COVID-19 has shifted from the forefront of market participants’ minds, with a surge in new infections in the UK last week barely causing a stir to the Sterling. As per Bank of America’s latest Global Fund Manager survey, inflation, a ‘taper tantrum’ and asset bubbles all now rank as bigger concerns for institutional investors. This is thanks to the rapid development and deployment (at least in the US & Europe) of vaccines that based on UK data certainly appear to have broken the link between cases and hospitalisations. As a result, the UK government is confident in the latest figures. New Health Secretary Sajid Javid all but confirmed last Monday that ‘Freedom Day’ will proceed on 19 July as planned.

The data are unquestionably positive but are markets underplaying the significance of the delta variant, which is two-to-three times more transmissible than the initial strain? COVID-19 remains disruptive from an economic perspective, something that we are clearly seeing in high-frequency data. OpenTable reservation figures show UK restaurant bookings are down sharply since the delta variant took hold in early June, while Bank of England (BoE) card spending data are trending in the wrong direction. It may be that consumers are waiting until 19 July to splurge again and the potential end of self-isolation rules for those vaccinated would act as a significant tailwind, but for the first time since January/February, the clouds are beginning to darken somewhat. Given lofty UK growth forecasts and expectations for a consumer spending boom are underpinning BoE rate hike bets, it is unclear for how long Sterling can remain immune to the trend in the data.

One factor in Sterling’s favour is that the spread of the delta variant is not a distinctive risk facing the UK. The strain now accounts for 25% of cases in the US and between 15-25% of new infections in France and Germany, with the experience in the UK suggesting it will quickly become dominant. The UK has a considerable lead in the vaccination race over these countries, with 66.3% of the population having received one dose, versus 54.2% in the US and 51.3% in the EU. This suggests it is better positioned to cope with the current surge without having to rely on re-introducing measures to curb economic activity.

That said, the bar for the re-introduction of restrictions in the US appears high, as states adopted a more light-touch approach over Q4 2020/Q1 2021 as the virus became politicised. As such, a surge in US cases may not emerge as a major headwind for the Dollar. In fact, it is quite likely that the virus could benefit the Dollar, either on the back of the safe-haven demand if its spread elsewhere sees investor risk appetite sour or if it prolongs global supply chain issues, pushing US inflation higher and bringing forward expectations for US rate hikes.

In contrast, there is a real risk that a surge in cases on the continent will see the Euro soften, due to the negative impact on the key tourism sector in Southern Europe (accounts for anywhere between 10-20% of GDP). We have already seen Portugal re-impose a night-time curfew, with restaurants in Albufeira ordered to close at 15:30 over the weekend. To date, these developments have had a negligible impact on the Euro, but it is striking that the Travel and Leisure sub-index of the Euro Stoxx 600 index is down some 6.0% since mid-June. As cases climb higher in the coming weeks, as the WHO is guiding is likely, markets may begin to question what a second year of drastically reduced tourism revenues implies for already weakened labour markets in periphery economies, pushing the Euro lower.

Overall, while COVID-19 may be gaining less attention, there is still potential for the virus to regain its role as a market mover over H2 2021. As we saw last summer, nothing can be taken for granted when it comes to the pandemic.

Week Ahead

Dollar

The US macro schedule in what is a holiday-shortened week (Independence Day) should see the recent bout of Dollar strength remain in place, though the greenback may struggle to build on its gains. Attention will largely focus on the release on Wednesday evening of the minutes from the Fed’s June policy meeting, which was the catalyst for the rally in the Dollar back in mid-June.

We have heard from a raft of Federal Reserve speakers recently, suggesting a significant amount of new information may not be conveyed. However, markets will still look to the minutes for more insight into what prompted the change in the central bank’s dot-plot. Previously officials were forecasting the fed funds rate would remain unchanged through 2023, but now the median projection is for an increase in the central bank’s policy rate from a 0.00-0.25% range to 0.50-0.75% by end-2023. Our own view is that traders overreacted to the change, given the dot plot has historically been a poor guide for the future path of the fed funds rate and as it is unclear what role it plays under the Fed’s new ‘outcome-based’ policy approach. However, with US jobs growth starting to pick up, inflation remaining elevated and markets doubting the Fed’s commitment to maintaining its accommodative policy stance, we expect the Dollar to remain well-supported in the near term.

Data-wise, the headline reading of the June non-manufacturing ISM is unlikely to be of much interest to Dollar-watchers. Another strong print is overwhelmingly likely, with the services sector continuing to rebound strongly from the pandemic as restrictions on activity in California and New York were further rowed back in the month. The ‘prices paid’ sub-index may attract outsized attention and could offer some support to the Dollar at the margin if it points to a further build-up in inflationary pressures. Last Thursday, the sub-component of the manufacturing index jumped to its highest level since 1979.

Sterling

There isn’t a huge amount out in the UK to influence Sterling in the coming days, though the macro calendar has a busier look to it on Friday. From a data perspective, we’ll get the ONS’ estimate of May GDP in the morning, which is expected to show a modest deceleration in growth from 2.3% m-o-m in April (when non-essential retail and outdoor hospitality re-opened) to 1.7%. High-frequency indicators (namely card-spending data) suggest bad weather in the second half of May poses some downside to the consensus forecast, though it will take a very weak figure (sub 1.0%) to generate a move in Sterling. BoE Governor Bailey is also scheduled to speak on Friday, but he is unlikely to offer any fresh insights after his comments last week sent Sterling lower.

Euro

We expect the Euro to continue to struggle for direction this week. We do get some ‘hard’ data for May, including industrial production figures from Germany, France and Italy, as well as Eurozone retail sales. The releases look set to confirm that growth rebounded in May as the continent emerged from April’s lockdowns, but the data are not typically movers for the Euro. Generally speaking, we expect that Eurozone data will largely be overlooked by markets in the near term, as a cyclical recovery in output is largely priced in for Q2 and Q3 by this point. On the monetary policy front, the ECB will also release its account of its June policy meeting on Thursday. However, given the meeting was something of a non-event, the publication of the minutes is also unlikely to be a mover for the Euro.

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