A precarious climb higher
2022 may appear to have started on a bright note, at least judging by equity prices, but the underlying truth is more mixed. Yes, Chinese Purchasing Managers’ Index data from overnight is good news in that it doesn't augur the Omicron-induced supply chain disruptions many had feared, but there might be another reason for the rally. Two-year and 10-year US Treasury yields imply a meaningful increase in policy rates this year, which is absolutely shredding bond returns. Our thought is that at least part of this equity rally is just a flight from the bond market route, piling into the least unattractive alternative.
Bottom line: We’ve been arguing for some time that asset prices are over-stretched, but the dynamic playing out now is truly concerning. Rate expectations are driving bond yields higher and pushing yet more cash into equities, which are are in turn, getting less attractive in terms of upside/downside risk. Central bank liquidity is going to recede and refinancing rates are going up, and yet somehow, the meagre discounted cashflows of already overpriced securities are worth more! The bet is that supply chain disruptions and commodity prices will ease, or at least not climb, which should facilitate faster growth for businesses. It's not an unreasonable proposition but hardly offsets the tighter financing and deleveraging that rate hikes will trigger. Of course, this ignores any political roadblocks we might encounter—think Brexit, delayed Build Back Better, Ukraine invasion, fresh Turkish central bank folly, etc. Given how lofty prices are already, the downside just looms larger than a marginal new high.
The week ahead
The Pound has had a positive start to the New Year, trading back above $1.35 against the Dollar and pushing well above the €1.19 handle against the Euro. The currency was given a boost in December after the Bank of England opted to raise interest rates to 0.25%, and with the expectation of another rate hike, there could be more Sterling strength to come. The implementation of more Coronavirus restrictions in England looks unlikely as things stand; Health Secretary Sajid Javid has suggested it will be the government’s last resort with Plan B set to continue. However, the Prime Minister is due to hold a press conference later today answering questions on how the government is tackling the Omicron variant spread. UK travel stocks jumped in early trade as signs emerge that Omicron is less severe than previous Coronavirus variants.
- The British Retail Consortium Shop Price Index y/y read 0.80% this month, coming in significantly higher than the 0.30% print in December.
- Mortgage Approvals are due to be released today with little change expected from last month’s reading as house prices continue to soar.
- The Halifax House Price Index m/m looks likely to rise by 1.10% in December, building on the 1.00% climb seen in November.
- Construction data will be published this Friday, with the latest Purchasing Managers’ Index reading expected at 53.9 versus the 55.5 December print.
The Euro has been stuck in a rut for the last month, trading mostly range-bound against the Dollar after consistent declines in the second half of last year. Monetary policy divergence has been the main perpetrator of this move, with economists expecting the European Central Bank to finish scaling back its bond-buying programme in 2023, with an interest rate hike to follow. The pace at which the Bank of England and Federal Reserve are moving towards tighter monetary policy may only compound the weakness we’ve seen in the Euro in the coming months. Omicron continues to cause issues throughout the continent as worker shortages and healthcare pressures mount.
- Germany’s preliminary Consumer Price Index m/m for December is forecast to come in at 0.4% following November's 0.2% decline.
- The Eurozone’s Producer Price Index m/m for November looks likely to rise by 1.1% after seeing a 5.4% gain in October.
- German Industrial Production m/m is predicted to continue its gains in November, growing 1.1% after rising 2.8% in the previous month.
- Eurozone flash estimates y/y for CPI and Core CPI are expected to read 4.8% and 2.5%, respectively, for December.
The US Dollar started 2022 on the front foot after a strong rally overnight with the Dollar Index jumping back above the $96 handle while US Treasury yields rose across the board. The S&P 500 hit fresh record highs at the start of the week as the ‘everything rally’ trend continues. The Federal Reserve bond-buying programme is expected to end in March as an acceleration of the withdrawal of stimulus looks more likely. The Federal Open Market Committee will be meeting on Wednesday, and more colour is expected on the pace of the taper. Coronavirus continues to rip through the US, with over one million cases reported on Monday.
- The latest ISM Manufacturing print is due out later today, with consensus pointing to a reading of 60.0 for December following a print of 61.1 in November. The Services PMI due on Thursday is expected at 67.0 versus 69.1, respectively.
- ADP Non-Farm Employment Change is scheduled for release tomorrow with a 405K print predicted for December after reading 534K in November.
- The first FOMC meeting minutes of the New Year are due to be released this Wednesday.
- Finally, Non-Farm payrolls will close out the week. The figure is forecast to come in at 426K in December after coming in at 210K in November.
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