Over the weekend, the Federal Reserve took dramatic action by cutting interest rates by a full percentage point to 0-0.25%, and promised to purchase an additional $700bn in bonds. The Bank of Japan also agreed to act as necessary, promising to double its monthly asset purchases. The Bank of Korea cut rates from 1.25% to 0.75%, while the Reserve Bank of New Zealand cut from 1.00% to 0.25%. The market’s reaction was surprisingly one of panic rather than relief. S&P 500 index futures are down nearly 5% heading into the US market open, auguring another day of declines.
On Friday, the S&P 500 index seemed to have reached a bottom and made a considerable rebound through the sessions, closing nearly 9.0% up on the day’s low. European equities, which we have argued were at much loftier levels versus underlying fundamentals, have continued their downward trend. Some of the pessimism surrounding European equities can almost certainly be laid at European Central Bank President, Christine Lagarde’s feet, as she appeared to deviate from Mario Draghi’s ‘whatever it takes’ paradigm. Lagarde was forced to explain her position shortly after the communication, but the damage has already been done. Even at the tense part of this market sell-off, there exists a reticence among some of the Skandi-Germanic contingent to countenance European debt mutualisation – which is political jargon for ‘they’re on their own’!
Bottom line: The Fed’s bold and decisive action will allow capacity for other national central banks - particularly those with large US-denominated debt which face repayment with rapidly depreciating currencies - to follow suit. Even if it isn’t the medicine we need, it is the medicine we have; efforts from governments to contain their various responses remain firmly behind the curve.
The week ahead
The trade-weighted Sterling Index had a dismal week last week, dropping almost 6%. The Pound reached lows of 1.2265 against the US Dollar, having opened the week at 1.32 and bottomed out at 1.1049 against the Euro, after falling from 1.1552. Chancellor of the Exchequer, Rishi Sunak delivered an expansive budget, adding £30 billion of fiscal stimulus, and the Bank of England cut interest rates by 50 basis points in a coordinated effort to support the UK economy amid the COVID-19 outbreak. A light week ahead for UK data does not mean a quiet week for Sterling. FX volatility across the board is heightened as markets try to digest the impact of the coronavirus pandemic on the global economy.
- Labour market data is the only notable release this week, including the Average Earnings print. An uptick in earnings growth is expected, as 3.0% growth is forecast for the last three months over the past twelve. This is up from 2.9% previously. Unemployment is expected to stay flat at 3.8%.
The US Dollar regained its safe-haven status, recovering most of its losses in recent weeks, following the initial stock market crash and the emergency interest rate cut a couple of weeks ago. We begin this week’s trading with another emergency interest rate cut by the Federal Reserve. The Fed cut rates by 100 basis points last night, bringing their effective rate band to 0-0.25%. Despite the drastic move, the trade weighted US Dollar Index is so far relatively unchanged. Economic data is likely to take the back seat again this week.
- On Tuesday afternoon, month-on-month Industrial Production is expected to come in at 0.4%, up from -0.3%.
- Wednesday’s Building Permits is forecast to show no slowing down in the US housing market with an expected 1.5 million increase.
- Thursday’s Philly Fed Manufacturing Index is forecast a 10.2 reading, down from 36.7 previously.
The Euro’s recent rally came to an end early last week, falling nearly two percent over the course of the week. This translated to four-and-a-half cents lost against the US Dollar, but Sterling’s more dramatic fall led to a 4% gain against the Pound. The European Central Bank had its official policy meeting last week, but surprised markets by not cutting interest rates as expected. However, other stimulus measures were implemented and a change in policy to encourage greater fiscal spending was introduced. The policy decision echoes Chief Lagarde’s recent plea for fiscal policy to carry the burden of an economic downturn.
- The German ZEW Economic Sentiment reading is forecast to come in at -25, a sharp downturn from last month’s 8.7.
- German PPI month-on-month is expected to show -0.2% price growth, down from 0.8% growth last month.
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