Goldman: Holding Steady Amidst Defensive Rotations And Omicron Uncertainty

Goldman Sachs note that “the broad USD remained roughly stable over the past week despite a sharp drawdown in risky assets, likely in part due to the narrowing of rate differentials as markets priced out Fed rate hikes in ‘23 and beyond. But the defensive rotation visible in other asset classes was also clearly apparent in FX markets: commodity currencies and other high-beta crosses underperformed while safe havens outperformed. Over the coming 1-2 weeks we should learn much more about the transmissibility and lethality of the omicron covid variant, and the deep drawdown in many cyclical assets means that the near-term market trajectory could break in either direction depending on how the news flow evolves. But incoming data from South Africa continue to show rising hospital admissions, and tactical caution may still be warranted. For the USD specifically, risks are likely still skewed to the upside, even if omicron proves less damaging than feared, in light of continued strong U.S. data and hawkish signals from Fed officials. Over the past week a number of speakers have added their support to the “fast taper” option, in line with our economists forecast and opening the possibility of rate increases as early as March. Will any G10 central bank dial back rate hike expectations in light of the latest covid outbreaks? The BoE may be a candidate: the typically hawkish Michael Saunders said Friday that “there could be particular advantages in waiting to see more evidence on its possible effects on public health outcomes and hence on the economy.” There is still 6bp priced for the December 16 MPC meeting (and it remains our economists’ base case forecast, although now by a narrow margin), so a delay could imply additional GBP/USD downside.”