The winter months are upon us, and once again Covid-19 can’t help but stick its ugly nose into the picture.
First discovered in Southern Africa, the new variant of the virus – dubbed as Omicron (B.1.1.529) –has caused a ruckus across Europe and the rest of the world.
Initially, world media was riddled with superlatives when describing the Omicron variant. It was labelled as the most dangerous variant yet, highly contagious and even resistant to antibodies and vaccines.
The news shocked the currency market amid fears of fresh restrictions and lockdowns in some of the world’s major economies.
Highs and lows for the US dollar
The US dollar (USD) was king of the currency market on Wednesday last week. The re-election of Jerome Powell as Federal Reserve (Fed) Chairman combined with impressive Treasury yields poured wind into the greenback’s sails.
Consistency in the Fed filled investors with confidence. They believed the central bank could now focus on its monetary policy and raise interest rates sooner rather than later. Higher interest rates tend to boost the value of currency as investors are more likely to save in banks with better rates.
The warmth for the dollar was supported by US inflation figures reaching 6.2% – the highest it’s been in 30 years. And, despite the chaotic prices, US consumer spending elevated by 1.3% between September and October.
In instances such as these, central banks often look to pump-up rates. This helps to tame inflation but can reduce consumer spending as keeping money in the bank looks more favourable to the public. But, with consumer spending still fighting fit, the Fed should have little to worry about.
The positive market sentiment became priced into the world’s most traded currency – helping it to reach yearly highs of 96.8 on the US Dollar Index (DXY). However, just as the dollar started to look invincible, news of a fresh Covid-19 variant sapped the wind from its sails.
The toxic relationship between interest rates and lockdowns
When the news broke on Friday 26th November of a new, heavily mutated Covid variant, the dollar lost its momentum. It could be argued that the hawkish tone (likely to raise interest rates) of the Fed played a pivotal role in its demise.
In times of uncertainty, safe haven currencies tend to do well. As one of the major safe haven currencies in the world, the dollar would usually gain some ground in instances such as these. However, the news on Friday had the reverse affect: the greenback dropped from around 96.72 to 96.07 on the DXY.
As previously mentioned, when bank rates go up, currencies tend to benefit. The Fed has adopted a hawkish tone in recent weeks which gave the dollar some might. But, if the new Covid variant is to force nations such as the US into lockdown, a rate hike could be damaging.
One of the main reasons for this is the impact on consumer spending. Firstly, people may go into survival mode and choose to save their money rather than spend through fear of what’s to come.
Also, restrictions which limit business activity such as closures in sectors like travel and hospitality, reduce the opportunities for where people can spend. For example, you wouldn’t be able to book a plane ticket somewhere if the government banned travel due to a Covid outbreak.
When this happens, governments want people to splash the cash as much as possible. By keeping interest rates low, people gain little by keeping their money in the bank so may be more likely to spend it.
As such, the value of the dollar fell, and eyes have turned back to the Fed for a potential rethink on its monetary policy shift.
Europe reaps the rewards
On the flipside to the dollar’s freaky Friday, the euro had a day to remember. It had been fighting what seemed to be a losing battle against the US currency, progressively sliding to 1.119 – the lowest value since July 2020 – on Wednesday last week.
One of the predominant reasons behind the downslide was the European Central Bank’s (ECB) assurance that it would not be increasing interest rates until at least 2023. This is despite inflation causing the continent headaches.
The dovish tone (not likely to raise rates) stifled the shared currency against its rivals. However, with lockdowns already kicking into action in Europe, the ECB’s dismissiveness of a rate hike gave the euro some oomph.
On Friday, it climbed to 1.131 against the dollar and from 0.840 to 0.848 against the pound. It presents an example of the strange ways in which the currency market works: one moment something’s damaging a currency, the next it’s saving it.
Once the world gets a better idea of the Omicron variant and the threat it possesses, we may see the dollar and euro in another role reversal. Only time will tell.
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