- Risk-off sentiment continues to build as the coronavirus spreads
- Fed easing expectations continue to intensify; February inflation readings for the US will be reported this week
- The ECB meets Thursday and markets are split; the stronger euro is doing the eurozone economy no favors
- The UK has a heavy data release schedule Wednesday; UK government also releases its budget that day
- Japan has a fairly heavy data week; the yen continues to benefit from risk-off sentiment
Risk-off sentiment continues to build as the coronavirus spreads. Oil prices are down sharply after Saudi Arabia and Russia were unable to agree on output cuts, leading the former to flood the market with low cost oil. There will be a lot of collateral damage, including EM producers, DM producers, and US shale producers. NOK and CAD are likely to remain under pressure, as are RUB and COP.
The yen and Swiss franc are likely to continue outperforming. On the other hand, the dollar bloc, Scandies, and EM are likely to remain under pressure. The dollar itself is a puzzle to us. With US Treasuries rallying along with other safe haven assets, the greenback should also benefit. Yet DXY is trading at the lowest level since October 2017 and the September 2017 low near 93.80 is up next. We think Fed easing expectations are overdone (see below), but until these adjust higher, then the dollar is likely to remain vulnerable.
AMERICAS
Fed easing expectations continue to intensify. Next FOMC meeting is March 18 and WIRP suggests a 50 bp cut is fully priced and a 75 bp cut is nearly priced in. Either way, another 75 bp of easing is fully priced in by the April 29 meeting and one last 25 bp cut is nearly priced in by late 2020. This would take the Fed funds target range down to the crisis-era low of 0.0-0.25%. Before the cut, markets were pricing in 75-100 bp of total easing vs. 150 bp that’s now expected.
Could policy rates go negative in the US? We don’t think so. To us, there is no definitive example that suggests that negative rates work. The eurozone, Switzerland, and Japan have all tried negative rates but have little to show for it. If rates hit the lower bound and further stimulus becomes necessary, we think the Fed would favor balance sheet expansion over negative interest rates. With the media embargo now in effect, there will be no Fed speakers until Chair Powell’s post-decision press conference.
The US government is taking other measures to cushion the negative impact of the coronavirus. Senior advisor Kudlow said the White House prefers “timely and targeted micro-measures.” This was the first time that Trump officials have acknowledged the growing negative economic impact here in the US. President Trump signed a bill Friday authorizing $8.3 bln in emergency spending. Elsewhere, reports suggest that the travel and tourism industries may be allowed to defer tax payments until their situations improve.
February inflation readings for the US will be reported this week. Data have taken on even less importance in light of last week’s surprise Fed rate cut and growing coronavirus fears. To wit, last Friday’s blockbuster jobs report (+273k) had little impact on markets. CPI will be reported Wednesday. Headline inflation is expected to ease to 2.2% y/y from 2.5% in January, while core inflation is expected to remain steady at 2.3% y/y. PPI will be reported Thursday. Headline inflation is expected to ease to 1.8% y/y from 2.1% in January, while core inflation is expected to remain steady at 1.7% y/y.
Other minor US data will be reported. February budget statement will be released Wednesday, where a -$238.5 bln deficit is expected. If so, the 12-month total would rise to a new cycle high of -$1.077 trln. Weekly jobless claims will be reported Thursday and are expected at 218k. February import/export prices and preliminary March University of Michigan sentiment will be reported Friday. Headline sentiment is expected to drop to 95.0 from 101.0 in February, with both current conditions and expectations seen falling.
US Q4 GDP growth was unrevised at 2.1% SAAR, and Q1 is on a similar pace. The Atlanta Fed’s GDPNow model estimates Q1 GDP growth at 3.1% SAAR vs. 2.7% previously. Elsewhere, the NY Fed’s Nowcast model estimates Q1 GDP growth at 1.7% SAAR vs. 2.1% previously. Both models were updated Friday. Yet it’s clear that markets are betting on a sharp slowdown in Q2, with an uncertain recovery outlook.
EUROPE/MIDDLE EAST/AFRICA
The European Central Bank meets Thursday and markets are split. The analysts polled by Bloomberg are tilted 30-21 in favor of steady rates, but WIRP suggests over 75% odds of a rate cut vs. less than 50% a couple of weeks ago. It will be a very close call but either way, the bank will have to do a 180 from its upbeat stance at the previous meeting. With Germany and Italy already slipping towards recession in Q4, the growing headwinds must be acknowledged. That said, going more negative on rates will face resistance.
Yet the stronger euro is doing the eurozone economy no favors. So far today, the euro is trading at its highest level since January 2019 near $1.1495. The January 31 from that year near $1.1515 is up next, followed closely by the January 10 high near $1.1570. Draghi often pushed back at euro strength during his tenure, let’s see how Lagarde approaches it. We believe she will have to try and prevent further gains.
Germany reports January trade, current account, and IP Monday. Exports are expected to rise 0.9% m/m, imports by 0.5% m/m, and IP by 1.7% m/m. France and Italy both report IP Tuesday and are expected to rise 1.8% m/m and 1.6% m/m, respectively. Eurozone IP will be reported Thursday and it is expected to rise 1.4% m/m. Yet this is all old news. With the industrial north of Italy shutting down, there are clear downside risks building.
The UK has a heavy data release schedule Wednesday. January GDP, IP, trade, and construction output will all be reported. GDP is expected to rise 0.2% m/m, while IP is expected to rise 0.3% m/m. The trade balance is expected to return to a small deficit of -GBP356 mln, while construction output is expected to be flat m/m. The UK is seeing a small bounce so far in Q1, but the road ahead is rocky.
The UK government also releases its budget Wednesday. With Javid gone, markets are looking for more expansionary budget. Officials said recently that the budget would reflect the economic impact of the coronavirus. Incoming BOE Governor Bailey last week pledged to work with the Treasury to help shield the economy from the impact of the coronavirus. WIRP suggests nearly 100% odds that the BOE cuts rates at the next meeting March 26. Sterling is lagging the euro and so the EUR/GBP is trading at its highest since October 14. With the break above the .8740 area, that month’s high near .9020 is the next big target.
ASIA
Japan has a fairly heavy data week. January current account and final Q4 GDP data were reported earlier. The adjusted current account surplus came in close to expected at JPY1.6 trln, while growth was revised down sharply to -7.1% SAAR vs. -6.6% expected and -6.3% previously. February machine tool orders will be reported Tuesday, followed by February PPI Thursday.
The yen continues to benefit from risk-off sentiment. USD/JPY is trading at the lowest level since 2016. The November 2016 low near 101.20 is up next, followed by the September 2016 lows near 100.10. Ultimately, the June 2016 low near 99 is within reach. Reports suggest the BOJ views 100 as the line in the sand. As that level approaches, the bank is more likely to take action to weaken the yen.
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