FX Matters December 2021 | Article – HSBC VisionGo

Fed’s hawkish pivot, BOE’s hike, China’s RRR and LPR cut
Finance  ·    ·  20 mins read

  • Fed December dot plot signals three 25bp rate hikes in 2022
  • The BOE delivers surprise 15bp rate hike to 0.25%
  • The PBOC implements a broad-based RRR reduction of 0.5%; China’s 1-year loan prime rate (LPR) is lowered by 5bp to 3.8%

Summary – Fed gearing up for 2022

The US Dollar Index (DXY) fell 0.3%[1] in December but ended 2021 up 6.4% at 95.67. On 3 December, US non-farm payrolls for November disappointed with a 210k gain, far below expectations for 550k. Meanwhile, the unemployment rate fell to 4.2%, beating expectations. Nonetheless, the USD was unfazed. The currency dipped slightly after US CPI for November surged 6.8% from a year earlier, the fastest annual pace in nearly 40 years. That said, a hawkish pivot by the Federal Reserve (Fed), which announced a doubling of the taper pace to USD30bn per month during the 15 December Federal Open Market Committee (FOMC) meeting, alongside signalling three 25bp hikes in 2022 in the December “dot plot” (i.e., interest rate projections, but the projections are not a policy commitment rather they reflect the personal views of policy makers), boosted the USD. Towards the end of the month, hawkish comments from Fed Governor Christopher Waller, who said the first rate hike could come as early as March, carried the USD higher.

The EUR traded in a tight range in December, remaining between 1.1220 and 1.1390 through the entire month. That said, the EUR did experience notable intraday volatility, driven by monetary policy developments at the European Central Bank (ECB) and the Fed alongside swings in broader risk appetite. On 16 December, the ECB delivered a slightly hawkish surprise, announcing that when it eventually ends its pandemic emergency purchase programme (PEPP)[2], it would only increase the asset purchase programme (APP)[3] to around EUR40bn per month. EUR-USD rallied to 1.1360 on the day but firmed gradually near the end of the month amid a recovery in risk appetite.

In contrast, the GBP climbed 1.8% against the USD in December, aided by a hawkish surprise from the Bank of England (BOE), which unexpectedly hiked the bank rate by 15bp on 16 December after data showed UK November headline CPI rose to 5.1% from a year ago, the highest level in a decade. Despite a disappointing downward revision to Q3 GDP (from 1.3% to 1.1% QoQ), the GBP was buoyed by improving sentiment towards the end of the month as concerns over the pandemic waned and the UK government ruled out further restrictions during the holiday period.

Elsewhere: Brent rebounds and the TRY crashes

Oil prices rallied 10.2% in December, recouping some of its losses from November, even as news surrounding the widening spread of the Omicron variant weighed on oil’s demand outlook. That said, Brent crude finished 2021 up 50.2%, for the largest annual gain since 2009, driven by a recovery in oil demand. Similarly, gold prices also trended slightly higher in December, gaining 3.1% following losses in the month prior. The precious metal received support from Omicron variant fears, geopolitical risks, and bouts of broad USD weakness but relatively firm yields helped cap gains. The TRY faced extreme depreciation pressures as the Central Bank of the Republic of Turkey (CBRT) cut rates further. USD-TRY rose from just below 13.0 at the start of the month to peak at over 18.0 on 20 December, before retracing the move.

[1] This report uses Bloomberg prices.
[2] The PEPP, a temporary asset purchase programme of private and public sector securities, is a non-standard monetary policy measure initiated in March 2020 to counter the serious risks to the monetary policy transmission mechanism and the outlook for the euro area posed by the COVID-19 outbreak.
[3] The APP is part of a package of non-standard monetary policy measures that also includes targeted long-term refinancing operations, and which was initiated in mid-2014 to support the monetary policy transmission mechanism and provide the amount of policy accommodation needed to ensure price stability.

US: Little changed on changes

The DXY mostly traded sideways during December to end 2021 at 95.67, up 6.4% in 2021. On 3 December, the US once again averted a government shutdown after the Senate passed a stopgap spending bill, which would provide temporary government funding until 18 February 2022. Meanwhile, US non-farm payrolls for November disappointed, registering a 210k increase against expectations for 550k. That said, the unemployment rate was better than expected and fell to 4.2% in November from 4.6% in the month prior. Despite the raft of news, the DXY remained unfazed and ended the day almost flat.

Thereafter, the USD continued to edge higher, before pulling back 0.5% on 8 December, amid EUR short covering as European yields climbed. Price action remained choppy as markets likely awaited the 15 December FOMC meeting. On 10 December, US November CPI rose 6.8% from a year ago, the fastest annual pace in nearly 40 years. However, 2-year US Treasury yields cooled, as the CPI data matched expectations. The DXY dropped 0.2% and US stocks rallied.

On 15 December, in a hawkish pivot, the Fed announced it would double the pace of tapering to USD30bn a month from mid-January and dropped “transitory” from its statement regarding inflation. The new taper pace puts asset purchases on track to conclude by March 2022, rather than mid-year as originally planned. The median dot plot also signalled the FOMC expects three 25bp hikes in 2022, compared to the one hike projected in the September dots. The new projections implied the policy rate would reach 0.875% in 2022 and 1.625% by 2023. The DXY jumped 0.4%, testing its year-to-date high, but it later reversed these gains amid a rebound in US shares after Fed Chair Jerome Powell said the US economy could “handle” the Omicron variant.

The DXY fell 0.5% the next day as US Treasury yields slipped after it was revealed the US had imposed sanctions on several Chinese entities over biometric surveillance, sparking risk-off sentiment. That said, these losses were quickly pared the day after, as the DXY jumped 0.5% following Fed Governor Christopher Waller’s comment that March would be a “live meeting” for the first Fed rate hike. Thereafter, the DXY stabilised between 95.4 and 96.8 heading into the end of 2021.

Eurozone: A mirage

The EUR traded in a tight range in December and ended the month up a paltry 0.3% against the USD. EUR-USD mostly stayed between 1.1220 and 1.1360 through December, although this meagre 1.2% range did hide a lot of intraday volatility, as the EUR was driven by a range of forces such as monetary policy developments at the ECB and the Fed, and the broader risk environment.

EUR-USD started the month at the highs of around 1.1360 but softened in the first week as German retail sales for October were extremely disappointing (-4.1% YoY versus -1.7% expected) and regional PMIs broadly softened versus the flash readings. The EUR did get some brief respite from a softer-than-expected US non-farm payrolls print, which saw the USD weaken, but the trend lower in EUR-USD persisted, falling to 1.1228 on 7 December. The following day saw a sharp rebound higher, however, with the pair jumping back above 1.13 on what appeared to be a squeeze of short EUR positions, with little obvious news flow or data on the day catalysing the move.

The EUR then weakened again, with a 40-year record US CPI print on 10 December pushing the EUR lower ahead of the Fed meeting on 15 December and the ECB meeting on 16 December. The initial reaction to the hawkish Fed outcome saw EUR-USD fall to the monthly low of 1.1222. Although the weakness was short-lived, EUR-USD ended the day closer to 1.13, as positive sentiment from Fed Chair Jerome Powell’s comments about the economy overshadowed the faster pace of tapering and expected rate hikes. The next day the ECB also delivered a slightly hawkish surprise, announcing that when its temporary PEPP ends, it would only increase its APP to around EUR40bn per month. ECB President Christine Lagarde also noted upside risks to inflation. This saw EUR-USD rally to 1.1360. However, the next day the EUR gave up all of those gains and fell back to 1.1240, after Fed Governor Christopher Waller said the first Fed rate hike could come in March. The ECB, meanwhile, had been guiding that hikes were still unlikely in 2022.

Thereafter, the EUR firmed more gradually near the end of the month, as risk appetite returned to markets and fears around the severity of the Omicron COVID-19 variant started to wane. This saw the USD weaken and helped buoy the EUR to some extent.

UK: BOE shocks markets

The GBP rose 1.8% against the USD in December and was the third best G10 FX performer over the month. The GBP was supported by the BOE’s surprise 15bp rate hike on 16 December. Global risk sentiment broadly recovered into the end of the month as fears about the severity of the Omicron COVID-19 variant dissipated and the UK government ruled out imposing any further restrictions during the holiday period, helping buoy the GBP.

The GBP started off the month largely on the back foot as the USD strengthened and concerns rose around the rapid spread of COVID-19 in the UK. Data-wise, UK PMIs for November were revised marginally lower on both 1 December and 3 December, while monthly GDP and industrial production for October both surprised to the downside on 10 December. However, from this point onwards, the GBP started to strengthen as the data going into the BOE’s December meeting proved punchier. UK October employment data and November CPI data released on 14 December and 15 December, respectively, which suggested that the BOE might need to tighten.UK headline CPI for November surged 5.1% from a year ago, the highest in a decade, and core inflation for November also reached 4.0%, its highest level in nearly 30 years.

On 16 December, the BOE surprised the consensus, which had mostly expected an unchanged rate decision, by hiking the bank rate by 15bp to 0.25%. This saw GBP-USD spike from around 1.3260 to roughly 1.3375. However, the GBP did not sustain this strength, despite BOE Chief Economist Huw Pill’s comments on 17 December that he was uncomfortable with the inflation readings and that more rate hikes could be coming. Broad USD strength and risk-off sentiment as COVID-19 cases continued to climb saw GBP-USD drop below 1.32 again before a rebound late into the month. Despite a disappointing downward revision to Q3 GDP (from 1.3% to 1.1% QoQ) on 20 December, the GBP was able to benefit from improving sentiment about the apparently lower severity of the Omicron variant, and the UK government’s decision not to impose greater restrictions over the Christmas holiday period. This saw GBP-USD push above 1.34 again on 23 December and consolidate around this level before advancing towards 1.35 in the final days of the month as the DXY turned lower.

Japan: Another poor performance

The JPY was the worst performing G10 currency in December and fell 1.7% against the USD. December saw a slow but steady grind higher in USD-JPY, with the overall direction driven mainly by risk appetite and broader USD resilience. Early in December, the JPY managed to make some small gains amid “safe haven” buying, as COVID-19 fears and concerns some Chinese companies may be delisted in the US, eroded risk sentiment. However, after data on 6 December revealed the Omicron variant had not led to a surge in hospitalisations, COVID-19 fears eased, and the JPY fell 0.6% against the USD.

Towards the end of December, improving risk appetite, higher US Treasury yields, and rising US share prices weighed on the JPY. USD-JPY broke above 114 on 21 December and the JPY weakened more notably versus the commodity-linked G10 currencies. Meanwhile, domestic data painted a more upbeat picture. Core machine orders for October rose 3.8% from a month ago, beating expectations of 1.8%, and industrial production for November surged 7.2% from a month ago, higher than expectations of 4.8%.

China: Jumping back to 2018

The CNY rallied to a three-year high against the USD in December but ultimately ended the month up just 0.1% against the USD. On 8 December, the CNY advanced 0.3% against the USD, nearing its May 2018 highs the following day. The currency’s climb was aided by upbeat risk sentiment as pandemic concerns receded and a boost in optimism over China’s growth outlook following the announcement of the People Bank of China (PBOC) on 6 December that it would implement a broad-based cut in banks’ reserve requirement rate (RRR) of 0.5%, effective from 15 December.

That said, the central bank signalled its discomfort with the CNY’s advance on 9 December by setting the reference rate at a weaker-than-expected level and implementing banks’ foreign exchange measures. According to the PBOC’s announcement, the reserve requirement ratio on foreign exchange deposits at financial institutions would be increased from 7% to 9%, effective from 15 December. USD-CNY jumped 0.5% after the fixing to back above 6.37.

USD-CNY mostly traded around 6.37 for the remainder of the month, despite briefly climbing above 6.38 on 17 December amid broad USD strength. On 20 December, China’s 1-year loan prime rate (LPR) was set at 3.80% versus 3.85% in November, the first reduction since April 2020, according to a statement from PBOC on 20 December. The 5-year LPR, a reference for mortgages, was unchanged at 4.65%.

However, on 31 December, a jump in China’s overnight repo rate by 83bp (i.e., higher overnight borrowing costs) amid a surge in cash demand at month-end saw the CNY rally to a three-year high, as USD-CNY briefly touched 6.34, before the CNY pared some of its gains to end 2021 up 2.6% against the USD.

On the domestic data front, China’s factory inflation moderated in November from a 26-year high, with producer price index (PPI) rising 12.9% from a year earlier, above consensus expectations of a 12.1% gain. CPI sped up and rose 2.3% for the fastest pace since August 2020. Early signs that price pressures have begun to abate and may give the PBOC more room to add further stimulus, if the trend continues to bolster sentiment around China’s growth outlook. Exports for November also jumped, up 22% from a year earlier, whilst imports surged 32% from a year earlier, both beating expectations as external demand soared ahead of the holiday season.

Canada: Coming in first against the USD in 2021

The CAD rose just 1.1% against the USD in December but outperformed its G10 peers in 2021. It was the only currency to rise against a broadly stronger greenback and ended 2021 up 0.7%. On 6 December, the CAD rose 0.7% against the USD as oil prices pushed higher. The CAD climbed a further 0.9% the next day, alongside a rebound in risk appetite as pandemic fears receded, which boosted commodity prices. With the unemployment rate for November close to pre-pandemic levels, around 6%, and annual inflation for November at a two-decade high of 4.7%, markets were anticipating at least one rate hike by March 2022.

However, the Bank of Canada (BOC) pushed back against market expectations during its meeting on 8 December, reiterating a rate lift-off is not to be expected until the “middle quarters” of 2022. The BOC held the policy rate at 0.25%, in line with expectations and highlighted labour market strength alongside concerns that persistently elevated inflation was bolstering expectations for imminent rate hikes. USD-CAD ended the day little changed. The BOC later renewed its flexible inflation-targeting mandate on 13 December, which suggested a little more emphasis on employment and could encourage patience towards policy tightening in the short term. Towards the end of December, a broad recovery in global risk appetite and a rally in oil prices supported the CAD, which saw USD-CAD slide lower to end 2021 at 1.2637.

New Zealand and Australia: AUD back on top

The NZD was basically flat against the USD in December. On 3 December, Omicron variant cases were confirmed in six US states, sparking risk-off sentiment over the variant’s widening spread. Meanwhile, New Zealand business and consumer confidence for November declined further, as lockdowns took their toll. That day saw NZD-USD fall 1.0% for its worst one-day performance in December. However, risk appetite took a sharp U-turn on 7 December after initial data suggested Omicron infection cases were relatively more mild, easing concerns. The NZD climbed 0.6% against the USD alongside other “risk-on” G10 currencies. On 15 December, New Zealand GDP for Q3 was not as bad as feared by consensus, falling just 0.3% in the quarter, versus a decline of 1.4% expected by the economists surveyed by Bloomberg. However, some of the confidence data released later in December showed a decline in local sentiment. The second half of December saw the NZD oscillate as post-Fed USD strength and softer commodity prices weighed on risk sentiment, but some concerns about the severity of the Omicron variant waned.

The AUD started December on the back foot as rising 2-year US Treasury yields and softer global equity markets saw the currency fall 1.5% on 3 December to a one-year low of 0.699, briefly breaching the key 0.70 support level before recovering some ground. On 7 December, the Reserve Bank of Australia (RBA) stood pat on rates and left its QE programme unchanged at AUD4bn per week until mid-February 2022, in line with expectations. AUD-USD advanced 0.4% alongside a rise in Australian bond yields after RBA Governor Lowe said the Omicron variant was not expected to “derail the recovery”. AUD-USD rose 1.0% and climbed a further 0.7% the next day amid broad USD weakness. On 16 December, after November employment data beat estimates of 200k at 366k, AUD-USD initially climbed alongside Australian 3-year yields but later pared these gains amid broad USD strength following Fed Governor Waller’s comments about a potential rate hike in March. That said, the currency finished the month as the second best G10 performer, having risen 1.9% against the USD.

Norway and Sweden: Neighbouring opposites

The SEK was the runner-up G10 underperformer in December and slid 0.3% over the course of the month. Price action for the SEK was choppy throughout December, with EUR-SEK fluctuating between 10.20 and 10.35, as it tracked changes in risk appetite and the broad USD, with the pair ending the month close to the highs of 2021. The SEK was not immune to the downturn in risk appetite at the start of the month and fell 1.0% against the USD on 3 December, as Omicron variant concerns intensified. On 15 December, the SEK pared some losses as it rose 0.7% on broad USD weakness after the greenback reversed its post-Fed gains amid a rally in US stocks. However, these gains were short-lived as the USD turned higher on 17 December after Fed Governor Waller’s hint of a rate hike in March. Towards the end of the month, as pandemic woes eased, broad risk sentiment began to recover, which buoyed the SEK alongside broad USD weakness. CPI inflation continued to accelerate in November, beating expectations at 3.3% from a year earlier, up from 2.8% in October. Retail sales for November also improved, rising 0.9% from a month ago, after increasing 0.4% in the month prior.

In contrast, the NOK was the best performing currency in the G10 sphere in December and rose 2.4% against the USD and 2.2% against the EUR. The currency staged an impressive three-day rally from 6 December to 8 December, climbing 3.4% against the USD, as risk-on sentiment swept through markets and oil prices bounced back after a sharp fall in late November. However, broad USD strength on 9 December sent the NOK tumbling 1.2%. The NOK retraced some of its gains amid a rise in US Treasury yields, while stocks and commodities weakened. Towards the end of the month, the NOK continued to rally against the USD, as risk sentiment recovered amid easing fears around the Omicron variant, which bolstered commodity prices and global equities. On the domestic front, headline CPI for November surged to 5.1% from a year ago, exceeding expectations for 4.6%, while the unemployment rate matched forecasts at 2.2% for December. The Norges Bank also hiked the deposit rate by 25bp to 0.50%, which was widely expected. However, it left the path of its projected future rate hikes somewhat unchanged, making it harder for the NOK to rally purely on shifting monetary policy expectations.

Turkey: Flash crash to record lows

USD-TRY fell 1.3% in December, but this monthly figure obscures the volatile moves in the Turkish lira. During the first half of the month, USD-TRY was fairly stable and mostly traded sideways just below 14.00. However, between 14 December and 20 December, USD-TRY rose 33.0% to hit a peak at 18.36. The move was largely driven by loose monetary policy, with the CBRT cutting interest rates against a backdrop of still-elevated inflation and swifter Fed tightening expectations. After the TRY reached a new record low on 20 December, when USD-TRY hit 18.36, the TRY reversed its losses the next day and strengthened sharply as USD-TRY fell from over 18.0 to below 12.0 in one swift move. This swing followed the government’s announcement of new FX-linked TRY deposits, which could be protected against sizeable TRY depreciation. If the percentage move up in USD-TRY were to exceed the interest paid on TRY deposits, the Turkish Treasury has indicated it will compensate the depositor. The TRY continued to strengthen over the subsequent days, with USD-TRY dipping back below 12.0, before ending 2021 with USD-TRY at 13.304.

Oil: Run, Brent, run

Brent crude managed to recoup some of its losses from the previous month in December as oil prices rallied 10.2%. On 6 December, oil prices jumped 4.6% as Omicron variant-related demand fears subsided after reports showed symptoms were milder than anticipated. Crude prices were further buoyed as prospects for an increase in Iranian oil exports diminished after US-Iran talks faltered. The rally continued the next day as oil prices climbed a further 3.2%, amid easing pandemic fears and a boost to risk appetite from a surprise RRR cut by the PBOC. Thereafter, oil prices mostly traded sideways before pulling back 2% on 17 December as they dipped below USD74 per barrel. This came amid growing concerns over the impact on oil’s demand outlook from the Omicron variant – daily cases hit record levels in the UK, for example – and tighter monetary policy following a hawkish Fed and surprise BOE rate hike earlier in the week. Crude prices tumbled further on 20 December as the rapid spread of the Omicron variant led some countries to impose new lockdowns and travel restrictions, heightening demand fears. However, towards the end of December, oil recovered above USD78 per barrel, boosted by a decline in US crude inventories, while stronger-than-expected new home sales and consumer confidence data in the US blunted pandemic concerns.

Gold: Limited upside

Gold prices trended slightly higher in December, making up for some of the losses in November. Gold started the month at USD1,771 per ounce, finishing up 3.1% around USD1,829 per ounce. Gold received support from a slightly weaker USD but relatively firm US Treasury yields capped gains. Gold gained on inflation concerns as US November CPI data showed prices had risen at the fastest annual pace since 1982. Gold also absorbed a hawkish FOMC, including the doubling of the taper pace to USD30bn and higher rate hike expectations (implied by “dot plot”) without weakening, but much of this may already have been anticipated by the market. Gold received additional aid from Omicron variant fears, which boosted “safe haven” demand. Physical demand notably from India and to a lesser degree China also recovered and complemented generally strong retail coin and small bar demand in western markets. Geopolitical risks, including frictions over Ukraine and US-China relations, lent indirect support to gold as well. However, institutional demand remained notably weak, evidenced by ongoing leakage out of gold exchange traded funds (ETFs). Trading volume dropped noticeably towards the end of 2021, which raised volatility as gold prices trended towards USD1,829 per ounce.

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