Monthly Update: October 2021
“This quarter was characterised by the panic surrounding energy prices, with inflation concerns also putting global growth into question. This led to market participants pricing for aggressive rate increases across the G10, with the US no longer as unique in terms of rate hike expectations. The Fed is still expected to announce tapering of its bond stimulus program in November but will likely stay away from higher rates for now.”
Sam Cornford, Partner & Head of Trading
Towards the end of October, a flurry of activity in the Senate made headlines. Democratic senators tried to impose a 15% corporation tax on companies reported profits over $1bn, before the proposal collapsed due to jostling over the politicisation of major legislation. Changes to the $2trn social Spending and Climate Bill as well as $3.5trn Infrastructure Bill are likely to continue as negotiations have embroiled and halted President Biden’s key legislative instruments. The President is adamant to raise taxes on corporate America but it may come at a cost to both the Infrastructure Bill and the Spending and Climate Bill. Through the middle of October, supply bottlenecks and labour shortages drove up the costs of shale production and the prices of crude oil, adding to inflationary pressure throughout the economy. US lawmakers reached an agreement on a debt ceiling, extending the government’s borrowing limit until December to stabilise the economy and refocus their efforts on passing President Biden’s economic agenda.
October saw Boris Johnson’s government lay policy foundations for the long-term. The month started at the Conservative Party conference, where the Government detailed plans for “Levelling Up” to build a high wage, high skill, high productivity economy across the country. UK Chancellor Rishi Sunak had a busy end to the month, using his third budget to invest in public services, increasing total departmental spending by £150bn by 2024-2025. As the UK economy looks to recover from Covid-19, taxes will reach the highest level since 1950, inflation is likely to stay between 4 and 5%, and the government has introduced a fiscal charter to curb unwarranted borrowing and shrink public debt. Throughout the month, London and Brussels have been moving towards a trade war in the absence of compromise over the Northern Ireland Protocol. EU Member States threatened retaliatory measures such as blocking access to energy in Europe, imposing tariffs, and terminating the UK-EU trade agreement. Earlier in the month, the Government took 47 countries off the “red list” for travel, freeing up travel for British citizens.
Compared to a month ago, sterling is higher against the dollar and the euro. Having dropped 2.5% in last quarter, sterling started the month poorly, weighed by worries about a hawkish sounding Bank of England, despite the unfolding supply chain crisis. The pound then became firmer on growing expectations that the BoE could raise interest rates to curb stubbornly high inflation. As a result, the markets have already priced in rate rises by the time the central bank’s governor Andrew Bailey remarked that it “will have to act” in response in the third week of October. Surprisingly, figures then showed that British inflation slowed in September, but that did little to change expectations that the BoE will become the world’s first major central bank to raise rates, especially since the severe labour shortages were here to stay. The unleashing of the high-spending budget at the end of the month led to a slight dip in the pound.
The euro is mostly unchanged against the dollar and weaker against the pound than it was a month ago. The single currency started October on a weak footing, touching its lowest levels since July 2020, with concerns over gas shortages spilling onto currency markets. The low-interest euro continued a downward crawl throughout the month, as problems persisted and policymakers repeatedly reaffirmed the appropriateness of an accommodative stance. Market estimates of projected inflation have increasingly been at odds with the European Central Bank’s guidance. Christine Lagarde, who has been facing a dilemma of having to acknowledge higher inflation without committing to policy changes, said that “inflation is largely transitory” after her IMF lecture. German business sentiment came out softer-than-expected in the last week of October, and the German government cut its 2021 growth forecast. At a policy meeting in the end of the month, Lagarde’s comments went against the market expectations, not being assertive enough in their reaffirmation of the central bank’s dovish stance.
The dollar is lower against sterling and unchanged against the Euro, compared to the previous month. The greenback began the last quarter near its highest levels this year, supported by a spike in Treasury yields, caused by the expectations of tighter monetary policy. The surging energy prices fuelled fears of stagflation, hastening the Federal Reserve to taper bond purchases sooner. Even soft payrolls figures – which has recently been the Fed’s main focus – did little to alter market expectations in the second week of October. In the middle of the month, US inflation data surpassed expectations, thus showing signs of being more persistent that transitory, weaning the dollar off one-year highs. This made the markets rethink the priced-in date for a rate hike from December 2022 towards November of that year. The dollar dipped further after data showed a fall in US homebuilding amid acute shortages of raw materials and labour. A jump in commodity prices improved the risk sentiment, further chipping away at demand for the safe-haven dollar.
The Canadian Dollar is lower against the US Dollar and the Euro, with a clear drop from September to October. Inflation is at its highest rate for almost two decades, complicating the Bank of Canada’s monetary policy plans to keep interest rates pinned near zero well into 2022. Pressure on prices will likely keep inflation above the target range through much of next year due to higher energy prices and supply bottlenecks. Governor of the Bank, Tiff Macklem, is expected to take a decision soon on reducing stimulus by halving the government’s weekly bond purchases. Reducing this stimulus combined with an increase in interest rates early in 2022 will help to take the sting out of high-paced inflation which is weakening the “loonie” against major currencies. This appears to be the path the central bank will tread but they will need to do so delicately, having initiated and halted the stimulus program four times since March 2020 to respond to the Covid-19 pandemic. With this in mind, we may be looking to April 2022 at the earliest to see a hike in interest rates. The decision to taper stimulus now comes as vaccination rates remain strong and Canada experiences high economic growth and employment gains.
The Australian Dollar is stable against the US Dollar and lower against the Euro, compared to the previous month. The Australian economy shrank by around 3% in recent months, as the strict public health rules and the Covid-19 pandemic forced businesses and the hospitality sector to curb economic activity. As consumer spending fell rapidly with two-thirds of the population in lockdown since the start of August, the Aussie dollar has weakened against most majors. In parallel, inflation figures jumped quite dramatically due to supply chain shortages boosting oil prices as well as unexpected rises in real estate prices. The result of these two economic movements: stagflation. Persistent high inflation matched with high unemployment or lower productivity caused by lockdowns and stagnant demand has weakened the Aussie dollar against the Euro. This does not come as a major surprise as the currency is counter-cyclical and volatile by nature due to its dependency on the price of commodities, however, the Reserve Bank of Australia is historically conservative and likely to act quickly to curb inflation.
What to look out for
31 October – 12 November: COP26
1 November: European Commission assumes office
3 November: US Fed Interest Rate Decision
3 November: US FOMC Press Conference
4 November: UK BoE Interest Rate Decision
4 November: US Congressional Elections
10-11 November: APEC Leaders’ Summit
11 November: GDP (YoY) (Q3)
12-13 November: ASEAN Summit
15-16 November: G20 Summit
17 November: UK CPI (YoY) (Oct)
17 November: EU CPI (YoY) (Oct)