A test of patience
Today’s news headlines:
‘Markets shift to bet on UK interest rate cuts’. Money market investors are pricing in a Bank of England interest rate cut at this month’s monetary policy meeting in response to the economic threat of the coronavirus. Economists at Goldman Sachs have warned that the impact of the virus could push the UK economy to the brink of recession in the coming months. There is also a small chance that the Bank of England will cut rates by 50bps to equal the all-time low of 0.25%. UK bond yields have tumbled to historic lows on expectations of a longer period of low interest rates. (Financial Times)
‘German orders rebound just as coronavirus disruption about to grip’. January’s German Factory Orders data signalled that the two-year downturn in the manufacturing sector was about to end before the sudden outbreak of the coronavirus. A marked increase in foreign demand, especially in other Eurozone countries, prompted the orders to rise by 5.5%, the biggest gain in over five years. Unfortunately, the widespread supply-chain disruption from the coronavirus will probably curtail the recovery before it’s had a chance to take hold. (Financial Times)
The entirety of this week has been an agonising test of patience, hoping that the virus-induced market sell-off has found a bottom. As it turns out, there’s further downside to be endured. After wavering around the 200-day moving average since Tuesday, the trade-weighted US Dollar has taken a sharper turn downwards. In a similar fashion, the trade-weighted Euro has rocketed off it’s 200-day moving average and has continued to appreciate, which indicates a fresh wave of risk-aversion entering the market.
Early in the week, the main oil benchmark, Brent Crude, had seemingly bottomed around the $48 per barrel level, signalling a limit to the decline in fuel demand. The OPEC+ cartel was, even then, positioning itself for further supply cuts. Russia, which has a lower cost of production was partial to a wait-and-see approach – but to date nothing has been agreed. As the week has progressed, we find Brent Crude approaching the low once again and with more conviction. Good, bad, or ugly, economic data has truly fallen by the wayside; further patience is required, so strap in, as the second ride is about to begin!
Bottom line: Pressure remains high on central banks to ease policy into the next stage of the virus scare, until it’s clear how much business conditions will be impacted. Again, the heavy lifting must come from national government levels – targeting assistance to SMEs who are most vulnerable to disruptions – but the expectation for central bank action has only risen since the Federal Reserve's cut this week. In fact, the market is pricing in a further 50bp cut for the Fed meeting next week and near 0% interest rates by mid-year. In contrast, only a further 10bp is expected from the European Central Bank, which is already at -0.5% deposit rates and probably doesn’t have much room for movement.
The US Dollar has continued to sell-off in the face of the economic threat posed by the coronavirus as US Treasury yields plunge to all-time lows. This has effectively wiped out the currency’s advantage of higher interest rates when compared to its most significant trading partners. Sterling has continued its climb back towards the 1.30 interbank level, and the current trend could see this level broken at some point today.
The currency pair has bounced off the 200-day moving average three times in the past few days, and we’re watching to see if this level is tested again today. We could see the Pound come under some renewed selling pressure if markets begin to price in an interest-rate cut larger than 25bps this month.
We’ve seen a continuation of the decisive shift higher for the pair, which is approaching a 5% increase since the low of 1.0778 on February 20th. The benefit of USD carry trades is dwindling fast, meaning that currency flows have shifted into the Euro and Japanese Yen despite a void of positive fundamental data. Expectations of future US interest rate cuts might continue to drive the Dollar’s value in the near-term.