Morning Brief – Confused valuations

Confused valuations

I haven’t forgotten about Covid-19, how could I? But it has come in second place with respect to currency valuations in recent weeks. At least ahead of last week’s series of key central bank policy announcements, the key determinant in currency movements was monetary policy. What is surprising in today’s market is that it is apparent that the market has disregarded the surprising and pivotal announcements made by respective central banks. What markets were expecting to see on the back of last week’s announcements has largely not played out and in some cases, the very opposite has happened. So what is going on, and are prices or analysts wrong?

So what were markets expecting? Moving into the Fed decision, markets were looking for the pace of tapering to speed up to conclude the current asset purchase program sooner. In line with the sooner conclusion of tapering, markets were expecting the Fed to in turn forecast for its committee to deliver two rate hikes in 2022 via its closely watched dot plot. Any more than that would be seen as hawkish and benefit the Dollar, any less and the Dollar should face headwind. In the eurozone by contrast, the centre of attention was whether the ECB dropped language on transitory inflation and what their inflation forecasts over the next two years looked like. In the UK, the Bank of England’s previously foregone conclusion of a rate hike in the December meeting had been priced out with most participants looking for no hike at the December meeting.

What did they get? Well the Fed alluded to a more hawkish three hikes in 2022 and 2023. This was previously expected to send USD higher. The ECB didn’t drop language surrounding transitory inflation and kept low inflation (and growth) forecasts for the years ahead. This was a dovish decision that traders had expected to weaken the Euro. Lastly, the Bank of England did surprise with an unexpected hike taking interest rates back up to 0.25%. According to market opinions moving into the events, we should have expected to see as we open this week a stronger Dollar and GBP, versus a weaker Euro.

What do we see? Exactly the opposite. Hmm… Never fear, there is an explanation, for now at least. For this week of light traded volumes and liquidity ahead of Christmas and New Year, market positioning plays a significant factor in creating noise in markets. The impact on GBP from the surprise rate hike can be somewhat explained away with the developments in the UK’s covid backdrop and policy response. However, EURUSD must come down to year-end positioning and a market that was longer of Dollars and shorter of Euros than previously believed. It is likely therefore that a delayed fuse from last week’s fireworks is to blame for the confused valuations in markets.

Discussion and Analysis by Charles Porter

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