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Weekly Focus – Team Dovish or Hawkish to Prevail?

The concern about omicron abated over the past week as vaccines were deemed effective against the variant with a booster shock. Preliminary analysis from the European health agency suggests the symptoms are milder than with previous variants. Furthermore, a new study shows that a third shot of the Pfizer vaccine could neutralise the omicron virus. The news boosted risk sentiment over the past week with equity markets rebounding along with yields, where 10Y Treasuries moved above 1.50%, and Bunds tested -30bp while the spread between Italian and German yields widened in anticipation of tighter monetary policy in the euro zone. If the fears of omicron indeed abates, we think focus in the markets should move back to the monetary policy and to what extent they will move in a more hawkish direction or remain accommodative.

The Fed meeting next week is likely to confirm Powell’s more hawkish message that inflation is more permanent and hence that monetary policy may need to be normalised faster than previously thought. We have changed our Fed view accordingly seeing QE to be phased out by April (instead of June) and three hikes in 2021 (June, September and December) instead of two followed by four hikes in 2022. The US labour market appears to be very tight with jobless claims this week hitting the lowest level since 1969. In our the view the relatively weak non-farm payroll report last Friday, was more due to labour supply constraints than demand problems. The unemployment rate fell significantly to 4.2% from 4.6%, as employment in the household survey was extremely strong. On another positive note, the labour force rose by almost 600K, which is very important to avoid the need for premature tightening by the Fed if wages rise faster.

A difficult communication exercise awaits ECB with regard to the inflation outlook amid growing divisions in the Governing Council about pro-inflationary risks and a stuttering economy. We expect new forecasts to show a marked upward revision in the near-term inflation outlook, but with HICP inflation falling back below 2% in 2023 and 2024, supporting the ECB’s communication of a patient approach with regard to rate hikes. That said, to placate the ‘hawks’, a first step towards policy normalisation will likely be done by phasing out the PEPP programme as scheduled in in March 2022, see ECB Preview – Baby steps to normalisation, 10 December.

Meanwhile, the Chinese central bank eased monetary policy further this week lowering reserve requirements and thereby enabling more credit to enter the financial system. The stimulus will in our view support a modest rebound in the Chinese economy in early 2022. It is a close call whether the Bank of Japan will prolong its pandemic measures set to run off in March on its meeting next week. Very few newly infected, a high vaccine uptake and a decent looking Q4 rebound has paved the way, but the Omicron variant adds uncertainty.

The concern about omicron abated over the past week as vaccines were deemed effective against the variant with a booster shock. Preliminary analysis from the European health agency suggests the symptoms are milder than with previous variants. Furthermore, a new study shows that a third shot of the Pfizer vaccine could neutralise the omicron virus. The news boosted risk sentiment over the past week with equity markets rebounding along with yields, where 10Y Treasuries moved above 1.50%, and Bunds tested -30bp while the spread between Italian and German yields widened in anticipation of tighter monetary policy in the euro zone. If the fears of omicron indeed abates, we think focus in the markets should move back to the monetary policy and to what extent they will move in a more hawkish direction or remain accommodative.

The Fed meeting next week is likely to confirm Powell’s more hawkish message that inflation is more permanent and hence that monetary policy may need to be normalised faster than previously thought. We have changed our Fed view accordingly seeing QE to be phased out by April (instead of June) and three hikes in 2021 (June, September and December) instead of two followed by four hikes in 2022. The US labour market appears to be very tight with jobless claims this week hitting the lowest level since 1969. In our the view the relatively weak non-farm payroll report last Friday, was more due to labour supply constraints than demand problems. The unemployment rate fell significantly to 4.2% from 4.6%, as employment in the household survey was extremely strong. On another positive note, the labour force rose by almost 600K, which is very important to avoid the need for premature tightening by the Fed if wages rise faster.

A difficult communication exercise awaits ECB with regard to the inflation outlook amid growing divisions in the Governing Council about pro-inflationary risks and a stuttering economy. We expect new forecasts to show a marked upward revision in the near-term inflation outlook, but with HICP inflation falling back below 2% in 2023 and 2024, supporting the ECB’s communication of a patient approach with regard to rate hikes. That said, to placate the ‘hawks’, a first step towards policy normalisation will likely be done by phasing out the PEPP programme as scheduled in in March 2022, see ECB Preview – Baby steps to normalisation, 10 December.

Meanwhile, the Chinese central bank eased monetary policy further this week lowering reserve requirements and thereby enabling more credit to enter the financial system. The stimulus will in our view support a modest rebound in the Chinese economy in early 2022. It is a close call whether the Bank of Japan will prolong its pandemic measures set to run off in March on its meeting next week. Very few newly infected, a high vaccine uptake and a decent looking Q4 rebound has paved the way, but the Omicron variant adds uncertainty.

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