After strong growth on the equity and commodity markets, there is hesitation fueled by disappointing inflation data from the US.
Playing for inflation return remains trendy
In 2021, the main investment theme is the expectation whether the economies rebound from the pandemic bottom fueled by a gigantic bailout in the form of massive fiscal stimulus and extreme easing by central banks will result in an intensification of inflationary pressures. A powerful fiscal and monetary easing through central bank balance sheet bulking is a simple recipe for strong money supply growth. In such an environment where the key feature is unequivocally negative real interest rates (rising inflation accompanied by zero central bank rates), market participants are betting on high returns in equity and commodity markets and capital inflows into emerging markets.
The US dollar exchange rate at a crossroads
Initially, a weaker dollar was to be the key piece of the puzzle, but a month ago theories that the Federal Reserve would abandon its bailout policy under the influence of strong growth started to gain popularity. Excluding the impact of the gigantic fiscal package prepared by Joe Biden's administration, the IMF estimates that GDP growth in 2021 will exceed 5%. It is also hard to see a strong downward trend in the US currency when the EUR/USD, which is called the main currency pair for a reason, has its brake on due to the reluctant strength of the euro by the monetary authorities and the clearly disappointing course of the vaccination program on the Old Continent. However, we believe that the monetary authorities will not allow a strong increase of Treasury bond yields, which would be beneficial for the dollar. The US's economic dominance over other developed economies will not be enough in such a situation to boost the dollar. The strength of the rebound in the world's largest economy will rather fuel the appetite to seek high yields in risky markets and should mean a retreat from the US currency and a continuation of its weakening (but at a slower pace than in 2020).
A game of reflation without inflation
What is referred to as the reflationary trend investment theme dominated most of January and February. Yesterday's inflation data from the US (which we outlined in yesterday's analysis) threw the markets off course, as price pressures show no signs of escaping control and it will probably be a while before they rise. Therefore, investors have no grounds to throw down the gauntlet to the Federal Reserve without giving any credence to the official communication. The positive scenario for the dollar, especially after the weak labour market data for January (more on them can be found in Monday's analysis) is now less likely to happen. Positive trends for the dollar are not in the process of crystallizing, but the expectations of a return to inflation are definitely not outdated. On the other hand, cyclical currencies, including both the euro and emerging market currencies will probably have to wait until Q2 for positive trends, when tangible evidence of economic recovery emerges, vaccination programs are in more advanced stages and covid restrictions are lifted.