See the latest Australian dollar analysis here:
Nordea with the note:
We warned back in September how lockdowns would become relevant again within a matter of months despite right about every politician declaring victory against Covid-19. We currently see targeted measures against those who remain unvaccinated across Europe to combat “the pandemic of the unvaccinated”, but these measures are very unlikely to work wonders for the virus spread as studies show that the vaccination-effect on transmission risks wanes quickly three months after the second jab. Maybe a broader booster-jab-strategy will be attempted before the lockdownistas will gain the upper hand and implement broader restrictions during the winter? At least it will be interesting to see what authorities will do when they figure out that scapegoating the few un-vaccinated will NOT change the course of the virus spread.
We remain very sceptical that inflation is about to drop back for the same reason as the pamphlet of political decisions taken through Covid; i) direct transfers, ii) vaccine mandates and iii) restrictions on services consumption (leading to a pick-up in goods consumptions) is very inflationary in nature and we are about to be served MORE of that same cocktail this winter, not less.
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Chart 1. Inflation surprises remain historically high, while economic surprises are negative
Biden meanwhile remains stuck in a tragicomedy at the COP-26 conference as the energy supply crisis is of much bigger urgence than the climate developments. Even Elizabeth Warren and her green ilk have started asking Biden to pump more oil. What a difference a little energy crisis makes.
We remain on #Dragonbear watch (a phrase invented by the tremendous geopolitical watcher Velina Tchakarova) as the timing seems better than ever for China and Russia to launch a coordinated geopolitical conquest. What would the West do currently, if Putin marched towards Donetsk or maybe even Odessa, while Xi Jinping targeted Taipei at the same time?
Putin promised that Russian gas flows would start filling up German underground gas storages from last week and onwards, but the flows remain to be seen at the compressor station at the Polish/German border. Was the market a bit too gullible when it took Putin at face value a few weeks back? Despite Bidens domestic oil-struggles, we find that the energy crisis is a much bigger issue for the currently “leader-less” Germany than for the US.
Chart 2. Russian gas-flows through Poland to Germany are still very subdued
EUR/USD has accordingly recently fallen off a cliff, helped by the “surprise” beat in US inflation. We argued at the start of this year that relative growth, relative inflation and relative central bank policy will favour the dollar – and we firmly stick to this view.. (also, in the xCcy bor/bor basis swap, where we stick to our 2y1y EURUSD xCcy receiver position targeting -25 bps)
The downside to the relative monetary policy argument could be that the Fed is yet to admit to a weakening labour supply, which may make them chase unobtainable higher employment to population ratios through 2022. Scared from recent NAIRU-disasters post the great financial crisis, the Fed may also be (too) late to admitting to a substantially higher NAIRU post Covid.
Chart 3. Higher US core inflation helpful for the USD
While it may seem counter-intuitive that higher inflation will be good news for a currency (from the point of your old economics textbooks), high CPI inflation outcomes – and we continue to expect more of them (more “dumbflation”) – bolster the likelihood of a more hawkish Fed.
The US economy is also much nearer to closing its output gap than the Frankensteinian monster in Europe known as the Euro-area, which will basically never close it gauging from the consensus forecast. Relative output gaps should underpin the relatively hawkish Fed view and ought to be positive for the USD.
Chart 4. US economy much nearer to close its output gap
ECB seem likely to continue to err on the dovish side. Europe will also have to cope with a (worse) energy crisis partly of its own making, component shortages are more likely to be bad news for EA than for the US and China’s slowdown could hit Germany more than the US (not to mention that Russia’s Belarusian minions are threatening the EU with shutting down gas transit).
And if the ECB were to turn hawkish – against our beliefs, a return of the debt crisis can’t be ruled out. The mere risk of material spread widening in peripheral bonds makes it unlikely that the ECB can react to inflation in the same way that the Fed can. The only feasible “hawkish” ECB package is a hike(s) sugar-coated by truckloads of bond buying, which is yet to turn into a scenario that anyone in Europe dares talking openly about. Still 1y1y EUR rates remain positively correlated to 1y1y USD rates, which makes for a tricky environment for the ECB to manoeuvre as 1y1y USD rates are likely going even higher, if we are right in our “dumbflation”-view.
Chart 5. Germany could be hit more than the US from China’s slowing
We have recently gotten partial lockdowns in several EU countries, and this has arguably been EUR-negative (though many clients don’t care – hence the “arguably”). These lockdowns so far primarily involve locking down the Untermensch (the unvaxxed) and implementation of vaccination passports instead of locking down whole swaths of the population. This limits the economic and market take-away’s (in this weekly we won’t mention that the vaccinated carry the same viral load as the unvaccinated, which means that the push towards vaccine passports make no scientific sense whatsoever, at least not unless booster-shots are given to everyone). In Austria the unvaccinated will now be lock-downed, while the vaccinated can carry on almost as usual. This is unlikely to work wonders for the virus spread, but it may lead to extreme political polarization instead.
But as Germany’s Drosten (the “Fauci of Germany”) said in a big interview – perhaps this two-tier system for the citizens won’t be enough, and if not, schools may need to be closed – or more… Even Sweden’s public health agency – which has tread its own path so far – has flagged that new restrictions could be introduced during the winter.
Chart 6. But US case growth started to surge around this time of the year in 2020
We will however note that after the recent (predictable) surges in European & UK case counts, around this time of the year in 2020 the US was ready to take over the viral baton. Last year, northern areas such as the state of New York saw a rapid pick-up of case growth – let’s see what New York governor Hochul and the new Bitcoin mayor of NYC (alas, still de Blasio until 1 Jan) make of that (should that occur).
While Western equities remain in “nothing to see here mode”, Chinese equities have started to showcase bizarre weekly volatility. Last week we highlighted the worst week ever in property-linked equities in China, so let us also highlight the best week ever – namely the last. Despite some unconfirmed uncertainty around whether Evergrande paid due coupons within the 30-day grace period on Wednesday, it seems as if investors received the payments right before the deadline, which has since catapulted property-linked equity higher again.
Chart 7. Up and down, we go in Chinese property linked equity
We have long said that international bond-investors are at high risk of receiving a Chinese middle-finger in the Evergrande-process, and bonds trade around index 25 already, why a default on offshore bonds would not be the biggest surprise in history. Xi Jinping’s focus is rather on the rest of Evergrandes debt, which is local. Remember that offshore debt is just 18bn out of 300bn.
State media outlets have started reporting that banks (and authorities) have started easing conditions for property developers again over the past week, and that lending volumes are increasing again – we are yet to see any confirmation of that in the official data as the credit impulse keeps worsening. This is eventually the only feasible soft landing for the Chinese property market. Pour more credit growth on the open fire (see chart 8).
This leaves the CNY (CNH) vulnerable in coming weeks as further easing might be needed to refuel the momentum in China. This usually leads USDCNH higher with a time-lag, but it all depends on whether Xi Jinping finds that there is already enough blood on the streets in the property sector.
Chart 8. The credit impulse is still in extremely weak territory and credit losses are material!