What Happened

• A new COVID variant and the Fed’s will to taper boosted the greenback by 2.0% in November.
• Hesitation to tighten monetary policy and renewed medical concerns crushed the euro
• Sterling sank to its weakest point in a year as the Omicron variant delayed interest-rate hikes.
• Jerome Powell was nominated for a second term as Fed chair and no longer refers to inflation as “transitory,” aiding the buck.
• Mexican Peso fell to its worst value since March 2020; Japanese yen traded near a 2017-nadir.

GreenShootsFX’s View

• With the infrastructure bill passed, December will test the USD on other metrics, labor data.
• Many will be relieved to end a tumultuous pandemic year, but Omicron could create challenges to ongoing recovery and growth.
• Uncertainty takes ahold of markets as different approaches to the new variant already witnessed per nation.
• U.S. Dollar is on pace to close the year a winner with over 5.5% overall gain, but if the variant proves less troubling, the globe could rally.

In Focus

• The Buck has climbed 6.8% from its weakest point of the year.
• 2020 may have been the year of the unprecedented, so 2021 was the year of coping with the results of prolonged inactivity.
• Vaccination campaigns, in general, have succeeded in giving most people a chance to return to consume and engage.
• Nevertheless, an uneven recovery has developed, and there is room for improvement.
• We experienced the “reflation” we foresaw at the start of the year, stronger than anticipated.

In Depth

Omicron variant throws a wrench at the end-of-year outlook and central banks’ hands seem tie as the ongoing pandemic challenges projections.

November marked a return to seeing the dollar as a safe-haven unlike any other. However, the need for stimulus in Japan, the debut of a new variant, and a resurgence of outbreaks in China forced a re-thinking of the strength behind the global economic recovery narrative.

Furthermore, the end of the month was characterized by a down-beaten Europe, which has been forced to bring back safety measures, border closings, and local curfews. It certainly feels like the Euro-zone is taking a major step back. UEFA Champions League soccer matches in Germany were already announced to take place without any public in the stadiums.

Indeed, it is frustrating to come to this point in our battle with COVID and still see the need to reduce any level of public activity. While mask-wearing mandates seemed to be ready to be taken off the table, Omicron has brought back a sense of helplessness against the disease and its effects, causing a loss of faith in riskier assets. More importantly, the current supply-chain crisis will not see an end if local regulations further delay transport at global ports, already facing a logistical nightmare.

Overall, the dollar benefitted greatly from a combination of seeing another COVID variant spread that can resist previous vaccinations and treatments, as well as the willingness of the Federal Reserve to address inflationary pressures by tapering its quantitative easing. Omicron was first detected in South Africa but quickly made its way into Europe, and slowly, but surely, other countries started taking in patients.

One positive note is that early stories suggest the variant may be mild, and some who tested positive have been asymptomatic. If it is proven that we managed to build enough antibodies and some immunity that the variant will not matter in a significant way, perhaps the buck will take some steps back. We hope for the best, although Moderna leadership, one of the pharmaceutical vaccine manufacturers, warned that it would take months to see how this strain threat can be eliminated.

When it comes to the Fed, a change of tone occurred because of Consumer Price Index figures that have not stopped surpassing general economic estimates. This also came during the time of confirming whether Powell would remain head of the Fed, which was surprisingly intriguing.

Lael Brainard, who has been at the Federal Reserve Board of Governors since 2014, was also a candidate for the position. Her commentary has always been associated with being a ‘dove’ amongst hawks; thus, the prospects of her filling the job caused the buck to weaken. But, ultimately, she was assigned to Vice Chair, and Powell’s continuity bodes well for the dollar because the policy is more likely to continue gradually tightening.

Throughout the past six weeks, comparisons have been made between today’s inflation and what was experienced during the energy crisis of the 1970s. Then, a period that also dealt with the closing of a major armed conflict (back then, Vietnam, now Afghanistan) was also plagued by uncertainty across global markets because of changing dynamics in the oil and gas industry. Prices were so high that lines at the gasoline pumps would stretch for blocks, sometimes in cities and towns across the country.

While today’s situation has similarities, some economists have wondered if it is time for the Fed’s Jerome Powell to have his “Volcker moment.” This is in reference to when in the ’70s, Fed Chairman Paul Volcker took it upon himself to reduce inflation with several unpopular interest rate hikes. However, are rate hikes, increments to borrowing costs, what we really need at the moment?

Perhaps what Powell will do in his spotlight is make it clear that his stance will not change when it comes to allowing for an accommodative and easing-driven environment until the economy reaches full employment. If the goal is to get people back to work and to make sure the recovery is even across social lines, then Powell’s “Volcker” moment will be one of staying dovish and refusing to hike interest rates.

Although he has already admitted to inflation needing some control, the Fed is determined to stay away from messing with rates, especially after the excess to which it was done post-financial crisis.

On the other side of the Atlantic, Christine Lagarde assured that the European Central Bank sees no need to increase interest rates until seeing how 2022 turns out, while EU Chief Economist Philip Lane seconded the sentiment. Lockdowns in the Netherlands, Germany, and the central part of the continent are already causing a slowdown. December will be crucial to see if those measures must remain as holidays only mean gatherings.

Meanwhile, in Britain, the Bank of England’s resolve to fight inflation via rate hikes has taken a dive as even the hawkish voices are changing their reasoning and explicitly refusing to promote them. Michael Saunders, a BOE member known for pushing to hike, already expressed it is prudent to wait and not act.