Markets Weekly podcast - 28 June 2021
“We’ve already been a standout by saying the US dollar wouldn’t depreciate this year” – Marvin Barth, Head of FX Strategy, gives his latest thoughts on FX markets, and the currency he thinks has the biggest potential to shock. Also in this week’s podcast, Henk Potts, Market Strategist for EMEA, looks at why markets are shrugging off inflation fears – for now at least.
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Henk Potts (HP): Hello. It’s Monday, 28th June 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 discuss the outlook for foreign exchange markets. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
The Fed’s impression of the Grand Old Duke of York has played out in markets over the course of the past couple of weeks. The Fed’s June statement marched expectations higher as officials suggested that price rises are becoming more ingrained and indicated a speeding up of the expected pace of policy timing.
However, last week officials were trying to march expectations down again. In testimony, Jerome Powell reiterated the spike in inflation is transitory. New York Fed President Williams reminded markets that rate hikes were still way off in the future.
The soothing tone encouraged markets to take a more measured approach to the Fed’s hawkish pivot. Equity investors appear increasingly comfortable with the prospect that policy timing will be gradual, controlled and a transparent process, and will indeed take place against the backdrop of a robust recovery.
Risk sentiment also got a boost from the agreement on a half a trillion dollar infrastructure bill in the United States as well as the results of the US bank stress test. President Biden announced a $579 billion bipartisan infrastructure plan has been agreed. The deal would see the largest investment in public transit in US history all in an effort to boost productivity. Stronger tax enforcement and sales from a strategic petroleum reserve will help to pay for the measures.
Financials got a boost as the major banks sailed through the Fed’s stress test. The test evaluated the impact of a hypothetical fall in unemployment to near 11% and a 50% fall in stock market. Under the scenario, the biggest banks would still have a Tier 1 capital ratio of 10.6% which is more than twice the minimum amount.
The results paved the way for a flood of dividend and share buybacks that were banned during the course of the pandemic. We expect more details on pay-out amounts during the course of today.
The calmer Fed, the stimulus deal, the strong bank balance sheets helped to propel US indexes to all-time highs. The S&P 500 was up 2.7% over the course of the week, in fact had its best week since early February, financials, commodities and industrials very much leading the way.
In Europe, the STOXX 600 rose 1.2% over the course of the week. That’s its best weekly gain in seven, although Friday’s core PCE inflation reading of +3.4% year on year for May, the biggest advance since 1991 coupled with the inflation fuelling infrastructure plan, resulted in a spike in benchmark treasury yields and a steepening of the curve.
Ten year yields hit 1.54% on Friday. It was up 8.6% basis points over the course of the week. That’s its biggest weekly gain since March.
At the Bank of England meeting on Thursday, the MPC refused to follow the Fed’s suit and pushed back on the prospects of premature tightening. The Bank of England as we know kept rates on hold at that historically low level of 0.1% and maintained the quantitative easing programme at the current level.
The Central Bank maintained a balanced narrative that acknowledged there have been upside surprise on growth, inflation and the labour market but concluded it’s not yet clear if this activity will fuel medium term stronger demand or merely result in a faster recovery to pre pandemic levels.
The central bank is now forecasting inflation will exceed 3% for a temporary period. Second-quarter growth will be 5.5% quarter on quarter but then seeing those measures start to fall back.
On the labour market the MPC minutes stated that the fast unexpected reduction in the number of furloughed workers and rising wage growth was not conclusive evidence of a tight market given the higher levels of inactive people.
In terms of our view, we anticipate inflation will peak somewhere round about 2.7% in the fourth quarter, then start to ease back through the course of next year getting back below that 2% target rate as base effects rescind and growth rates ease.
We estimate that unemployment will peak at 5.7% in the fourth quarter as the furlough programme is unwound. We look for unemployment to average 5.4% during the course of next year, still significantly higher of course than that pre pandemic average of 3.8% back in 2019.
We have raised our growth forecast for the full year for the UK economy now stands at 6.7% but the unwinding of those support measures and disruption caused by the Delta variant continues to create uncertainty around the forecast.
In terms of the policy outlook, the MPC doesn’t intend, I think, to tighten policy at least until there is clear evidence that significant progress is being made on eliminating spare capacity. What does that mean? Looks like rates will be on hold through the course of next year.
There are risks to that forecast if there’s a significantly stronger recovery materialising and inflation is protected to be sustainably above that 2% mark. Such a scenario could be achieved by a combination of factors. Consumers running down accumulated savings at a faster rate, a quicker recovery in labour markets could create wage growth, and of course businesses could start to exert some pricing power in response to the robust demand.
So that was the global economy and financial markets last week. Let’s move on to look at foreign exchange markets.
I’m pleased to be joined by Marvin Barth, Head of FX Strategy for Barclays Investment Bank. Marvin, great to have you with us today. When I look at your latest forecasts and am I right in saying you expect the dollar will very slowly strengthen over the course of next year, the euro will weaken and sterling to trade sideways?
Marvin Barth (MB): Yes, that’s basically the case. We do have a range bound dollar here. We have some differentiation across the G10 so it’s not a clear dollar outperformance scenario.
So some of the commodity currencies in G10 do outperform the dollar over the course of the year, but generally the dollar is stronger than European currencies, than the yen and this is really about a relatively constrained environment as people are not sure what the clear narrative is when we have these supply constraints keeping inflationary pressures there potentially slowing down the path of global growth and questions about how different central banks are going to react to that.
HP: OK. So let’s get into some of the fundamentals of those points, particularly when it comes to foreign exchange markets. Interest rate predictions, growth rate projections with an overlay of value are some of the key drivers as we know. Which of these do you think will be the most important over the course of the next six to 12 months and what are the main risks to your base case?
MB: Well, so I think that one of the reasons why you have this range trade that I just described is a lack of conviction associated with all of those factors being much more uncertain than they normally are and, you know, we’ve had the pricing in and the clear updraft from vaccines in the world, but we’re now running into these supply constraints that are transitory in nature but I think the key problem here is that nobody really knows how long transitory is.
Is this a couple of months or is this, you know, six months, 12 months? We don’t know. And neither do central banks. At this point they can hold the line, at least within the G10, and as a result we’re seeing relatively flat interest rates but people questioning are those going to change?
Same thing about growth. How much are these supply constraints going to restrain growth? We’ll get another big signal on that in the payrolls report later this week. But unfortunately none of these questions are going to be answered quickly.
What are the big risks to our forecast? Well, I think in one direction it is that, indeed, we do see that these supply constraints that are creating inflation on one side, but central banks are saying they can look through because they don’t see a shift in consumer and business expectations for inflation that will lead to a more permanent state of inflation. Then if we did see that shift in inflation expectations clearly that’s going to have big effects and we think that that’s most likely in the dollar.
And so the real risk in that scenario is that we do get a much stronger dollar because the Fed we do think will show aggressiveness if it is convinced, and it will take a lot to convince them, but once they’re convinced we do think they will react to it and they’ll probably go earlier than other central banks in that tail scenario.
And the flipside is we’re still in the middle of a pandemic that we don’t fully understand. There’s plenty of potential for COVID to rebound in some unforeseen form and, you know, that could drag us down into another low growth world. It’s not clear if the dollar does so poorly in that environment but I think it may help some of the safe havens that have been hurt by the prospects for a strong global recovery and people wanting to be in growth rather than value so to speak.
HP: OK. So let’s pick up on that point a little bit. What is your view on those traditional safe haven currencies, particularly the Swiss franc, the Japanese yen, how do you expect those currencies to perform over the course of the next year?
MB: OK. So we do have them weakening over the course of the next couple of quarters and this is largely because, you know, we still are in an environment where people want to own call options on growth and they also, they want to have a residual safety but right now the dollar’s kind of offering you both, right? It’s the growth leader of the world and we’ve seen that it is the premier safe-haven currency out there.
So as a result as, you know, the back-end of US yields start to rise in relative terms versus the yen and Swiss franc you’re starting to see a weakening of those currencies and we expect that to continue probably through the end of this year into the first quarter of next year.
As the recovery matures more we do think people are going to want to diversify more into other types of safe havens and you’re likely to see that the dollar loses some of its growth leadership stature as the rest of the world starts to catch up.
And at that point we do have the Swiss franc coming off a bit as well as the yen. So just to put some numbers around it. You know, in Swiss franc terms we have euro/Swiss going up through 1.10 by the end of this year. But when you get to the middle of next year we’re back down to 1.08. So not huge moves here but you can see some of the direction there.
Same thing with dollar/yen. We see it going up towards 1.12 by the end of this year, coming back to 1.09 next year versus the dollar.
HP: OK. Let me try and throw you a little bit of a curveball for my final question. Which currency do you think is most likely to shock consensus over the course of the next 12 months?
MB: Well, I think the one that certainly has the biggest potential and would have the biggest effect is the dollar. And so go back to that risk scenario that you asked me about before in terms of, well, what if we do see that these sustained supplier pressures creating elevated inflation do start to feed into consumer expectations sooner than the Fed expects and they have to move a lot earlier than everyone expects?
That’s going to be a big adjustment for markets and I think one of the reasons why it’s a big adjustment is not just that, you know, obviously the dollar is fundamental to all global financial markets and the anchor for global currency markets but also, you know, we’ve already been a standout on the street in saying the dollar wasn’t depreciating this year.
Everybody has been expecting it to depreciate and the fact that it hasn’t has been, you know, a major source of consternation for the rest of the street. Maybe suggest they should pay more attention to Barclays forecasts but if you actually have the dollar appreciating significantly next year, I think that’s going to be a real challenge for people.
HP: Marvin, great to have you with us today as always. We certainly know our listeners are always interested in your latest currency forecasts and no doubt we’ll have you back on again very soon.
Let’s move on to consider the outlook for this week. This week the focus will be on Friday’s non-farm payroll report and the OPEC Plus meetings. While inflation has grabbed many of the headlines over the course of the past month, attention will turn to the second element of the Fed’s dual mandate, maximum employment. Despite the recent slowing, the US labour market has recovered remarkably over the course of the past year.
We looked for the US economy to have created 625,000 jobs last month. The unemployment rates ticked down to 5.7%. Lots of investors will be focusing on those average hourly earnings as well where we expect a rise of 3.6% year on year.
As economic conditions normalise we would expect the unemployment rate to continue to fall. We’ve got it at 4.6% at the end of this year, 4.1% at the end of 2022.
The mixture of improving labour market conditions, pent up demand, more than $2.6 trillion of excess savings should boost consumer confidence and drive retail sales and also help to propel growth prospects to around 7% in the world’s largest economy.
With the OPEC+ meeting on Thursday recovering demand, constrained supply, falling inventory levels helped to push crude prices to two year highs. Brent trading above $76 a barrel this morning and of course that has been fuelling inflation expectations. Members are expected to discuss whether to boost production levels beyond the two million barrels per day committed to between May and July.
And the International Energy has called upon the group to start tapping its spare capacity to bolster supply. So watch out for that one as the week goes on.
But with that, I’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.
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