Currencies and equities sold off sharply on Tuesday after Federal Reserve Chairman Powell said, “It is time to retire the word transitory regarding inflation.” Investors bid up the USD but having sold off before Powell’s announcement, the greenback was unable to turn positive against all of the major currencies.
Tuesday’s announcement is significant because investors have been waiting months for the Fed Chair to admit that high price pressures may linger for longer – something other central bankers have given into. Powell does not see inflation subsiding until the second half of 2022. They will talk about speeding up taper at their next meeting on December 14 and 15. They may even need to consider ending taper a few months sooner than anticipated.
What makes Tuesday’s announcement so important is the timing. The COVID-19 Omicron variant is a serious risk that many scientists are still struggling to understand. As Powell put it, we won’t know more about Omicron for another week to 10 days. The Fed could have easily waited another week before making this significant shift in forward guidance but their decision not to wait is a reflection of how worried they are about price pressures accelerating and how desperately they felt the need to prepare the market for policy change, pace of taper, next month.
Although Powell was quick to add that these assumptions do not include the risk of Omicron variant, which they’ll know more about in a few weeks, it is clear from his comments today that as long as it does not cause new lockdowns in the US, they will normalize monetary policy quicker. Investors can expect upgrades to next month’s inflation forecasts along with more “dots” moving in favor of rate hikes next year.
While the prospect of less stimulus is generally positive for the USD, the combination of weaker economic data and ongoing Omicron concerns will limit its gains. Instead, the Japanese Yen and Swiss Franc should be the biggest beneficiaries of Powell’s comments. Consumer confidence and the Chicago PMI index dropped more than expected in the month of November and with Omicron, we have every reason to believe that sentiment will dampen further.
Traditionally the USD catches a safe haven bid from bad news but instead of rising, the greenback weakened after Moderna’s CEO said it is very likely that current COVID-19 vaccines will be less effective against Omicron COVID variant. The explanation for this counterintuitive move is simple – it is only a matter of time before cases of the Omicron variant are found in the US at which point everyone will begin speculating about the local and national response. Even if new restrictions and lockdowns do not return, consumers could retreat before the holidays, leading to less shopping, cancel trips and reduce other end of year expenditures. The risk to the US economy could be significant which explains why some investors are selling first.
EUR was the best performing currency behind the Japanese Yen and Swiss Franc which is surprising as European nations are the most likely to come down hard with restrictions. There’s already a full lockdown in Austria and Slovakia with partial lockdown in the Netherlands. Belgium and Portugal announced new restrictions while France requires masks for all indoor activities. Pressure is growing for tighter restrictions in Germany. Yet, stronger Eurozone inflation and German labor market numbers kept euro supported and prevented it ending the day lower against the greenback.
Between falling oil prices and a rising USD, the CAD was hit the hardest. Over the past month, the price of crude has fallen from a high of nearly US$85/barrel to a low US$64.45, the first time WTI crude trades below US$65 in 3 months. Omicron has already made its way into Canada with 5 reported cases. While Canadian labor market numbers are expected to improve, the plunge in oil prices combined with the demand for USD should keep loonie under pressure.
On the calendar for Wednesday will be Australia’s third quarter GDP report, revisions to Eurozone and United Kingdom. PMIs, ADP, ISM Manufacturing index and the Federal Reserve’s Beige Book report. While important, these numbers may have limited impact on in light of Powell’s comments, which along with Omicron headlines will continue to drive risk appetite and FX flows.