A Year in Review: What Happened on The FX Market in 2021
The globe turns
This year was one of recovery for the global forex economy and a shift of focus to inflation. Pandemic and supply chain disruptions have remained present, but contrary to expectations, growth concerns are placed second to inflation. The world’s currency is growing strong – USD’s strength against the EUR is one that stands out in particular in favor of the dollar.
Asia’s top performer has proved to be the renminbi with its main unit the yuan. Despite occurrences in China throughout the year, the CNY has remained on top given its trade surplus and strong bond inflows, though policy choices have also been of help. Other currencies that have been performing well against the dollar are the SGD and IDR.
The CEEMEA (Central and Eastern Europe Middle East and Africa) region has been going into a tightening phase initiated by the Czech National Bank and is still tightening. PLN’s downside is so far balanced with light foreign positioning. HUF’s volatility proposition is fastening, as elections are just around the corner. RUB is also holding its gains with a hawkish central bank to back it. TRY and ZAR have shown signs of vulnerability.
As the two major factors in the forex market movement of 2021, they will most certainly be relevant in the upcoming year as well. But what actually happened?
Central banks’ policy decisions are influenced by inflation data and that itself is a key subject of analysis in deciding whether to cut or raise interest rates. A currency’s value is pulled down if there is a cut and is boosted by high interest rates. That is why the consumer price index gauge of inflation is deemed of importance to forex market data releases. Economies reopening and ramping up activity leads to price increases and bottlenecks in the supply chain. As a result, we saw a 30-year high in the consumer price index (CPI) in the US to 6.2% and another 30-year high due to an increase in the eurozone’s CPI due to inflation to 4.9%, along with a 10-year high in the UK with inflation hitting 4.2%.
Though central banks have been insisting inflation is but transitory, after some of them changed their stance, currency pairs price movement has become more active The Fed’s hawkish stance since late November indicates that inflation may have completed its transitory run and is here to stay. He shared that acceleration in bond purchases due to tapering would increase interest rates, provoking the US dollar’s value to go higher.
The EU and UK central banks also took stances that would be important for the coming months. The Bank of England (BoE) followed suit not long after the Fed. It is currently expected that a hike in interest rates will take place in the February meeting. On the other hand, the European Central Bank (ECB) has been dovish and insists on the inflation rise being transitory, with forecasts predicting that next year we will witness a return to the 2% inflation rate. ECB’s reasoning appears to be rooted in the unemployment rate of 7.5% that is comparatively higher than that of the US and the UK. In their late run, the EUR/USD and GBP/USD have been weakened due to the divergence between central banks.
Unfortunately, this risk does not seem to go away. The spreading of the new coronavirus strain Omicron poses a threat to people across the world. Not much is known about the strain yet, but symptoms appear to be less severe than its predecessor. Keeping the virus at bay means that the forex market is also going to perform in relation to central banks’ decisions and divergences.