The daily obsession with Coronavirus is completely understandable, given the pace of events. Still, it won’t last forever, and markets seem to be positioning for brighter weather when the storm passes. The legacy of the Phase One trade deal between the US and China – limited as it may be – is a more positive trade outlook for 2020. Obviously, this outcome depends on the underlying speed of the global economy; after all, removing the parking brake doesn’t necessarily mean a car will move, only that you can now hit the gas. During the last year of political tumult, arguments among economists over this underlying speed have been fierce, not least because it's so difficult to prove what might be if something as complex as the trade dispute was to end. Now that we’ve had the deal, everyone is desperately seeking signs of the coming change, like rheumatic limbs predicting the weather.
If we are to search anywhere for signs of change, the market is no better place to start. Let’s first establish that transitioning from a slower speed global economy to a faster one is likely to have an impact on asset prices – risk assets should gain versus safe-haven assets. The effect on currency valuations is less clear, because it's dependent on the scale of the eventual asset reallocation when growth returns, but the safe-haven Greenback is expected to decline from its five-year-long trading range. To put this into context, the trade-weighted US Dollar Index is about 7% above the top of the prior range. After Trump’s infrastructure bill of 2017, the last time that growth was moving in a positive direction, the Dollar nearly breached that level. So how can we tell if this will happen again? To continue the car analogy, we are looking for the foot above the accelerator. One sign is that bets on EUR appreciation versus the USD have become the most positive in two-years. That’s really saying something because while the US was pulling the global economy along, the EU was experiencing patches of recession across its breadth. To show that the market is betting on reversal, in spite of the noise from China, is positive indeed.
Bottom line: Another sign of this reversal is to look at the relative difference between US Government funding costs between three months and ten years. Prior to the Coronavirus this was becoming positive once again – the sign of a so-called steepening yield curve. The fact that this has widened again is due to the viral outbreak, but we’ll be watching very closely for a rebound in this metric once the number of infected persons plateaus and markets start thinking long-term once again.
There was some great two-way price action for Sterling last week, as futures markets wagered on the future path of UK interest rates. On Monday, markets were pricing in a 60% chance of an imminent cut for the January Bank of England Monetary Policy Committee meeting, causing a bearish run 1% lower for the Pound against the Greenback. However, by Friday there was just a 20% chance of a cut at the next meeting in March, causing an almost 2% bullish run higher against the Dollar. This week, attention will turn to the future of UK-EU trade negotiations as markets look for clues as for what to expect over the coming months. The data calendar is light, so we expect trade news to dominate Sterling’s price action.
It’s set to be a big week for the US Dollar with plenty of data releases and global news stories which could provide the catalyst for price action in either direction. The most significant news story continues to be the global spread of Coronavirus, and we expect this to dictate the risk-on/risk-off sentiment throughout the week. Month-end flows and bets on the next US interest-rate cut caused a fall in the Dollar’s trade-weighted Index at the back end of last week, but sentiment for the Greenback has improved over the weekend.
The Euro’s trade-weighted Index may have finally broken out of its downward trend on Friday as the single currency posted an index gain of 0.5% on the day, after losing over 1.5% since the end of December. The Euro’s next level of resistance against the Dollar should come around the 1.11 mark, which represents both a psychological barrier and the 50-day moving average. It’s set to be a quiet week on the data front so expect news headlines to dominate price movements.