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Fed’s Powell promises a “humble and nimble” approach to policy normalisation

January 12, 2022by Nicholas Kabaso
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Local Market Commentary

  • It was a relatively uneventful day in Zambia yesterday amid a continued absence of domestic data releases. On the global front, Fed Chairman Powell addressed the Senate banking committee yesterday and has ultimately put forward a more metred approach to Fed policy than some in the market feared. Stocks have rallied and yields have dropped in response, with the 2-year UST yield down around 6 basis points on the session. While geopolitical concerns could also be supporting the curve, note that almost all EM currencies are stronger since the Fed’s comments. This suggests that the market is pricing with a less aggressive Fed in mind.
  • Powell is quoted as saying that the Fed is “just going to be moving over the course of this year to a policy that is closer to normal, but it’s a long road to normal from where we are now…” while adding the policy normalisation “should not have negative effects on the employment rate”. However, there was a distinction drawn. He also highlighted that Fed policymakers need to be “humble and a bit nimble” in policy settings. This latter feeds into the view that the Fed will remain highly reactive to the market and economic dynamics and will be mindful of the potential that policy tightening could tip asset markets in such a way that catalyses recessionary forces.
  • The outlook for a reduction in QE nevertheless holds several uncertainties for financial markets, which have been supercharged on the back of loose monetary and fiscal policies in the US. The S&P 500, in particular, looks highly overvalued and has ultimately untethered from economic fundamentals when considering that its cyclically adjusted price/earnings (CAPE) ratio is at its highest levels since 2001.
  • Against this backdrop, focus today will shift to inflation. Consensus expectations suggest that inflation likely rise to a three-decade high of 7.1% y/y. While much of this inflation is due to higher food and energy prices, rising core inflation as US demand picks up is becoming a growing concern for the Fed, and looks set to trigger an acceleration in its policy normalisation process through the months ahead.
  • The base metals outlook continues to be supported by supply chain issues that are compounding on one another. Various LATAM sources of key base metals have reported lower output in recent data, while geopolitics in Europe and the threat of economic shutdown in China are also of significant concern. Recall that much of Europe’s industrial activity is conducted in Eastern Europe. The Olympics in Beijing could also add to the lower supply outlook for some time still, while the recent hike in Chinese power prices to industrial consumers disincentivize maximum capacity. Copper, aluminum, iron ore, nickel, steel, and coal are all higher on the session. The Bloomberg industrial metals subindex, which tracks key base metals prices, has risen to two and a half month highs against this backdrop, up nearly 3% month-to-date. The reaction to omicron in China and geopolitics seem likely to be the major changing drivers in the short term.
  • In the currency markets, it is worth noting that the Zambian Kwacha (ZMW) has started off the year on the back foot. For context, the ZMW is among the laggards on a month-to-date basis. The local unit has lost around -1.74% against the greenback and is ranked as the second-worst performing currency among those tracked by Bloomberg. Note, the ZMW is expected to remain on the defensive this week as the market awaits a full pick up in corporate activity such as exports after the holiday season. Therefore, a tight supply of dollars will likely continue to weigh on the local unit.
  • Meanwhile, the USD is trading heavy and responded negatively to the comments made by Fed chairman Powell that made it clear there was no rigid and pre-determined path to monetary tightening. Given how much has been priced into the USD concerning policy divergence, this led some investors to look at the USD as fully priced and to further trim positions. As risk appetite improves, the USD will correct even further and that might arise if today’s inflation data beats expectations to the downside.

Rand and International FX Commentary

  • Overnight, the USD has depreciated and slipped to its weakest levels on a trade-weighted basis since mid-November. The catalyst for the move was the Fed Chairman’s confirmation hearing before the Senate Banking Committee. He indicated that it might take several meetings to decide if and how the Fed would allow the run-off in its balance sheet, otherwise known as quantitative tightening. Although he did also add that the Fed felt the economy could withstand tightening, the market seemed to overlook that and focus instead on the news that automatic tightening was not guaranteed.
  • The USD-ZAR immediately capitalised on the news that has nudged back below the 15.5000 mark this morning which is the lowest level since the 18th Nov. Although the daily chart now reflects a USD oversold position, there are no obvious signs of a reversal. On the contrary, the weekly technical chart shows that the USD-ZAR could march lower still as it unwinds much of the ZAR weakness that took place in early Q4.
  • Now the focus will shift to today’s US inflation data to see whether it generates an equally influential market response. A strong reading will support the USD, but if the data matches expectations or comes in a little softer, the USD will likely experience an even deeper correction. There has been so much in the way of policy divergence priced into the USD that it is now vulnerable to any information that might challenge the view that the USD must appreciate on the back of a very hawkish Fed.
  • Domestically, there is nothing in the way of data to focus on. However, there is some good news for the economy in the intensifying calls to end the State of Disaster. Opposition parties as well as a body of scientists, now argue that there really is no need to persist with the state of disaster and that removing it would offer business the certainty it needs to invest and plan for the future without the stress of worrying about the re-imposition of more restrictions. This may well stand SA and the ZAR in good stead, at least in the short to medium term. 

Nicholas Kabaso

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