Inflation calls expected to be more conservative

The second half of 2021 was characterized by predictions over inflation by the Bank of England, the Government and market analysts that have turned out to be incorrect.

The supply side of the economy has been badly hit by shortages of raw materials and spare parts, and this has surprisingly come as something of a surprise to many experts.

It is obviously easy to cherry-pick errors that have been made for whatever reason, but as we enter a New Year, it is likely that predictions will be more conservative than they have been.

Central Banks had to prioritize growth over inflation, so were prone to ignoring what was right before their eyes. Andrew Bailey, the Governor of the Bank of England was also accused of misleading the markets in the run-up to November’s MPC meeting but in reality, his hits at a rate hike were more likely simply a misread of his colleagues intentions.

There is no doubt that Central banks have made a significant return to the forefront of market activity this year, following an extended period when monetary policy took a backseat.

Now that the era of low interest rates and easy money is behind us, the purchase of assets will need to be more discerning, relying on more than predictions of future income to make valuations.

Before inflation created the current situation, equity markets were beginning to take on the look of a one way bet where relatively few stocks were in complete control of the market and creating a false impression for small investors.

Hopefully, a continued tightening on monetary policy will bring back a sense of reality and proper valuations.

The pound has generally reflected the economic developments in the country. It fell to a low of 1.1411 in March as the country was gripped by lockdowns, but quickly recovered as take-up of the vaccine illuminated a path to recovery.

It would be a brave man who would commit to a firm prediction of where it will be in a year’s time. Even a firm idea of whether it will be higher or lower than yesterday’s close of 1.3497 would be tough.

Farewell 2021, let’s hope that 2022 brings more obvious trends and better communication between Central Banks and the markets.

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Next week’s NFP predicted to be around +300k

The final weekly jobless claims data for 2021 showed continuous progress for the economy and gave the market more optimism for the December employment report that will be published next Friday.

To quote a term used by former Fed Chairman Alan Greenspan a generation ago when describing the Dot.com bubble, there has been an irrational exuberance about numbers of jobs created.

Indeed, that term could rank close to the top of market descriptions about the way experienced fund managers have accepted the predictions of companies like Netflix, Facebook and Tesla about their future earnings as a way of valuing their stock price.

The single word that Trumps (no pun intended) the use of irrational exuberance has to be the now retired transitory. First coined by Jerome Powell in late spring, it became the watchword for Central Banks struggling to explain the now obvious rise in inflation that came from pumping cash into the market.

The dollar index has seen two fairly discernible trends this year following a first quarter in which the entire global economy was in almost total lockdown. The first started in March, a month that was particularly volatile. In April, a rise in the index was repelled as traders tried to again reach the high of 102.99 from the previous month.

That saw the start of a reversal to a low of 89.50 by the end of May that has resulted in the current uptrend created by expectations of a divergence in G7 monetary policy.

It is fairly predictable that the Fed will bring emergency support to an end in the first part of 2022, and this is seeing the dollar trend higher, but questions are now being asked about ECB policy and any change, or prediction of change, will slow the dollar’s advance.

Yesterday, the index remained in the narrow range that has been seen in the second half of the month. It closed at 95.98.

The employment report for December will be the highlight of the first week of New Year. Latest predictions, see the headline new jobs figure around +400k.

Policy may be tightened if prices continue to rise

Earlier this week, comments by the Austrian Central Bank Head about rising inflation appeared to be taken in its stride by a market which understands the concerns of the more hawkish Eurozone Central Banks.

However, it is now considered that this may be considered to be the start of the fightback against the dovish stance which continues to be promoted by Christine Lagarde.

Robert Holzmann commented that inflation is targeted to remain well above the ECB’s 2% target throughout 2022 and will likely see more rapid increases early in the year.

Holzmann’s colleague across the border in Germany Jens Weidmann who will end his tenure at the Bundesbank today was even more hawkish, expressing an opinion that inflation won’t return to target until the end of 2023.

These two hawks have seen their influence wane somewhat as weaker Eurozone economy’s Central Banks have lapped up the support on offer from the Central bank.

The current round of PEPP will finish at the end of the first quarter but is already set to be replaced by a slightly watered-down version.

The Euro, which was considered dead in the water, will be reactive to any talk of a change to ECB policy, but that is unlikely on the short term.

One change that is on the horizon, is the almost meteoric rise of Mario Draghi.

He is expected to be asked to be Italy’s new President by Parliament, a move that could counter intuitively weaken Italy’s economy, or at least its stability.

Currently, four Parties are neck and neck in the race to form a government. Two are hard right, one left facing, while the fourth is both Centrist and populist.

Draghi’s technocratic hand has been on the tiller only since February, but its standing in both Brussels and Frankfurt has been significantly strengthened.

This will be a story for the first weeks of the New Year. Meanwhile, the single currency is hemmed in by a reluctance in the market to buy and a correction that is taking place in the dollar index that restricts any move lower.

Yesterday, it fell to a low of 1.1298 and closed at 1.1319 in slow trading.