2nd February 2021 – The money supply risks loom triggering reassess of equities progress

Walid Salah Eldin

Active member
The single currency is still depressed by the ECB’s worries about its appreciation in the beginning of this year which drove it 1.235 versus the greenback sparking criticizing against this unreasonable appreciation negative impact on the current struggling inflation forces and the exporting activities in EU.

Fear of Deflation in EU

EURUSD bounces above 1.2150 have been faced by more comfortable selling speculations since ECB’s broad Dutch member Klass Knot highlighted these worries by referring to the probability of cutting the deposit rate further to face that appreciation which erodes the ECB’s efforts to stimulate the economy and caps it from reaching its 2 percent inflation yearly target.

His comment did not shock the single currency only, but also triggered risk aversion sentiment, as his comments were more aggressive than the ECB announced stance and more obvious than the ECB’s president Christian Lagarde which has tried to neglect criticizing the single currency appreciation and focused in its words on the impact of that appreciation on the inflation outlook.

After the ECB decided last month to keep unchanged the main refinancing rate at zero, the marginal lending facility at 0.25% and the deposit rate at -0.5% with extending the Pandemic Emergency Purchase Program (PEPP) to March 2022, totaling €1.85tr for purchasing the issued bonds by the EU governments which are in strong sake of lower money costs to finance their needed reflation plans to boost the economy.

No way to object inflation

From the other side of the Atlantic The Fed Chief, Jerome Powell assured on the Fed’s tolerance stance on inflation by saying that it will be patient and will not react if there are small transient inflation increases.

After he has previously outlined at Jackson Hole symposium last August a new strategy of letting inflation to run hotter than normal in order to support the labor market and the broad economy prioritizing employment over price rises, showing tolerance about The Fed’s normal 2% yearly inflation expansion target it adopts over the medium term.

His words came to calm the equities markets, following rising worries about inflation upside risks in US, have been triggered by the release of December labor report which has shown average hourly earnings for all employees on private nonfarm payrolls rising by 23 cents to $29.81 by 0.8% monthly and 5.1% yearly, despite unexpected losing of 141k of jobs out of the farming sector last December.

So, we can get ready for higher inflationary wage pressure, without intervening from the Fed to trim the current offering money pace by raising rates or even by tapering of its QE purchases which reached $120b a month.

The Fed’s opened hand

As widely expected, The FOMC members assured last week on their readiness to act again, if needed to underpinned the economic activity and support the labor market which moderated recently.

After robusting labor market performance has been sparked in the second quarter of last year by the Fed’s response to the crisis last March by widening its balance sheet initially by USD2.3tr, before driving it up to surpass last May USD7tr level ahead of reaching its highest level ever by reaching to USD7.414tr on last Jan. 18. The Fed could support by this way the small businesses and weigh down on the cost of borrowing for stimulating the economy generally and lower the US government borrowing costs to help it to finance its reflation plans easier.

The reflation boosts

In the same time the new US secretary Janet yellen promised to not impose higher corporate taxes to finance these plans and indicated that she will not plan to impose higher taxes, before getting the economy out of the crisis because the economic risk is more important now than the financial situation which can be sustained later!

While the new government is trying now to start Biden’s era with passing new relief package worth $1.9tr, Despite the current debt levels which reached USD27.8tr and US Debt to GDP ratio which reached new all times high at the end of 2020 third quarter recording 127.7% and hurting the creditability of US which is still struggling to have faster growth rates, after easing down to 4% annualized GDP growth rate in the fourth quarter of last year.

The US economy has already got boosts by several reflation plans valued more than USD1.5tr, before the virus crisis during Trump's era which watched also threats to the global economy because of his trade wars which drove the Fed to lower the Fed fund rate three times by 0.25% in the period from Jul. 31 to Oct. 31, 2019.

While The markets are still looking forward for substantial relief packages to revive the household sector and underpin the government spending and in the same time betting on easier Sino-American trade tensions under the new US President-elect Joe Biden's leadership which may end the US trade wars too.

In Brief, The Fed's easing policy can be extended for considerable period of time and it has the ability to do on contrary with others less-flexible central banks which face difficulties at the current historical low rates.

By a way or another, The Fed can twist again its current holding of governmental debt into longer period debt and it can increase its purchasing and widen its balance sheet further.

While the financial policy in US is expected to give further support to boost the economic expansion momentum in the wake of Corona virus by more reflation plans.

So, it looks that we are ahead of further floods of cheap money supply to boost the economy, the demand for energy and raise the prices of assets, equities, Gold and the digital currencies as well as a hedge against inflation by God's will!

Money Supply risks

We can see also negative consequences and risks of this cheap liquidity like what we have seen recently of Game Stop stock manipulation which can easily be repeated with others to come as targets to make quick profits by short-term traders using excessive high leverages to make profits in the equities markets or even in commodities market which is looking waiting for its turn in this usual circulation of liquidity.

While it is hard to make such profits and manipulations with giant’s well-bid blue chips equities in the market having solid fundamental and financial situations specially after what they have made of the rallies last year.

Game stop could really put doubts about the financial stability and highlighted the current serious need for taking measurements to tackle excessive use of leverage can risk the financial stability.

Amid the current pumped liquidities from central banks and governments into the financial and the banking systems to boost the real economy which is still lagged behind what have been made of profits in wall street because of this cheap bid money which is expected to reside at the end in the companies’ profitability as the investors plan and wish.

Kind Regards

Global Market Strategist of FX-Recommends

Walid Salah El Din