Markets Weekly podcast - 6 December 2021

Henk Potts (HP): Hello. It’s Monday, 6^th December and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy, and financial markets.

My name is Henk Potts, Market Strategist for Barclays Private Bank. Each week I’ll be joined by guests to discuss both risks, and opportunities for investors.

Firstly, I’ll analyse the events that moved the markets, and grabbed the headlines, over the course of the past week. We’ll then consider the outlook for foreign exchange markets. Finally, I’ll conclude by previewing the major events, and data releases that are likely to shape the week ahead.

Investors spent much of last week looking at the global economy through the lens of the Omicron variant. The new strain is creating vast swathes of medical, economic, and policy uncertainty. When you get high levels of uncertainty, it very quickly translates into financial market volatility, and that’s exactly what we saw play out during the course of last week.

Equities and commodities were sent on a rollercoaster ride, as investors tried to price in the potential disruption of the new variant, which has been somewhat of a difficult task given the early mixed messages emerging from the medical community.

In terms of the immediate outlook, elevated levels of volatility are expected to continue over the course of the next couple of weeks, until greater clarity on transmission, severity, and vaccine efficacy is established. On the positive side, it’s clear that investors were prepared to buy on the dips as opportunities arose.

In terms of market performance, while there were wild swings in equity markets last week, the weekly changes, at the index level, were actually relatively modest. The S&P was in negative territory over the course of the week, but only fell 1.2%. The STOXX 600 in Europe was down just 0.3%. Though global stocks are down more than 4%, we should acknowledge, from the record that was achieved back in November.

In terms of bond markets, fears that the Omicron variant, and inflation will infringe upon growth prospects pushed the yield on 10-year Treasury notes down to multi-month lows on Friday. The yield on the 10-year Treasury note finished Friday’s session at 1.34%. That’s the lowest closing yield since 22^nd September.

Along with the medical outlook, the path of policy normalisation was sharply in focus. After singing the transitory song over the course of the past few months, Fed chair Jerome Powell switched to a new hawkish tune for the Senate Banking Committee last week.

He finally acknowledged that inflation is becoming more persistent than originally projected, thereby preparing markets for an accelerated tapering of its asset-purchase programme, and clearing the decks for an earlier rate hike. To remind you, the Fed has been reducing its asset purchases at the rate of $10 billion for Treasuries, $5 billion for mortgage-backed securities, per month.

Economists are now anticipating that paring rate could double from December, which means the programme could be concluded by mid-March next year, although the Fed chair reminded the Committee the threshold for rate hikes is much higher than for tapering. There is also plenty of uncertainty over the outlook for growth, for labour markets, and inflation given the developments of the pandemic.

The US employment report was a little bit mixed. Headline payrolls disappointed, but the underlying employment data added to the evidence that progress has been made on the labour market mandate.

In terms of those numbers, the US economy created 210,000 jobs last month. The market was looking for a figure closer to 500,000. You could say there was weakness, in terms of some of the seasonal flows, that accounted for those figures, but separately the unemployment rate fell to 4.2%. There was also a small improvement in the participation rate, although it still remains at uncomfortably high levels.

In terms of the policy outlook, Barclays now thinks the rate “lift off” in the United States will occur in March next year. We’re looking for three 25 basis point rate hikes in 2022, and four more in 2023.

The headline grabber in Europe was inflation, which accelerated at its fastest euro era pace on record in November. Consumer prices rose 4.9% year on year. The economist forecast was for a 4.5% increase. Price pressures have been coming from a combination of surging energy prices, which were up 27% year on year, supply bottlenecks, production delays and supply and demand imbalances continued to generate price pressures.

Food inflation accelerated to 2.2% year on year, and we should remember there’s still a broad range of technical and statistical factors that have been influencing those numbers. The energy crunch, we think, could continue to be a driver of inflation into next year, given the low inventory levels predictions of a cold winter, tight gas supply from Russia. But prices are expected to ease from the recent peaks as we go through the first half of 2022.

Recent COVID restrictions could also influence inflation by exacerbating supply constraints, and infringing upon output. They could also dampen demand for services, but increase pressure on goods.

On the positive side, the latest inflation print is expected to be close to the peak. We forecast that inflation in the eurozone will, indeed, moderate over the course of the next couple of years.

We’ve got CPI averaging 2.5% in 2022, then falling back below target as we look through the course of 2023, where we think it will average 1.5%.

What does that mean for the European Central Bank?  Well, the ECB has been maintaining the message that the cost-of-living squeeze will not endure, therefore, are expected to remain accommodative.

The European Central Bank have stated that net purchases, under its PEPP programme, will end in March, although this could be, of course, extended if the pandemic situation deteriorates further. We still expect the central bank to commit to its quantitative-easing programme through its asset-purchase programme, or an additional policy tool, through the course of next year with purchases of around €700 billion.

Rate hikes in the eurozone still look some way off. We’re still looking at the end, probably, of 2023, perhaps even the beginning of 2024.

So that was the global economy and financial markets over the course of the past week. In order to discuss the outlook for foreign exchange markets, I’m pleased to be joined by Marek Raczko. He’s the FX strategist for Barclays Investment Bank.

Marek, great to have you with us today. As we’ve been discussing, Omicron continues to occupy the news headlines. In your view how does it affect the global economy and, specifically, how can it affect exchange rates?

Marek Raczko (MR): Thanks, Henk. So, you know, Omicron at this stage is definitely a big uncertainty shock for global economies, and for financial markets. This type of uncertainty shock is related to the fact that we still are unaware of what’s the spreading pace of the virus. We do have some indication that it definitely spreads much faster, but we also don’t know how resilient the virus is to the current vaccines, and most importantly we don’t know how deadly it is.

We do have some sort of initial indications that it is less deadly, but at this stage we do not know, hence, it is very difficult to assess what is going to be the impact on the global economy.

Two things on that, you know, we’ve learnt that each time we have a next wave of COVID, the global economy seems to cope with it a bit better, as it’s better prepared. But, of course, at this stage we can’t exclude a very extreme scenario, where it would turn out that this virus is very deadly, and we will have to have a new wave of very severe lockdowns.

So this whole uncertainty naturally impacts exchange rates. And in what way does it impact exchange rates?  Essentially, investors will try to deposition themselves from risky investments, and that triggers two things.

One, first it triggers the unwind of their long position in emerging markets, supporting funders such as the euro. Second, investors will look for safe-haven currencies, and in that case it is supporting the US dollar, and it’s also supporting other safe-haven exchange rates such as Japanese yen, and in particular Swiss franc.

HP: Aside of the re-emerging COVID risks, what other factors and events do you think will be pivotal to exchange rate markets?

MR: Well, I think in the very near-term period, what’s really important out there is inflation, and central banks’ reaction to it.

So we’ve been flagging those inflation pressures which are supply type driven. They essentially should peak roughly somewhere between December and January of next year. However, we have to now think that Omicron can also change this, by essentially making those bottlenecks, production bottlenecks, more persistent.

On the inflation front, it’s also very important how global central banks are going to assess not only these bottlenecks, but also the general stance of the labour market. We have recently seen a change in the Fed’s communication to tighter. On the back of that we changed our call on the Fed, and we are now expecting them to start tightening monetary policy as early as March next year, putting all together, hiking rates all together by 75 basis points next year, and up by 100 basis points in the year after that.

This sort of monetary policy tightening will, of course, have an impact on exchange rates, and, at least in the near term, should be supportive for the US dollar, and definitely in the longer term, should premium currencies with higher interest rates, and punish currencies which offer a very low interest rate.

HP: Marek, you’ve spent a lot of time this morning talking about developed markets, but how does the current environment translate into the emerging market complex?

MR: So I think I touched a bit on that point when you asked the first question. Essentially, you know, this is an uncertainty shock, which essentially means that a lot of investors deposition themselves from investments into emerging markets.

Now, when you look at it, we have two things. One, we already have quite low valuation of many emerging market currencies. Two, we’re going to have a different sort of range of responses to the Omicron, and we’re going to have a different range of responses to essentially this US monetary policy. Many emerging markets have already started to fight higher inflation, and they had to increase their interest rates, so they are offering a higher yield of return.

And I think that once we go through the initial stage of this massive uncertainty, and if none of the very extremely negative scenarios should play out, then we will see investors, potentially next year, trying to essentially look for investments that offer a high yield. And, that’s going to be a good time for those high-yielding currencies, while low-yielding emerging market currencies, unless they are going to be supported by a significant acceleration in the local economies, they essentially will suffer, and will probably underperform for longer.

HP: Well, Marek, thank you very much for your insight today. We know that listeners are always interested in Barclays’ views on the outlook for the foreign exchange markets, so we appreciate you keeping us updated.

Let’s move on to the week ahead, where the focus will be on US inflation and UK GDP print. Starting off with the US, the inflation print comes out on Friday. We look for headline CPI to have increased by six-tenths of 1% month on month in November, taking the annual figure to 6.7%, driven by energy and core inflation. We expect core CPI to increase by four-tenths of 1% month on month, coming in at 4.8% year on year.

The continued supply-chain bottlenecks point to upside price pressures to core goods, while core services inflation is likely to maintain strong momentum, led by shelter.

In terms of the UK monthly GDP report for October, well, go back to September, the print hinted to underwhelming underlying momentum, with the beat in the headline rate driven almost solely by health. We expect health to remain a contributor in October, given it was the month in which the booster vaccination campaign began in earnest.

Furthermore, continued normalisation in behaviour, such as return to office, we think is likely to have boosted GDP. That said, partly offsetting this is consumer confidence, which fell sharply in October, in part reflecting the onset of the gas crisis.

All told, we expect GDP to expand four-tenths of 1% month on month, driven by services, with industrial production and construction projected at 0% month on month, and just one-tenth of 1% month on month respectively.

And with that, we’d like to thank you once again for joining us. We will, of course, be back next week with our latest instalment, but for now may I wish you every success in the trading week ahead.