The IMF boosted this
year’s outlook and sees world growth at 5.5%, up from 5.2% in October. If accurate, it would be the strongest growth
since 2010’s recovery from the Great Financial Crisis. The chief economist Gopinath commented as the
new forecasts were published that “Much depends on the outcome of this race
between a mutating virus and vaccines and the ability of policies to provide
effective support until the pandemic ends.”
Fiscal stimulus from
late last year by the US and Japan were taken on board by the IMF, and it
revised 2021 growth higher its update.
US 2021 GDP is now estimated to be 5.1% rather than the 3.1% it projected
last October. The prospects for more stimulus mean that there is upside
potential in the IMF’s next update.
Japanese growth was revised up to 3.1% from 2.3%. Growth in the eurozone was downgrade to a
still solid 4.2% from 5.2%.
The IMF seemed
particularly optimistic about India. Last
year’s contraction is now estimated to be around 8% of GDP rather than more
than 10%. It is the 2021 forecast of
11.5% (from 8.8% in October) that grabbed attention. China’s growth prospects were shaved to 8.1%
from 8.2%. In 2022, the IMF also
projects India to grow faster than China (6.8% vs. 5.6%).
Most of the G7 are
at risk of contracting in the first three months of 2021. The main exception is
the United States, helped by the $900 bln fiscal package approved at the end of
2020. Although President Biden has
proposed a new $1.9 trillion stimulus bill, it is best understood as an opening
gambit that will most likely be negotiated down. The IMF estimated that
the stimulus proposal if adopted, would boost growth by 1.25% this year and 5%
over the next three years. Debating over
the size and priorities of this package will likely dominate the month ahead.
Ideally, it will be resolved before the extension of jobless benefits ends in
the middle of March.
A new divergence
appears to be opening between the US and other high-income countries. The
preliminary Purchasing Managers Survey for January is a case in point. The composite reading for the eurozone was
47.5, the third month below the 50 boom/bust level. At the end of 2019, it was at 50.9. Japan’s preliminary January composite PMI
stood at 46.7. It has not been above 50
since January 2020. In stark contrast,
the US preliminary composite PMI rose to 58.0, and it was the fourth month above
55.0. In December 2019, the composite
was at 52.7.
Although based on
comments from the Governor of the Bank of Canada, a window appeared to open in
favor of a mini-rate cut (10-15 bp), but for the most part, barring a new
undesirable turn of the virus, we are probably near peak monetary policy in
this cycle. In the US, several regional
Fed presidents are open to the possibility of tapering the long-term asset
purchases this year. Chairman Powell wants
to stay focused and ensure a robust recovery and argues it is premature to. In the ECB, there seems to be an agreement
that the full 1.85 trillion-euro Pandemic Emergency Purchase Program does not
have to use if favorable financial conditions can be preserved with less.
In late January, ECB
officials warned that investors were underestimating the risks that it reduces
rates again. The ECB’s dual rate regime,
whereby the deposit rate (minus 50 bp) is not functioning as the floor
for money market rates because the central bank makes loans (TLTRO) at minus
100 bp if certain lending targets are reached.
It is difficult to tell precisely what has been discounted, but we note
that the key overnight benchmarks are six-eight basis points below the deposit
rate. The implied interest rate on
three-month Euribor futures contracts is below the deposit rate by as much as
eight basis points until September 2023.
ECB President Lagarde
has repeatedly indicated that its measures are scalable in numerous dimensions. The
PEPP was symmetrical. The full authorization
need not be drawn upon, but if more was needed, it would be provided. The risk of an ECB rate cut has
not been more pronounced, maybe because it would likely be a 10 bp move, which
may be too small to have much impact.
And to think that it would have more than a short-term impact on the foreign
exchange market or that it would boost CPI seems somewhat naïve.
None of the three G10
central banks that meet in February (Reserve Bank of Australia, Bank of
England and Sweden’s Riksbank) are likely to change their stance. The BOE
continues to say that it is studying the implications of negative rates, but
implementation has not been discussed. The
short-sterling (three-month deposit rate) futures strip implies a negative rate
from April through December this year.
Gilt yields out five years also have negative yields. Barring a new negative shock, we do not
expect the BOE to adopt a negative policy rate.
While some emerging
market countries are likely to begin raising rates this year, February is too
soon. Turkey has turned back to monetary
orthodox and has been rewarded by a firmer currency. In three steps, the central bank more than
doubled the one-week repo rate to 17% in December (from 8.25% in August). In
January, the Turkish lira led the few advancing emerging market currencies
higher with around a 1.8% gain. It
appreciated by 3.75% in Q4 20 to narrow the whole year decline to 20%.
Emerging market
equities got hit hard in Q1 20 but have been trending higher since. The MSCI Emerging Market Index has been on a
tear. It rose by around 10% in the first
few weeks of the year before succumbing to profit-taking pressures. The 4.5% loss in the last week of the month still saw it finish its fourth monthly advance was about a 3% gain. And that
weekly loss was only the fourth since the end of September. It rose 15.8% in all of 2020, a little more
than in 2019
However, note what is
being measured here. The index is
heavily weighted toward a few large Asian markets. Nearly three-quarters of the benchmark is
accounted for by China (~39%), South Korea (~13.5%), Taiwan (~12.75%), and
India (~9.25%). Brazil is a distant
fifth with about a 5% weight.
Dollar: The $900 bln fiscal stimulus package approved at the end of
last year will help underpin economic activity as herd immunity to Covid-19 is
sought. Some of the jobless benefits were extended until mid-March, which now serves
as the new Congress's deadline as it debates another package. The first
two years of the Biden administration may be shaped by that debate. Will, the Democrats, use their majority to push-through stimulus through the reconciliation route, or
will it find a compromise a draw opposition support? Will the Democrats prevent the filibuster
from blocking their agenda? Meanwhile,
the Federal Reserve will continue to buy $80 bln of Treasuries and $40 bln of
Agency mortgage-backed securities. The
dollar appears to have been used extensively as a funding currency. If the
correction in the equity market and many risk-assets in general continues, the greenback may recoup more of the losses suffered since the election.
Euro: The extended social restrictions will continue to hamper
economic activity, and the EU has been slow to roll out the vaccines. The EU’s 750
bln-euro Recovery Fund is not expected to distribute money until closer to midyear.
The ECB’s Pandemic Emergency Purchase Plan (1.85 trillion euros) is not the
same as the Fed’s commitment to buy a fixed amount of Treasuries and Agencies. It
gives officials flexibility. The goal is to ensure favorable financial
conditions. It will use the PEPP as
necessary to achieve the goals. The European Union appears galvanized by the US
preoccupation with domestic issues. It seems
to be on the move. Brexit, the dispute
with Poland and Hungary over the EU budget, and the protracted negotiations with
China on an investment pact successfully completed at the end of last
year. It took the initiative on regulation
in the digital space. Over US objections, it
is proceeding with the Nord Stream 2 pipeline from Russia. In January, it released a paper outlining how
it wants to boost the euro's international use and regain the sovereignty
it feels it has lost as the US enforces its sanction regime.
Germany is reportedly contemplating sending a frigate to the disputed
waters in the South China Sea.
(end of January 2021 indicative prices, previous in parentheses)
Spot:
$1.2135 ($1.2215)
Median
Bloomberg One-month Forecast $1.2145 ($1.21)
One-month
forward $1.2140 ($1.2245)
One-month implied vol 5.7% (6.8%)
Yen:
The yen often seems driven by external
factors, such as its use as a funding currency used to buy higher beta assets. When those higher beta assets sell-off, which
they invariably do, the yen is repurchased. Japan’s fiscal stimulus prompted
the IMF to revise up this year’s growth forecast to 3.1% from the 2.3% estimate
made in October 2020, despite the formal state of emergency that covers about 60%
of the economy. Talk that the Bank of Japan could reduce its ETF buying seemed
to have dampened by the sharp drop in share prices at the end of January, which
left the Nikkei up 0.8% on the month, the only G7 bourse to finish higher. Based
on the minutes from the recent BOJ meeting, some thought a wider
range of the 10-year yield may be tolerated. Under yield curve control, the BOJ
targets the 10-year yield at zero and allows it to move in a 20 bp band around
it. Yet, the generic 10-year yield has not been below zero since last May and
has not been much above six basis points since last March. Prime Minister Suga’s honeymoon has not lasted
long, and hopes to call an early election (due in October) have faded.
Spot:
JPY104.70 (JPY103.20)
Median
Bloomberg One-month Forecast JPY104.50 (JPY104.00)
One-month
forward JPY104.75 (JPY103.25) One-month
implied vol 6.3% (6.3%)
Sterling: The rapid rollout of the vaccine in the UK and the cushion
of inventories dampening the initial disruptions of Brexit has underpinned sterling.
As the euro and yen fell around 1% against the dollar in January, sterling managed
to eke out a small gain (~0.30%). Still, it was the fourth consecutive monthly appreciation,
which matches the longest streak since 2009. At 4.5%, the IMF forecast is for
the UK growth to exceed the eurozone (4.2%) and Germany (3.5%). While the US contemplates more stimulus this month,
the UK Chancellor of the Exchequer Sunak will be preparing the budget for early
March and is under political pressure to demonstrate that fiscal policy will
return to a sustainable path. Meanwhile,
the race between the drawing down inventories and implementing
the technology and procedures of the new trade regime continues. The euro has
fallen from a little more than GBP0.9200 in December to almost GBP0.8800 in
January. This may have helped fuel sterling’s resilience against the dollar,
but it may have largely run its course.
Spot:
$1.3710 ($1.3660)
Median
Bloomberg One-month Forecast $1.3695 ($1.3540)
One-month
forward $1.3715 ($1.3670)
One-month implied vol 7.8% (9.2%)
Canadian
Dollar: The US dollar slipped
below CAD1.2600 on January 21 for the first time since April 2018 and reversed
higher. It finished January at its best levels for the month and has appreciated three consecutive weeks, the longest advance since last September. The
Canadian dollar’s 0.4% loss last month still made it the best performing within
the dollar bloc. Although Bank of Canada Governor Macklem held out the
possibility of a mini rate cut (presumably 10-15 bp), it appears in no hurry to
use that space. The Bank of Canada sees
the economy is flush with stimulus, and as confidence grows in a sustainable
recovery and expansion, the policy will be adjusted. This seems to hint at a further reduction in
bond purchases later this year, which have already been reduced from C$5 bln to
C$4 bln a week. Biden canceled the Keystone
XL pipeline project on his first day in office.
However, it probably says little about the political or economic
relationship. The Keystone pipeline
would have carried as much as 830k bpd, and the expansion of existing pipelines
is projected to boost capacity by 950k bpd.
Canada accounts for a little more than half of the US oil imports. The Canadian dollar seemed more sensitive to
the vagaries of equities than the 7.5% rally in crude prices in January.
Spot:
CAD1.2780 (CAD 1.2730)
Median
Bloomberg One-month Forecast CAD1.2770 (CAD1.2800)
One-month
forward CAD1.2800 (CAD1.2700) One-month
implied vol 7.0% (6.9%)
Australian
Dollar: After gaining nearly
4.8% against the US dollar in December 2020, the Australian dollar slipped by about
two-thirds of a percent. It peaked early
in the month (~$0.7820), its highest level since March 2018. It choppily traded
lower to approach $0.7600 at the end of January. The central bank is in a
wait-and-see mode, and the focus is on the labor market. Stronger wage growth is necessary, but there
is still too much slack. The government has yet to secure a rapprochement with China. Yet, Australia’s trade balance has held up
well, and its surplus through the first 11-months of 2020 was a little larger
than the same period in 2019. That is also true through the last three months
(through November), as Beijing escalated its pressure. If being a military and security outpost for
China’s chief rival is not provocation, Australia chose the timing of its confrontation
with the internet giants by drafting legislation to force payment for the media
service and be subject to mandatory arbitration. Google, which accounts for an estimated 85%
of the internet searches in Australia, has threatened to pull out of the $4 bln
markets to deter others. The Australian dollar is also vulnerable to the unwind
of risk-appetites.
Spot:
$0.7645 ($0.7695)
Median
Bloomberg One-Month Forecast $0.7640 ($0.7625)
One-month
forward $0.7650 ($0.7700)
One-month implied vol 10.3% (10.3%)
Mexican
Peso: The peso edged higher in
the first few weeks of the New Year. It rose to its best level since last March before risk appetites reversed and send the peso lower. Through January 21, when
the peso topped out, it had been one of the strongest of the emerging market
currencies. The increase in volatility dampens the attractiveness of Mexico’s
relatively high-interest rates. The peso also acts as a proxy for other
emerging market currencies. The six-week decline in the JP Morgan Emerging
Market Currency Index is the longest drop since July-August 201. Given the lack
of strong fiscal support, the central bank is still under pressure to cut rates.
Even though headline inflation, which spent August through November above the 4% ceiling, has eased back toward 3.0%, the core rate has firmed to 3.8% in December.
Although there is some risk that the central bank delivers a 25 bp rate cut at its
February 11 meeting, we suspect it may wait until after its inflation report in
early March.
Spot: MXN20.5750 (MXN19.9050)
Median
Bloomberg One-Month Forecast MXN20.5050 (MXN19.8850)
One-month
forward MXN20.5854 (MXN19.97) One-month
implied vol 15.3% (15.3%)
Chinese
Yuan: The dollar established a range
against the yuan in the first two trading sessions (~CNY6.43-CNY6.5150) that it
remained within until the waning hours of the month when it was pushed to about
CNY6.4235 after the mainland’s official close. Month-end pressures, tax
obligations, and a purposeful tightening of money market conditions, but shy of
a rate cut, also may have helped underpin the yuan. The overnight repo rate rose
to 3.33% at the end of January, its highest level in more than a decade, up from
a low of 59 bp in December and above the Standing Loan Facility rate that acts
as the funding ceiling. This squeeze in the domestic money markets has favored the onshore yuan (CNY) over the offshore yuan (CNH). The gap is the widest since last August. The
PBOC does not have to hike rates. The fear of its action is itself useful. Officials
may want to discourage the liquidity that it provides to cushion the New Year distortions (Year
of the Ox, February 12) to be used for more extend levered positions. It does appear that the pace of the recovery
is leveling off.
Spot:
CNY6.4285 (CNY6.5270)
Median
Bloomberg One-month Forecast CNY6.4750 (CNY6.5175)
One-month
forward CNY6.4750 (CNY6.5310)
One-month implied vol 5.1% (5.8%)
Disclaimer
Reviewed by Marc Chandler
on
February 01, 2021
Rating:
