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Three Questions: Week of March 21

CalendarMarch 21, 2022

Good morning, and welcome to Three Questions - a look at the big uncertainties facing currency markets in the week ahead.

Here are some of the things we're watching:

1. Will the ECB signal discomfort with the euro’s weakness?

This week will see a fresh round of speakers from the European Central Bank - including President Christine Lagarde, Chief Economist Philip Lane, and the Bundesbank’s Joachim Nagel – address economic challenges stemming from the war in Ukraine. They could reiterate that although the bank recognizes that the conflict will hit Eurozone growth, euro weakness would make it harder to bring inflation back down.

In a speech last week, Board Member Isabel Schnabel emphasized that “a reaction function that differs materially from other central banks” could “amplify the energy price shock by weighing on the exchange rate, thereby adding to the burden on real household income.” She also pointedly noted that a 45 percent rise in Brent crude over the last year has translated into a 60 percent increase in the euro price of the benchmark.

The bank’s current plan is to end asset purchases in the third quarter of 2022 before it hikes rates. This is obviously very different from the Fed’s calendar, where the median expectations among Fed members is for a total of 1.75 percent in hikes this year. Nevertheless, viewing a weaker euro as a negative factor that boosts inflation and depresses demand would represent a significant shift in the ECB’s stance since it began Quantitative Easing in 2014.

In a world where the ECB was consistently running below its inflation target, any boost to exports from euro weakness was welcome, particularly at a time when the Eurozone was running very tight fiscal policies. However, fiscal expansion is now contributing to growth, inflation is above target, and Europe has been hit hard by supply shocks from the war next door.

If the ECB now views imported inflation as its primary concern, this means euro weakness is likely to result in more hawkish jawboning and could even signal accelerated tightening plans. This week could confirm that the Eurozone has joined a “reverse currency war” where exchange rate weakness is unwelcome.


2. Will a Banxico hike boost the peso?

On Thursday, Mexico’s central bank is very likely to increase its benchmark rates by 50 basis points to 6.50 percent, fully in line with market expectations. The bank is also likely to signal that there will be more policy tightening to come given rising inflationary pressures and a Fed stance that could increase pressure on the Mexican peso. Banxico’s action could steady the exchange rate, but the currency’s direction over the medium-term will depend more on broader risk appetite.

At Banxico’s last meeting on February 10, one member registered a dovish dissent for a smaller rate move and will likely do the same again, but this meeting could also see at least one push for a jump by 75 basis points. According to the minutes of that meeting, this option was raised but its proponent did not file a pro-forma objection to the majority outcome. But a desire to convey that the bank remains committed to its inflation target of 3.0 percent – versus the most recent core print of 6.6 percent -- could lead to a formal dissent.

Meanwhile, Mexico’s economy itself remains in trouble, dropping into a recession in the second half of 2021 and additional monetary tightening will not help the outlook. Despite his populist credentials, President Andres Manuel Lopez Obrador has pursued a tight fiscal stance overall while increasing spending on controversial white-elephant projects such as a huge refinery in his home district. A persistent fall in oil exports has limited positive terms-of-trade impact of the spike in oil prices. Unlike Brazil or the Andean countries, Mexico is also less likely to benefit from efforts to substitute mineral imports away from Russia.

Against this backdrop, the Banxico is more likely to steady the peso than boost it significantly.


3. Will the rollercoaster ride in Chinese markets continue?

As of last Tuesday, everything seemed to be going wrong at once for China’s financial markets.

Western investors were bailing out after the Securities and Exchange Commission named the first five Chinese companies - out of at least 270 - that could be delisted in the US if audit requirements set out in the Holding Foreign Companies Accountable Act were not met.

Skyrocketing bond yields had eroded cash cushions, forcing some of the country’s biggest property developers to announce steep discounts on unfinished apartments - a step that risked tipping real estate values into an ever-deeper downward spiral.

Technology stocks, suffering under a draconian regulatory crackdown, were following a trajectory resembling the dotcom collapse of the early-2000’s, with the sector losing nearly $2 trillion in value relative to its early 2021 peak.

A surge in Covid-19 cases in Shanghai and Shenzhen threatened to cripple the country’s manufacturing hubs and snarl supply chains.

And Beijing’s implicit support for Vladimir Putin’s invasion of Ukraine risked a widening in Western sanctions.

Markets plunged, with some indices down 30 percent on the week. Hong Kong’s Hang Seng fell more than 10 percent on Tuesday alone. Oil and raw materials prices tumbled on falling expectations for Chinese demand - paradoxically driving an improvement in risk appetite in the currency markets as inflation fears subsided.

On Wednesday, sentiment executed a neck-snapping 180-degree turn after Vice Premier Liu He - the country’s most senior economic official - hinted stimulus would be forthcoming and crackdowns rolled back, saying that policymakers would act to “boost the economy in the first quarter,” and implement “policies that are favourable to the market”. The Hang Seng jumped 9 percent, and tech stocks were up more than double that.

By Friday, when Xi Jinping told President Biden, “The top priorities now are to continue dialogue and negotiations, avoid civilian casualties, prevent a humanitarian crisis, cease fighting and end the war as soon as possible,” markets had executed a full round-trip, soaring past levels that prevailed ahead of the sell-off. Inflation concerns were back, and risk-sensitive currencies on the defensive once more.

If China has indeed pivoted toward a more stimulative economic policy framework, this recovery could be sustained and the rollercoaster ride could slow.

However, market participants should be aware that many of the factors responsible for the tumult haven’t gone away.

Even if a compromise is found with America’s regulators, access to US markets is set to become more difficult. Policymakers know uncontrolled credit growth could blow more air into the country’s property bubble, and real estate investors are facing lean times ahead. Politicians are loath to allow the biggest internet companies to climb the commanding heights of the Chinese economy once again. Questions about the efficacy of homegrown vaccines and low immunization rates among the elderly mean authorities have little choice but to continue implementing lockdowns, interprovincial border controls, mass testing and digital surveillance in response to coronavirus outbreaks.

China remains locked in a great power competition with the United States, meaning that strategic imperatives are likely to overshadow Xi Jinping’s verbal assurances in driving foreign policy. Overt military support for Moscow is unlikely, but propagandists will continue to push misinformation about the war in Ukraine, sanctions will meet with political opposition, and trade transactions between the two countries - conducted by smaller, less traceable entities - will grow in volume and scale.

Turbulence in China’s markets - and in the global commodity complex that is so deeply entwined with them - will continue for the foreseeable future.




USD Federal Reserve Speech, Powell


GBP Consumer Price Index, February

USD Department of Energy Weekly Inventories


EUR ECB Publishes Economic Bulletin

USD Current Account Balance, Q4

USD Weekly Jobless Claims

USD Durable Goods Orders, February

MXN Bank of Mexico Rate Decision


USD Federal Reserve Speech, Daly

USD Baker Hughes Weekly Rig Count


“Beginning this fall, green 14-ton tractors that can plow day or night with no one sitting in the cab, or even watching nearby, will come off the John Deere factory assembly line in Waterloo, Iowa, harkening the age of autonomous farming.”

Associated Press: Tired of waiting for driverless vehicles? Head to a farm

“This isn’t just a one-off in an obscure commodity. This is the natural conclusion of a trend that is undermining free markets and creating all the wrong incentives: A growing reluctance by the authorities to let financial groups go bust, even when they aren’t too big to fail.”

Wall Street Journal: The moral hazard lessons from the nickel market disaster

“Last year, President Xi Jinping seemed all but invincible. Now, his push to steer China away from capitalism and the West has thrown the Chinese economy into uncertainty and exposed faint cracks in his hold on power.”

Wall Street Journal: Rollback of Xi Jinping’s Economic Campaign Exposes Cracks in His Power

“However, if my second explanation noted above is right (that the economy is in a high-pressure, high-inflation equilibrium), then the FOMC will need to act more aggressively and bring policy to a contractionary stance in order to move the economy back to an equilibrium consistent with our 2 percent inflation target.”

Neel Kashkari: Update on Inflation and Monetary Policy

“On March 8 as the global market for nickel seized up and commodity markets spasmed, the European Federation of Energy Traders, a leading industry group, called on central banks to provide liquidity to support vital commodity markets.”

Chartbook: Must central banks become lenders of last resort for commodity markets?

“Our findings suggest that fiscal stimulus boosted the consumption of goods without any noticeable impact on production, widening the gap between demand and supply in the goods market."

VOX: Demand–supply imbalance during the Covid-19 pandemic: The role of fiscal policy

“The democratic world’s response to Moscow’s aggression and war crimes is right, both ethically and on national security grounds. This is more important than economic efficiency. But these actions do have negative economic consequences that will go far beyond Russia’s financial collapse, that will persist, and that are not pretty.”

Foreign Affairs: The End of Globalization?