Morning Brief – 14 Days

14 Days

Bond yields and commodities continue to climb higher at a rapid pace. Commodity indices have now surpassed pre-pandemic levels amidst expectations of inflation around the corner. Commodities in particular are benefitting from analysts’ predictions that the restoration of pre-pandemic demand will outpace supply normalisation in the short-run. The ECB President moved yesterday to caution the market that her Bank was closely monitoring rising borrowing costs in the Eurozone. The bond and Euro market only reacted with a modest deviation in their trajectories, resolved to continue their respective paths higher. The longer run implications of steeper yield curves and economic growth look relatively certain given the inevitable bounce back from the pandemic in H2’21. But with Biden’s $1.9tn stimulus plan expected to be subjected to lawmakers’ votes as early as this week, what could the next two weeks hold in store for markets.

So far this year the worst performing currencies have been those of South America. Ranging from -6 to -4% on the year, the Argentine Colombian and Mexican pesos join the Brazilian Real as the worst performing currencies of the year. With limited or no vaccination schedules in place and monetary easing expected to follow, there is little evidence to present to suggest this trend will unwind anytime soon. The best performing currencies are those with strong pandemic responses and often in the cyclical commodity currency space. The best performers so far this year are TRY, GBP, AUD, NZD, NOK all with a considerable exposure to commodity prices. The Lira is the odd one out thanks to stubborn interest rates providing one of the only positive and significant real yields at the currency level on the planet. There is scope particularly in TRY and GBP for progress to be unwound given the fragile sentiment surrounding these currencies, but in the best performers too it seems the trend of higher yield, high beta and cyclical currency outperformance should continue.

The big story to watch out for over the comings days and short number of weeks is going to be how the market digests the outcome of the push to pass 1.9tn Dollars of stimulus program over the line. As with recent large fiscal stimulus measures, the sudden flood of new cash in such large volumes into the pool of USD should, by the simple laws of supply and demand, cause its price to fall. In the case of the Dollar especially, given its reserve and safehaven status, the extra fiscal push towards economic restoration and the positive global stillover of the stimulus in terms of trade and investment could release further defensive Dollar demand. In the run up to the vote expect an inverse correlation between the Dollar and the markets perception of the likelihood of the bill passing. The more likely Biden’s bumper fiscal spending plan looks, the weaker the Dollar should trend. This in turn should give space for emerging and commodity currencies to expand into.

However, what we could see if the mega stimulus plan gets voted through is potential reversal of this trend in a quasi-buy the rumour sell the news event. Subject to how the fixed income market reacts, if the passing of the bill triggers yet another sell off in US treasuries and the yield climbs even higher in the medium and long dated end of the curve, the reward could attract investors and hot money back to the Dollar. Over the next two weeks therefore, subject to the passing of the stimulus bill, it is going to be critical to monitor other markets’ interpretation of the fiscal package to determine the net result on the US Dollar. Certainly discussions overnight regarding how the US intends to fund the fiscal spending through higher corporate taxation and safe havens could encourage a deterioration of the capital account to the detriment of the Dollar also.

Discussion and Analysis by Charles Porter

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