Market sentiment has been hit by the news that a new COVID variant was spreading in Southern Africa. While we await more information on the new strain, the oversold JPY was getting a major lift and pro-cyclical currencies were dropping.
USD: All focus on the new strain
Thursday's closure of the US markets for Thanksgiving caused most FX pairs to trade within very tight ranges. On Friday, markets reopened, but only for half a day.
The general environment in FX remained quite supportive for the dollar, as the FOMC minutes and a bunch of good data kept market speculation on faster tapering and earlier tightening alive. On top of this, the worsening contagion situation in Europe and risk of fresh containment measures were generating further divergence in policy expectations between the ECB and Fed.
Into the weekend, we saw the highly oversold yen gain nearly 1% against the dollar while pro-cyclical currencies followed global stocks lower after the concerning news about a new COVID variant that appeared to have the biggest mutation seen so far. The most notable previous COVID variants proved, in general, to be also more transmissible and more lethal than the first strain, and scientists were attempting to evaluate whether this was the case as well. At a very early stage, the evidence seemed quite concerning.
The variant has been identified primarily in South Africa, and multiple countries were rapidly blocking all flights to the country, as well as other African nations. The rand was unsurprisingly a major underperformer, having dropped to one-year lows and still looking quite vulnerable.
More information on the variant will be needed, but it looked like it was indeed going to be a very “black” Friday for global risk sentiment. JPY and CHF should remain a favorite choice as safe-haven hedges above the dollar, which should, however, remain supported against all the pro-cyclical bloc. NOK, AUD and NZD appear particularly at risk.
EUR: Holding above 1.1200 for now
The COVID crisis in Europe deepened this past week, as rising cases across the continent saw another low-vaccination country—Slovakia—announce a full lockdown. The key question remains whether the highly immunized countries like France, Italy, and Spain will manage to weather this virus wave without ultra-strict measures.
For now, the approach has mostly been focused on applying tougher restrictions on non-vaccinated individuals and speeding up the rollout of third doses, although discussions about potential restrictions around Christmas were mounting in local governments.
We see the euro as still vulnerable due to the COVID situation in Europe which, as highlighted above, was further widening US-EZ rate expectations. Given weekend developments, a major question was whether the new variant has already reached Europe (which is geographically closer to Africa). This could deal another blow to EZ sentiment and the EUR, which otherwise seemed to have marginally benefited from its low-yielding status as the new variant shook markets and may hold above 1.1200 through the weekend.
We heard some ECB members this week indicating that PEPP will end in March. Still, the EUR has been quite unreactive to policy comments with most of the focus on the current COVID-related re-rating of EC growth expectations.
GBP: Is the UK more exposed to the new variant?
The UK rapidly imposed restrictions on flights from some African countries on Friday as the new variant started to cause major concerns. London is naturally highly exposed to new strains given its high volume of travelers, and markets will be on the lookout in the coming days for any evidence the new variant has already reached UK , with obvious downside risks for the pound.
For now, EUR/GBP has moved higher and may remain supported, mainly due to the pound’s higher sensitivity to risk sentiment than the EUR, but also as the story of EU-UK divergence in terms of severity of the virus situation is inevitably being challenged by the new variant.
On Thursday, Governor Andrew Bailey claimed that that rate guidance was “hazardous” for central banks, and it seemed likely that the Bank was trying to steer away from the kind of misleading communication we saw in the run-up to the November meeting.
We remain in the view that the BoE will hike on 16 December, which should ultimately put a floor under GBP into year-end—barring a material deterioration of the COVID situation in the UK.
SEK: External factors simply matter more than the Riksbank now
Thursday, the Riksbank took two tentative steps to tightening—first, by introducing a hike in its rate forecasts (a 20bp increase in 2024), then by signaling they could start shrinking the size of their balance sheet in 2023. Given the previous reluctance of the Bank to signal any kind of tightening in the forecast horizon, the move was a hawkish surprise even if it did not come anywhere close to the market’s tightening bets, which are now for 40bp in 2022 and 40bp more in 2024.
The impact on SEK proved quite contained and short-lived, which was not too surprising considering that: a) there was no real room for further tightening being priced in; b) external factors seem to matter more for the krona now.
Despite Sweden not suffering from a particular spike in cases, SEK is highly sensitive to global risk sentiment and in particular, the eurozone’s growth expectations (as most of Sweden’s exports are intra-EU). External drivers should remain dominant for SEK in the coming weeks and the risk is that—despite the krona having a positive seasonality in December—we could see a EZ growth re-rating capping the recovery.
We are currently forecasting 10.00 at the end of December, but given the worsening of the virus situation in Europe this is increasingly looking too optimistic for SEK.
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