What Happened

• Dollar strengthened 1.7% in September, rallying based on fears about “stagflation”
• A mix of inflationary fears and a more hawkish tone from the Fed boosted the buck
• € volatility spiked post-German elections and it weakened to lowest levels since July 2020
• Per the MSCI Emerging Markets Currency Index, all August gains were erased last month
• Pound sterling fell over 2.0% to its lowest point of the year as an energy crisis developed
• More Chinese interventionism scared equities

GreenShootsFX’s View

• Spending and the debt-ceiling will remain political items that could impact the buck
• Fed stance on tapering seems to send signal that economic growth will depend more on fiscal action, put pressure on Congress
• Mexican Peso likely drops if inflationary growth slows down despite interest rate hikes
• The alliance to form a German government could move Euro one way or the other

In Focus

• September’s late rally set USD at 3.5% growth thus far for the year
• Friction in Washington politics is holding infrastructure spending hostage, but remains better in comparison to other countries
• Delta has been reportedly causing less harm across the country, also a plus for productivity
• Idiosyncratic issues per region must be monitored with the globe getting through COVID in an uncoordinated manner

In Depth

Growth in Q4 could challenge the buck’s safe haven moment. Economic indicators have slowed down in the U.S. but the Fed looks to tighten policy.

Central banks did not change their tone. That is the answer to the question we posed at the end of last month’s outlook regarding banks following New Zealand’s example in backing away from raising borrowing costs via interest rate hikes.

Well, the dovish move did not inspire a call for leaving things untouched as now the Fed, the European Central Bank, and even the Bank of England stated their intent to start taking away some of the sovereign bond purchasing that the global economy has been relying on throughout the pandemic

The Reserve Bank of Australia’s decision reflects the other side of the argument about whether to taper or not. In the eyes of the Oceanic nation, China’s struggles in overcoming the pandemic’s pressures on manufacturing and investment leave no choice but to wait for indications of a healthier situation in the world’s second-largest economy. Supply-side concerns and rising costs are not making the Fed reconsider its position of less monetary intervention.

China is dealing with many issues that ultimately affect how the global community perceives the most populated nation. The news cycle seemed on a never-ending loop of the Evergrande debt case, which threatens to leave many Chinese investors in danger as this large real estate developer has failed to deliver on its works contracts as well as financial obligations. In the middle of recovering from a pandemic, this is the last type of financial chaos the country wished for.

Additionally, Chinese shipments, which the world depends on, have been awful to deal with as the Delta variant forced the closing of one of the largest global ports. Consequentially, this has translated into very expensive deliveries as all costs associated with it have skyrocketed. Container shipping rates from Asia to the United States are five times higher than they were a year ago.

As a bit of relief, the Purchasing Managers Index Composite managed to register an expansionary reading instead of the expected contraction that had been ongoing since the end of July. A deeper look into China’s PMI figures also showed a surprising expansion for Services during a contraction for Manufacturing. Lately, indicators paint a picture of an economy that seems to be transitioning more towards services and deprioritizing factories.

More importantly, China’s communist leadership seems more determined to control technology and new financial mediums such as cryptocurrencies. If the case is that China is indeed moving away from just making things and taking reins of its advancements to compete more heavily in high-end areas, could this development exacerbate the shortages, as well as prices, of goods and pre-production materials across global markets? While none of it will be easy to figure out, diplomatic shortcomings lately leave little room for imagining a more unified globe in production.

Continuing on a geopolitical pivot, recent meetings and phone calls between President Joe Biden and Premier Xi Jinping have contributed nothing to confidence in the two superpowers cooperating more than just commercially here and there. Circling back to Oceania, the country of Australia caused some unexpected waves by choosing to reward a submarine contract to an allied proposal between the U.S. and the U.K, thus leaving behind a former commitment to give this piece of defense business to France.

While French President Emmanuel Macron was left angry enough to recall his diplomatic representatives from their respective Australian and American posts, the push to get Australia those subs seem to be part of a greater effort by an alliance including the U.S., Britain, and India to counter China’s control and influence of the seas of the Pacific Rim. In large part, the interest emanates from wanting more monitoring of trade routes of the South Sea.

That leaves the other side of the Atlantic more concerned with domestic affairs that need to get in order for the Euro-zone to continue on a path towards pre-pandemic growth levels. European Central Bank President Christine Lagarde has gotten on board with the idea that emergency purchases can be tapered as she admitted that the region’s recovery has been unusual and good enough to merit tightening policy.

Nevertheless, the euro found a way to fall over 2.0% in value with fears about banks’ exposure to China’s debt crisis, uncertainty over the forming of the German government, and an undesirable energy shortage. Oil prices climbed to their highest in three years, and natural gas supplies are limited.

This energy crisis, also dramatically impacting the U.K., is the physical manifestation of problems we foresaw from Brexit and its long yet sloppy conclusion. Without a clear plan to increase taxes that would help government revenue and any potential delay from the Bank of England to taper, sterling could see further losses before it starts heading back up. Speculators turned bearish on pound for the first time since December in the middle of September.

Could a combination of rising yields, higher oil costs, and weaker stocks knock the dollar back down like it has historically? Stagflation is everyone’s enemy.