A week of retreat from the dollar (Daily analysis 12.03.2021)

Two important steps were taken this week to calm sentiment on global markets, primarily Treasury bonds. This is enough to cause Wall Street to rally to historic highs while the dollar weakens and emerging market currencies rebound.

The steps mentioned above included (again) lower than expected inflation in the USA and the European Central Bank's decision to intensify its asset purchase program. However, this is still not enough to declare the end of the turbulence on the debt market, especially from the perspective of emerging economies' currencies. After all, the bond depreciation was the strongest in eight years. The coming week's Federal Reserve meeting should be another important event, especially given the disappointment with Jerome Powell's stance last Thursday.

At the same time, the awakening of risk appetite increases the probability that the dollar has reached its local highs, especially against the euro. The Norwegian krone was again the leader, supported by the increase in the price of crude oil on the London Stock Exchange to around 70 USD per barrel, as well as the pound sterling, which is invariably the beneficiary of a smooth vaccination program.

Euro resistant to ECB policy changes

The European Central Bank will step up, meaning it will intensify its pandemic asset purchase (PEPP) easing. What does this mean? More than half of the 1.85 trillion EUR allocated for this lifebuoy is now available. The pool of bonds and other assets being raised will be increased in the coming weeks. Behind this decision is the recent sell-off in the bond market, which translates into less favourable financial conditions in the economy, threatening its rebound. The ECB has moved from words to action but has confirmed that the cut in rates recurring in the speech was more of a bogeyman than a real prospect. As a result, the easing did not hit the common currency.

More intensive purchase means higher demand, which is supposed to stabilize the prices of Treasury securities. The central bank's move from words to actions is also a clear signal to investors that it is better to avoid market bets that complicate the monetary authorities' task. ECB President Christine Lagarde emphasized that the rate change is not due to a worse outlook for growth. Although the Eurozone's GDP will probably contract in Q1, it is expected to grow by around 4 percent for the year as a whole. Such a value is more or less in line with both the refreshed forecasts of the Organization for Economic Cooperation and Development and market expectations. At the same time, the markets have been prepared for the fact that the very probable inflation growth in the vicinity of 2 percent (the ECB's mandate) will not be met with a reaction and a tightening of the rate. Clearly, central banks disagree with investors in assessing the endurance of an incoming episode of higher inflation. The tug-of-war continues.