Disinflationary emergence

Only a week ago, we discussed the Federal Reserve and Bank of England waiting until next February to tighten monetary policy because of inflationary pressure coming from rising raw material and energy prices that are expected to recede towards spring. However, this morning the inflationary trend seems to be reversing quicker than expected, and talk is now of disinflationary pressure. Other key pieces of news this week are that some developed nations are planning to implement further lockdowns and supply chain issues seem to be improving very quickly.

Let’s break this down and see what the net effect looks like:

  • Crude oil has come off circa $86/barrel highs in late October and is expected to trend even lower now that the US and Japan are to release supply from their strategic reserve holdings. If nations implement another lockdown, that will also generate a strong downward pressure on this price since travel would be restricted.
  • Metals are down on the month, suggesting a decline in demand or some alleviation of supply, but probably a mix of both factors.
  • Agricultural commodities are still rising, but context matters; it’s worth noting that they’re more or less flat since one year ago.
  • The cost of shipping is falling dramatically for non-Asian routes. The Baltic Index measures of price levels have largely receded since spiking in early October, although they remain up year-to-date (YTD).
  Since Early Oct YTD Chng
    Baltic Dry Index -56% 80%
    Baltic Handysize Index -22% 132%
    Baltic Supramax Index (New) -34% 116%
    Baltic Panamax Index -40% 76%
    Baltic Capesize Index (New) -68% 63%


Source: Bloomberg

Bottom line: Two different things are happening here: a decline in input costs means non-core inflation should fall, but while the alleviation of supply issues should drive the cost of consumer goods lower, costs of supply issues have largely been passed onto the consumer. The net effect is a rise in disposable income which should drive economic activity higher; this is the inflation central banks are looking for. Obviously, lockdowns have the opposite effect, but by many accounts, the impact of a two–three-week lockdown is not as large as it was a year or two ago, so the disruption should be modest. These signs of optimism are likely to result in counterintuitive language if they continue. This is because most pundits only look at the headline inflation number—which might fall—even though the composition of inflation indicates a tighter policy setting is appropriate sooner.

The week ahead
 

GBP 

Cable continues to be pressured by US Dollar strength and political tensions surrounding the Northern Ireland protocol, with the pair falling around 0.40% on Friday, erasing gains from the start of the week. The mood surrounding the NI protocol is somewhat mixed, with Irish Prime Minister Micheál Martin appearing more optimistic about a resolution. However, Lord Frost, the UK’s lead negotiator, isn’t ruling out triggering Article 16 if talks begin to stall. Bank of England Chief Economist Huw Pill played down the possibility of a rate hike last week, indicating he’s still undecided on his voting direction for the next meeting in December and admitting he’s exploring reasons not to raise rates.

  • The UK flash Manufacturing and Services PMIs are due tomorrow and are forecast to print at 57.2 and 58.2 versus 57.8 and 59.1 last month.
  • Monetary Policy Committee members Jonathan Haskel, Silvana Tenreyro, and Huw Pill are scheduled to speak throughout the week.
  • Bank of England Governor Andrew Bailey will be speaking alongside Mohamed El-Erian at the Cambridge Union this Thursday at 5:00PM.
  • The Confederation of British Industry’s Realised Sales will be released this Friday. Current projections suggest a reading of 32 for November following a print of 30 in October.

 

EUR

EUR/USD continued to drift lower last week, falling 1.50% as rising Coronavirus cases prove to be a major headwind for Euro strength heading into the winter. GBP/EUR exhibited a similar move, rising 1.60% on the week. Covid case numbers appear to be accelerating throughout Europe, with Germany declaring this wave as a national emergency, making further restrictions seem inevitable. This could lead to elongated economic recovery timelines for countries on the continent, keeping monetary policy dovish for longer and making the Euro outlook much more bearish. President of the European Central Bank Christine Lagarde also clarified last week that the conditions to raise interest rates are unlikely to be met next year, identifying supply-side issues as the driver of inflation. 

  • The Eurozone flash Manufacturing and Services PMIs are scheduled for release tomorrow and are predicted to come in at 57.2 and 53.6 for November after printing at 58.3 and 54.6 last month.
  • German flash Manufacturing and Services PMI’s are also due tomorrow, with readings of 56.6 and 51.4 expected this month following 57.8 and 52.4 previously.
  • German ifo Business Climate data will be published on Wednesday; forecasts indicate a 96.8 reading for November versus 97.7 in October.
  • ECB President Christine Lagarde will be speaking on Thursday and Friday.

 

USD

US Dollar strength was maintained last week; the DXY climbed 1.10% and is up around 7.00% year to date. In the past few days, Vice-Chairman of the Federal Reserve Richard Clarida has suggested that the pace of the Fed’s bond-buying taper could be accelerated to tame inflation, with discussions expected in the December meeting. A more pressing focus for markets in the coming days will be President Joe Biden’s decision on who will lead the Fed going forward. Market consensus is leaning towards the maintenance of the status quo with Jerome Powell holding onto the hot seat, but Governor Lael Brainard is in contention. It’s thought she could bring a more dovish monetary policy stance which could see a looser taper and slower rate hikes.

  • The US flash Manufacturing and Services PMIs will be released tomorrow and are forecast at 59.0 and 59.1, respectively, versus last month’s 58.4 and 58.7 reading.
  • Preliminary Gross Domestic Product q/q is projected to come in at 2.20% for Q3 2021 versus the initial 2.00% estimate.
  • The Core Personal Consumption Expenditures Price Index m/m figure for October will be released on Wednesday and is expected to come in at 0.40%. This follows a reading of 0.20% in September.
  • The latest Federal Open Market Committee Meeting Minutes will take place on Wednesday at 7:00PM.
  • The US markets will be closed this Thursday for Thanksgiving.

 

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