Thursday, January 23, 2020

Bank of Canada sends dovish signals; will the ECB unveil its framework review today?

Tags
  • Dollar
  • Gold
  • Euro
  • Stocks
  • Oil

Market Recap: Oil extends losses as virus death toll increases

Wall street ended mostly mixed on Wednesday after renewed worries that the new coronavirus could curb economic growth dragged on gains earlier in the trading session. The DJIA and S&P500 ended mostly flat, while the Nasdaq managed to edge out gains thanks to a rally in tech stocks. 

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The dollar remained mostly flat against other major currencies except the loonie and sterling. The loonie weakened against the dollar to as low as 0.7603 after the Bank of Canada (BoC) appeared to be more dovish on future monetary policy while leaving its current rates unchanged. Cable rose to as high as 1.3153 on Wednesday after business sentiment in the UK beat expectations of -20, surging to 23 from -44. The better-than-expected business sentiment in the UK sent the British pound soaring over the day as investors pared back on speculation for a rate cut by the Bank of England later this month. Cable ended the trading session 0.71% higher at 1.3142.

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Safe haven assets extended gains as investors hedge their risk against the new virus from China as death tolls rises to 17. Gold and the yen both gained on Wednesday. US Treasuries also continued rising, with benchmark yields falling 1bp to 1.77%.

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Oil continued to fall on Wednesday as outlook for demand sours. Brent and WTI crude oil futures tumbled for the second session in a row on Wednesday, both dropping more than 2%. WTI crude oil futures continued to decline early on Thursday, declining 2.03% as of 7.27am (GMT +4)

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Stocks in Asia looks set for losses on Thursday morning, as fear continues to drive capital flow out of equities. The Nikkei, KOSPI, ASX200, Hang Seng and Straits Times Index were all trading lower on Thursday morning. 

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P&G (after US market close), American Airlines (after US market close) and Southwest Airlines (3.30pm GMT +4) are set to release their quarterly earnings report today.

The European Central Bank (ECB) will having its first monetary policy meeting of the year today. Analysts expect the central bank to hold its rates at current levels and continue its Asset Purchase Program (APP) through the year. Focus will be on its framework review, which is expected to be launched today.

Economic releases for the day ahead include the ECB’s decision on monetary policy later at 4.45pm (GMT +4) and initial jobless claims in the US for the last week at (5.30pm GMT +4).

Todays’ Analysis: ECB likely to hold rates and quantitative easing at current levels

Today's European Central Bank (ECB) decision on monetary policy is unlikely to surprise investors. Rates are expected to remain unchanged and ECB officials are very likely to let the APP continue through the year. This is due to the aggressive easing that the ECB introduced in September last year, and as economic indicators in the EU continue to show improvement. Inflation in the EU rose from 1.0% in November to 1.3% in December. But headline inflation was driven mostly by transport which in turn was likely driven by higher oil prices during the month. ECB officials have little reason to stop its APP as a result and December's meeting minutes also highlight this. But investors expect this (overnight index swaps imply that a 0.3% probability for a rate cut is priced into the market) and the euro is unlikely to be driven by the decision.

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Economic data in the eurozone has also mostly improved since the last monetary policy meeting in December where the ECB had a more positive outlook for the European economy. Coupled with easing trade tension between US and China, the ECB should view global risks reducing. Although it will likely be cautious on the rising threat of US tariffs on EU goods and the most recent virus in China that looks to be spreading across several countries. The ECB should leave its economic outlook mostly unchanged as a result.

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Focus instead will be on the details for the framework review, which is expected to be released with today's monetary policy statement by the ECB. The review is set to end in around a year and broad outlines are likely to be highlighted at today's meeting. ECB President Christine Lagarde has already confirmed that the main focus of the review will be on all aspects of the ECB's price stability objectives. The central bank's inflationary target is likely to be a main topic for the review as the current target puts the ECB at a disadvantage when inflation starts to rise. Using an inflationary target of "close to but below 2%" sets expectations higher for the ECB to aggressively raise rates when inflation starts to rise towards 2%. A symmetric target is likely to be debated on and investors are likely to look out for a possible hard line 2% target.

Another area that the review is likely to focus on is its APP. The debate on its APP will likely be regarding the duration, composition and type of assets being purchased by the ECB. Climate change, another likely factor to be in the guidelines may however put pressure on the euro. If the topic of climate change is heavily included into the framework review, the timeline of the review may be affected as it will likely be a heavily debated topic. Lagarde has suggested that the ECB can consider incorporating climate change into its forecasts through its various outlets. But incorporating climate change into forecasts would imply certain biases, and ECB officials are likely to debate against this.
The final driver for both euro and sterling will be tomorrow's Markit Purchasing Managers' Index (PMI) report. For the eurozone, the market expects a pickup in manufacturing PMI, which will drive overall PMI in the bloc. PMI is also likely to improve thanks to receding geopolitical risk as a result of the phase one trade deal between China and the US, and as business sentiment in the bloc looks to be bottoming out.


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The UK’s PMI is expected to rise as well, especially after the UK elections and with trade tensions easing between the US and China. More jobs were also created in December, which is likely to spill over into January's PMI report as an indicator of business sentiment. A better-than-expected PMI should be expected for the UK in tomorrow's report. But tomorrow's PMI is also likely to factor into the Bank of England's (BoE) decision on monetary policy next week. We expect the UK's PMI to beat expectations for both the manufacturing and services sectors but still remain 51 or lower, which will continue to drive expectations for a rate cut by the BoE. Sterling should gain initially thanks to the better-than-expected economic data but retreat over the week as the market starts to price in a higher probability for a rate cut.

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Hence, the EUR/GBP cross should continue to remain little changed with potential downside risk (as a result of over emphasis on non-mandate considerations of the ECB's framework review) after today's ECB meeting. EUR/GBP is likely to range with an upper bound of +0.17% and lower bound of -0.10% from its current price as a result, with a possible downside potential of roughly 0.18%. Tomorrow, expect the sterling's gains to outweigh the euro's if both PMI reports beat expectations, putting downward pressure on the cross-currency pair of roughly 0.13%. In the medium-term, the sterling is likely to have more room to fall, as the market continues to price in a higher probability of a rate cut by the BoE at the end of January.

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