Risk assets were back under pressure Tuesday, with markets awaiting updated information on the vaccine coverage against Omicron. The discussion was shifting towards monetary policy as markets priced out the Fed's (and other central banks) tightening, ahead of the day's Senate testimony by Powell. This left USD and pro-cyclical FX, vulnerable.
USD: Fed rate expectations under pressure
The rebound in equities Monday was relatively contained, and Asian equities (as well as Western stock futures) were back in the red Tuesday morning. This was clearly an indication that markets were awaiting some solid confirmation that the current vaccines offered enough protection against the Omicron variant before jumping back on risk-on trades. For now, the US administration was not running on the assumption that new vaccine formulas will be needed and was simply planning to roll out booster doses faster (like in most other developed countries).
In FX, low yielders were finding fresh support yesterday morning, and a contraction in oil prices after Monday's tentative rebound was back to putting pressure on commodity currencies. In the pro-cyclical space, SEK emerged as a major outperformer Monday, likely benefitting from a sizeable short-squeezing, as some market sentiment stabilization allowed a delayed positive impact from last week’s hawkish Riksbank meeting.
Another factor that seemed to be offering support to the likes of the low-yielding JPY, EUR and CHF against both pro-cyclical currencies and the dollar, was the process of repricing of rate expectations in light of the potential danger caused by the new variant. After all, the three low yielders were inherently those with the smallest room for a dovish repricing when it would come to 2022 rate expectations.
Yesterday's Senate Testimony by Fed Chair Powell was the focus of much attention, as prepared remarks showed that he will flag significant downside risks stemming from the Omicron variant to both employment and economic activity. Markets have now pushed back the first rate hike by the Fed, to September 2022.
With this in mind, a recovery in the dollar remained strictly tied to some positive news on the vaccine coverage against the Omicron variant. The greenback should continue to stand in the middle between the group of low-yielders and pro-cyclical currencies—which like the dollar, have the largest room for dovish repricing of rate expectations. Things tend to change rapidly as virus-related news hits the market, but for now, indications of markets plunging into risk-off suggested we could still see USD capped and commodity currencies staying offered on oil underperformance.
EUR: Keeping an eye on inflation amid Omicron-related support
November estimates published Monday showed that inflation broke the 6% mark in Germany, and our economist expected more upward pressure on prices before a gradual retreat in 2022. We saw the French and EZ-wide inflation numbers yesterday, but the impact on the EUR was secondary to the swings in sentiment related to the Omicron variant.
A popular funding currency before the Omicron-induced correction, it is likely that we need to see some confidence being re-built into risk trades to see the EUR depreciate across the board. A return to 1.1200 in EUR/USD appeared strictly linked to an improvement in the general sentiment about the implications of the new strain. Early signs Tuesday seemed to point in the opposite direction.
GBP: Double threat to the pound
The UK will start offering booster doses to all adults, a move that followed fresh restrictions on international travel imposed by the Government to contain the spread of the Omicron variant. With the 16 December BoE rate decision drawing closer, a worsening of the virus situation globally and specifically in the UK, may not only put upward pressure on EUR/GBP due to the pound’s higher sensitivity to risk sentiment, but may also mean markets could increasingly price out a December rate hike by the BoE.
It is too early to draw any conclusions on that, but for now, a choppy risk environment may send EUR/GBP above 0.8500.
CAD: Growth data to play second fiddle
The loonie was a major victim of both the Friday risk sell-off and its exposure to oil prices and its overbought condition. Despite possibly having a more balanced positioning now, a hit to sentiment, oil prices and the potential pricing out of BoC rate expectations due to the Omicron variant spread, still signaled sizeable downside risks for CAD.
Yesterday, we saw Canada’s growth numbers for 3Q, with the annualized figure expected to come in at 3.0% YoY, but which surprised upward to 5.4%. We think the Bank of Canada’s tightening plans should not be impacted. After all, the economy is running quite hot in Canada and a tight jobs market is fueling concerns of persistent inflation.
We’ll see whether the Omicron variant dramatically changes the economic outlook in Canada, which as of now, looks set to be CAD-positive in the medium run. News on the variant will set the tone for global sentiment in the coming days and will drive all moves in CAD, likely out-shadowing any post-GDP reaction.
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