Currencies and equities sold off sharply today after Federal Reserve Chairman Jerome Powell said: “It is time to retire the word transitory regarding inflation.” Investors bid up the U.S. dollar, but having sold off before Powell’s announcement, the greenback was unable to turn positive against all of the major currencies.
Today’s announcement is significant because investors have been waiting months for the Fed chair to admit that high price pressures may linger for longer – something other central bankers have given into. Powell does not see inflation subsiding until the second half of 2022, which is why the central bank will talk about speeding up taper at its next meeting on Dec. 14-15. It may even need to consider ending taper a few months sooner than anticipated.
What makes today’s announcement so important is the timing. The COVID-19 Omicron variant is a serious risk that many scientists are still struggling to understand. As Powell put it, we won’t know more about Omicron for another week to 10 days. The Fed could have easily waited another week before making this significant shift in forward guidance, but its decision not to wait is a reflection of how worried it is about price pressures accelerating and how desperately it felt the need to prepare the market for policy change (pace of taper) next month.
Although Powell was quick to add that these assumptions do not include the risk of the Omicron variant, which it will know more about in a few weeks, it is clear from his comments today that as long as it does not cause new lockdowns in the U.S., it will normalize monetary policy quicker. Investors can expect upgrades to next month’s inflation forecasts along with more “dots” moving in favor of rate hikes next year.
While the prospect of less stimulus is generally positive for the U.S. dollar, the combination of weaker economic data and ongoing Omicron concerns will limit its gains. Instead, the Japanese Yen and Swiss Franc should be the biggest beneficiaries of Powell’s comments. Consumer confidence and the Chicago PMI index dropped more than expected in November, and with Omicron, we have every reason to believe that sentiment will sour further.
Traditionally, the U.S. dollar catches a safe-haven bid from bad news, but instead of rising, the greenback weakened after Moderna’s CEO said it is very likely that current COVID-19 vaccines will be less effective against the Omicron variant. The explanation for this counterintuitive move is simple – it is only a matter of time before cases of the Omicron variant are found in the U.S., at which point everyone will begin speculating about the local and national response. Even if new restrictions and lockdowns do not return, consumers could retreat before the holidays, leading to less shopping, cancelled trips and a reduction in other end-of-year expenditures. The risk to the U.S. economy could be significant, which explains why some investors are selling first.
The euro was the best-performing currency behind the Japanese Yen and Swiss Franc, which is surprising as European nations are the most likely to come down hard with restrictions. There’s already a full lockdown in Austria and Slovakia, with partial lockdown in the Netherlands. Belgium and Portugal announced new restrictions, while France requires masks for all indoor activities. Pressure is growing for tighter restrictions in Germany. Yet, stronger Eurozone inflation and German labor market numbers kept the euro supported and prevented it ending the day lower against the greenback.
Between falling oil prices and a rising U.S. dollar, the Canadian dollar was hit the hardest. Over the past month, the price of crude has fallen from a high of nearly $85 a barrel to a low $64.45, the first time WTI crude trades below $65 in three months. Omicron has already made its way into Canada, with five reported cases. While Canadian labor market numbers are expected to improve, the plunge in oil prices combined with the demand for U.S. dollars should keep the loonie under pressure.
On the calendar for Wednesday will be Australian’s third quarter GDP report, revisions to Eurozone and U.K. PMIs, ADP (NASDAQ:ADP), ISM Manufacturing index and the Federal Reserve’s Beige Book report. While important, these numbers may have limited impact in light of Powell’s comments, which along with Omicron headlines, will continue to drive risk appetite and FX flows.