, as there have been divergent opinions on the usefulness of negative rates among the voting members. On the other hand, there was no “full stop” to the NIRP talk, as the bank still guided that banks should prepare for negative rates if ever needed. To me, this is simply a signal that the BoE wants the insurance, or put option, on the matter in the event that the post opening-up economy doesn’t burst to life as anticipated and inflation and/or economic activity nosedives once stimulus begins to fade in Q3 or Q4.
Chart: EURGBP
Sterling rising farther here against the single currency in the wake of the BoE meeting, an extension of the recent move below the prior range. This could open up the 0.8600-0.8500 range in the weeks to come with the euro on its back foot over its negative rate policy as the UK may have the luxury of a quicker opening up on its more aggressive vaccine roll-out and a more rapid bounce-back in economic activity on post-Brexit capital inflows and fiscal stimulus. Resistance is now 0.8800-50.
Does the USD rally break the medium term trend?
The great USD bear market is on pause and even struggling for air as EURUSD 1.2000 falls and USDJPY zooms up toward its 200-day moving average (just above 105.50). Other pairs are not especially close to levels that suggest a reversal of the USD bear move, but if we take out 1.1890 in the EURUSD on a daily close, the technical bearish case for the broad dollar would begin to break down – stay tuned.
US data yesterday reminded of the resilience of much of the US economy despite some of the signs of momentum coming out late last year as the stimulus check effect faded and Oct-Dec retail sales were all negative. Of course, we have a new $600 dollar stimulus check issued in January and likely another one of probably greater size on the way very soon if Biden can fast track the stimulus spending as he hopes to do. After comments from the wily conservative Democrat Joe Manchin, it appears he will not stand in the way of the more generous end of Biden’s $1.9 trillion stimulus package, even if he and others may push back against some of the rest of the Biden agenda, including the $15 minimum wage.
Yesterday’s US Jan. ISM services Index was particularly strong, at 58.7 vs. 56.7 expected and 57.2 in December. The ack of comprehensive shutdowns in the US contrasts strongly with the situation in Europe, where the Services PMI’s for the month were below 50 for a second month. A well, the employment sub-index of that service survey hit 55.2, the highest reading since the outbreak of the pandemic, suggesting strong employment gains, a development that was partially corroborated by the US Jan. ADP private payroll survey showing a strong increase of +174k vs. +70k and the December number was revised +45k higher.
January was peak pandemic for the US, it is clear, and if vaccination roll-outs proceed apace (the , the UK numbers suggest the virus impact will disappear rapidly and most of the US is averse to locking down anyway. Stimulus compounding on a US economy that is opening up and already performing well in many areas could mean a spectacular rebound starting as soon as March, but especially following through in Q2. The question will be whether the market second guesses the ability to maintain strength beyond the next two quarters – again, once the stimulus impulse fades and as blitz of treasury issuance that the Fed is doing an insufficient job of absorbing, continues to turn the screws on liquidity as we are already seeing at the longest end of the US yield curve, where the US 30-year yield benchmark has poked to a new cycle high above 1.90%.
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