28 Jun 2021

FX in 2021 - a game of two halves

Demitri Theodosiou

Head of FX and Interest Rates Trading

Welcome to the first in our new “Thoughts of an FX Trader” article series, providing regular insights from Investec’s foreign exchange desk on the big issues and trends in currency markets. In this article, Demitri Theodosiou, Head of FX and Interest Rates Trading, takes a look at how inflation may impact currencies in the second half of the year.

The current European Football Championships have been a great way to introduce my two young boys to watch football. Fans are back in stadiums, the atmosphere pours through the TV, and England is playing well with the chants of “football’s coming home” ringing out. Before kickoff, the kids run to the “treat cupboard” in the kitchen and get some sweets or crisps to have while watching the game with me. I couldn’t help but be distracted through the start of a recent game by exactly how small the packet of crisps and sweets had become – I’m sure we’ve all noticed the Christmas tins of sweets aren’t as big as they were in our childhoods too!

 

The economic term for this is “shrinkflation” - the business practice of reducing the size or weight of a product while keeping its price the same. Put simply, it gets more expensive because you’re getting less for your money. The conspiracy theorists have been hot on this in recent years. They argue that shrinkflation does not get picked up by common measures of inflation, such as the Consumer Price Index and the Retail Price Index, which helps keep them subdued. While the image in my head of angry people counting the number of Skittles in the bag is probably an exaggeration, it has been an interesting issue over recent years when low inflation has significantly shaped economic policy.

"FX markets are currently steady, with currencies trading in narrow ranges, like a nervous 0-0 first half, awaiting the first goal as a catalyst for the game to open up."

                                                                             - Demitri Theodosiou, Head of FX and Interest Rates Trading

However, the time when retailers could hide price increases in ever-shrinking packages may be about to come to an end. As the world reopens after the pandemic, a combination of pent-up demand and officials pouring monetary and fiscal stimulus into their economies appears to be spurring the green shoots of inflation. Raw material prices are already on the rise, and both the US and UK have seen higher inflation prints in the last month. The real question is whether central banks will act or let inflation run hot as they see it as transitory due to the current extraordinary circumstances.

Either way, the return of inflation and the timing of any stimulus withdrawal or policy tightening is front and centre in the minds of traders and investors alike. This may well develop to be the central macro theme in FX markets in the second half of the year. For now, we watch the inputs to inflation, such as raw materials and labour costs, to follow the story as it unfolds. FX markets are currently steady, with currencies trading in narrow ranges, like a nervous 0-0 first half, awaiting the first goal as a catalyst for the game to open up. Much like football, if inflation keeps rising, this year could turn out to be a game of two halves.

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