Head of FX Strategy
Summary: The Bank of England is the first central bank to fire an impressive policy bazooka today with additional measures aimed at SMEs on top of a surprise 50 basis point rate cut. Sterling initially sells off but stabilizes quickly, likely as the market knows that every other central bank and fiscal authority will be pulling out the stops to support their economy as well.
Trading interest
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Markets were all over the map yesterday as Trump first teased a stimulus and then failed to deliver – a sign of his administration’s dysfunction. A larger package needs involvement from the US Congress, which holds the power of the purse, and House leader Pelosi indicated. In addition, the discussion of a payroll tax cut is very expensive in fiscal terms and the wrong medicine: any stimulus to deal with the specific risks of the coronavirus outbreak will have to be in the form of cash drops into the economy and credit forbearance to keep people fed and businesses from shuttering their operations and firing employees. The US response is to the coronavirus is an unfolding tragedy that will get far worse.
The Bank of England shot a big and effective bazooka today in cutting rates 50 basis points, but more importantly, ripping open the liquidity taps with a massive four-year funding scheme for banks with special incentives for SME’s, dubbed the TFSME. As well, the countercyclical buffer requirements were sliced to 0% from 1% - the measures together releasing something on the scale of £300 billion of funding. Already before today’s BoE, we saw the announcement of a fiscal stimulus of impressive scale, at £600 billion over the next five years (mid-2025), well north of 25% of current nominal GDP. The BoE and the UK government are going to keep the system liquid – rest assured!
ECB President Lagarde was out with strong language today on the scale of the current crisis, and given the advanced state of the coronavirus, she will need to trot out a very large bazooka at tomorrow’s meeting. Look for something very large along the lines of ensuring the banks stay solvent (buying bank senior debt, massive TLTRO against SME loans, etc.). I hope they avoid more negative policy cuts, which are counterproductive at this point – but this may be forthcoming as well.
Chart: EURGBP
The surprise rate cut from the BoE today saw a sharp knee-jerk lower in sterling, with EURGBP trading to almost 0.8850 before reversing sharply lower. The scale of the reversal suggests some underlying strength in sterling here as the UK yield curve steepened on this, perhaps on the news yesterday indicating the very large scale of the fiscal package to come. In other words, the market sees the UK as having the potential to getting ahead of the curve eventually. EURGBP is certainly a risk to trade given the sharp pickup in volatility, and the ECB meeting tomorrow is the first major test of Europe’s response to the crisis, but we will look for ways to short the pair if the ECB fails to inspire the rally to sustain above the 200-day moving average.
The G-10 rundown
USD – the USD is turning lower is our new strategic conviction – the difficulty in the near term being the risk of back-filling – first we like it lower versus JPY, EUR and then GBP, eventually elsewhere, but possibly too early.
EUR – the ECB will go bigger than we think tomorrow and we will need to see the follow-up from EU politicians for the market to gain some confidence in their efforts. They will prevent a replay of the sovereign debt crisis for now – but the key to watch is not just the ECB’s efforts here, but the longer term willingness of the EU core to allow fiscal expansion across all of the EU.
JPY – the JPY is lower as bond markets have corrected violently after their parabolic ascent. Still see an eventual move to at least 100.00 in USDJPY.
GBP – sterling stabilizes quickly after the surprise cut as the additional BoE measures are the right medicine to bolster UK confidence. GBPUSD closing back above 1.3000 would be a start for a technical comeback.
CHF – the franc trades like a non-entity in these markets – curious how the market continues to trade the franc as the country’s economic base and therefore current account surplus are at risk of a major impact from the current activity shutdown.
AUD – the talk of the town is QE, but fiscal is the more important signal Down Under and will soon be on its way. Still, it is too early to call a bottom on the risk that the market has yet to absorb the possible scale of the hit to the global growth outlook this year from the coronavirus.
CAD – Further upside risk in USDCAD if oil prices stay low as this will heavily impact Canada’s too oil-dependent economy. The private leverage problem in Canada has to produce a credit crunch that will compound the negative risks for Canada’s outlook.
NZD – AUDNZD pushing to major lows - long term value with no short term technical reason to buy.
SEK – EURSEK is one to watch as the EU transitions to fiscal stimulus and Sweden will have to follow suit – a more bold Swedish fiscal move is needed to jolt the SEK out of its . In favour of cautious long term exposure to downside options strategy – but only perhaps 30% of a full position.
NOK – unwilling to call a bottom in the oil market and therefore in NOK for now on the further risk from the price war together with the rolling demand shock.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
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