Something doesn’t feel right

The European Central Bank (ECB) and the Bank of England (BoE) refused to join the Federal Reserve (Fed)-thrown pivot party. Both Christine Lagarde and Andrew Bailey declined to discuss cutting interest rates judging a policy loosening too early as the inflation threat looms. BoE’s Bailey pointed at the possibility of another rate hike, as three MPC members favoured hiking rates, while the ECB announced to accelerate EXIT from the PEPP stimulus, and the Norges Bank popped up with a surprise rate hike. 

As a result, the rally in global stock and bond markets slowed. The S&P500 hit a fresh nearly 2-year high but closed nearly flat, the Stoxx 600 – I guess didn’t hear the news yet so it just – kept rallying. The US 10-year yield rebounded after tipping a toe below the 3.90% level. Note that there is growing speculation that the 10-year yield will fall to 3%, but I think that’s overstretched, and the dollar index had a rough day, because the hawkish European central banks further plummeted appetite for the greenback.  

The USDNOK fell sharply to the lowest level since summer and the EURUSD shortly flirted with the 1.10 level, as yesterday’s ECB announcement threw the foundation of a stronger euro into the next year. The divergence between a more dovish Fed and still hawkish ECB should support a sustainable appreciation. Presently, the EURUSD stands right at the middle of January 2021 peak (near 1.22) and September 2022 dip (below parity). A further rise toward 1.1260 level would reasonably reflect the Fed-ECB divergence.  

Cable, on the other hand, came close to the 1.28 level. Zooming out, the pair stands at around the mid-range of the 2021-2022 selloff (leaving the Liz Truss dip out of the analysis). The GBPUSD could reasonably be expected to extend gains toward the 1.30 level on the back of the divergence between the hawkish BoE and a softening Fed stance.  

This being said, the Fed is the Fed and you can’t fight the Fed for long. This is what traders say, and this is also true for the central banks. The fact that the USD is set to soften will naturally strengthen its counterparts. And a stronger euro and a stronger pound will further help taming inflation in the Eurozone and in Britain. And given the morose economic outlook in the old continent, the ECB and the BoE will easily feel the pressure for lowering rates in Q1, and that could, in the medium run, stall the dollar weakness and limit the euro and sterling strength. Even more so, as the only major central bank which hinted at the end of policy tightening continues to see strong economic data. Released yesterday, the US retail sales unexpectedly rose, business inventories declined, and the weekly jobless claims fell to around 200K.  Across the Atlantic Ocean, the flash PMI figures for December could show some improvement, but all the numbers are still comfortably in the contraction zone. The contrast between the resilient US economy adopting a dovish stance and faltering European economies holding on to a hawkish position gives the impression that something is amiss. 

Speaking of divergence, the People’s Bank of China (PBoC) infused an impressive 1.45 trillion yuan during the Medium-term Lending Facility (MLF) rate setting and rollover. Out of this, 650 billion yuan matured, and the rest was a substantial monthly injection of 800 billion yuan, marking its largest to date.  

On the data front, industrial production was stronger in November, but investment and retail sales missed expectations. China announced earlier this week that it will shift its focus to boosting industrial activity than consumer appetite – as consumers are difficult to cheer up with the tumbling property market. That’s a big U-turn for Xi Jinping who wanted to do things differently. In fact, China always boosted investment without caring much about transforming investment into consumption. That was one of the biggest problems regarding the whopping Chinese growth. Hence, originally, Xi Jinping was not wrong in wanting to throw the foundation of a healthier economy. But the way things happened was harsh. To tidy things up requires going back to a model that worked: boost investment, and spit growth. While the Chinese efforts will hardly bring masses back to the Chinese markets, industrial metals should benefit from China’s efforts to ramp up industries and real estate.