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FX outlook: Parky’s quick take – 28 February 2022

At the beginning of last week came the news that Russian forces had invaded Ukraine. The excuse used by Russian President Vladimir Putin was that he had sent in a peace-keeping mission to the country to protect people in the disputed Donetsk and Luhansk regions.

Russia: Invasion of Ukraine sets risk appetite on a negative path

At the beginning of last week came the news that Russian forces had invaded Ukraine. The excuse used by Russian President Vladimir Putin was that he had sent in a peace-keeping mission to the country to protect people in the disputed Donetsk and Luhansk regions. The West responded by levying a package of sanctions to restrict Russian banks and businesses, as well as directly targeting Russian government officials. As Russian forces closed in on the Ukrainian capital Kviv and Russian President Putin put the country’s nuclear weapons on high alert, those sanctions were stepped-up, and some Russian banks were ejected from the Swift payments system.

The invasion by Russia has prompted a decline in risk appetite, with investors fleeing equities for the safety of government bonds, which has benefited the USD versus the likes of the EUR and GBP. The effects on markets, though, pale into insignificance versus the death and destruction in Ukrainian towns and cities, with Russian forces attempting to cut off the Ukrainian capital from the rest of the country, as well as the West. The Russian rouble declined sharply, the Russian stock market has dropped by more than 30%, and the Central Bank of Russia hiked rates to 20% from 9.5%.  

United Kingdom: UK Bank of England testimony hints at more modest hikes than markets price for; will PMIs sustain improvement?

Whilst the markets were, quite rightly, transfixed by events in Eastern Europe, there were some domestic events that provided hints, regarding the pace of UK monetary tightening, and the performance of the UK economy. On the latter, last week saw the release of provisional February Purchasing Managers’ Indices (PMI) for manufacturing and services, both of which were better than expected, but significantly weaker February surveys on manufacturing and retailing from the Confederation of British Industry. First thing on Friday, the Growth from Knowledge consumer confidence index for February fell to its lowest level since January ’21, dragged down by a significant weakening in economic outlook and outlook for personal finances.

The drop in UK consumer confidence is consistent with drops in confidence elsewhere in the developed economies. But these moves are significant, since they highlight the difficulty that this supply side and energy shock led inflation is creating for households. Inflation didn’t get much attention when some of the Bank of England’s Monetary Policy Committee members testified to the Treasury Select Committee last week. They did re-emphasise that the markets appear to be over-pricing the size and frequency of UK rate rises needed to bring inflation back to target. That did little to alter expectations, and though there is a greater geopolitical risk because of the war between Russia and Ukraine, the macroeconomic consequences are less clear.

For this week, there aren’t any particularly important releases due from the UK. There will be interest in the manufacturing, services and construction PMIs: the first two revised from provisional February readings; whilst the construction PMI will be a first look at activity in February versus January. All are expected to retain strength or edge up from January’s figures. Other than those releases, there are only January Bank of England consumer lending figures, and the Nationwide house prices data for February due.

As for the GBP, it plunged through $1.33 towards the end of last week, but recovered to above $1.34 on Friday against the USD. But against the EUR it has, somewhat surprisingly, lost ground despite the more obvious economic pressures on Euroland versus the UK. I suspect there are greater downside risks versus upside risks for the GBP over the next few weeks at least.

Europe: Are Euroland vulnerable to energy shortages; are the ECB less inclined to reduce the stimulus?

Should Russia decide to reduce or stop gas supplies to Europe altogether, the consequences could be significant. A number of countries in Euroland rely upon Russian gas, in the main or in their entirety, for domestic energy requirements. Europe’s economic problems did prompt European Central Bank (ECB) Governing Council member Holzmann to suggest that the central bank might have to hold onto the economic stimulus programme for longer because of Russia’s invasion of Ukraine.

Economic data and surveys have little consequence because of Putin’s illegal incursion into the sovereign nation of Ukraine. However last week saw better preliminary February services PMI readings, but a weaker manufacturing outturn because of weakness in Germany. There was a better-than-expected return from the February Information and Forschung (Germany’s Institute for Economic Research) business climate index. The headline index climbed to a 5-month high, suggesting that the worst of the problems might have been coming to an end for German manufacturing, before Russia’s decision to invade.

Markets were unconvinced by the strengthening in the survey data even before this week, and had been negative on the EUR because of widening interest rate differentials as UK and US monetary authorities appeared to be far more aggressive on the need for interest rate rises to quell inflation pressures. The EUR’s underperformance was brought to at least a temporary halt last Friday, but can it make sustained gains from here whilst geopolitical uncertainty remains elevated? I’m not convinced it can.

This week’s data and surveys are fairly inconsequential with the exception of provisional February Consumer Price Index (CPI) inflation data. These figures are released in the first half of the week, and markets already expect inflation rates to have risen further versus the January readings. That could initially strengthen the EUR as markets price in additional monetary tightening risks towards year-end, but realistically there is little the ECB can do to alleviate short-term higher headline CPI inflation. In the second half of the week, the EUR could come under renewed pressure, if surveys (PMIs) and data disappoint market consensus forecasts, which is the risk, in my opinion.

United States: US consumer surveys flashing amber warnings to an unhearing Fed as markets wait on non-farms

Last week’s news from the US was still all about historical strength in the US economy, which continues to lead some on the US Federal Reserve to believe that a tightening in monetary policy is warranted and perhaps should be on the larger side of things (50 basis points rather than 25bps). The latest to comment on the inflation problem was Fed Governor Waller, who indicated that the Fed could hike by more if the data came in ‘hot’, but would have to assess the effects of the Ukraine invasion as well.

Data and survey releases over the course of last week offered a very mixed picture. There was some improved news in terms of activity from the provisional February manufacturing and services PMIs, strong house price growth in December, but weaker new and pending home sales figures in January. The Conference Board and University of Michigan consumer confidence and sentiment readings were also mixed, with the Conference Board reading dropping in February, but the University of Michigan sentiment index recovering a little in the final February reading (having recorded a larger slump initially). The consumer readings are heading in the wrong direction and are set to head further in the wrong direction in March given the destabilisation of geopolitics seen over the last week.

The USD benefited from safe-haven flows as investors looked for safety of capital over return on it, but gave back a little of its gains at the end of the week, as the initial panic over the attack on Ukraine died down in markets, albeit I’m not sure quite why, given the encroachment of Russia’s armed forces deeper into Ukraine.

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