FX Update: Policymakers readying their bazookas

Trading interest

• Stopped out of GBPUSD longs – but re-establishing a 1.3200 3-month long call option position (129 pips with spot at 1.2940 this morning)
• Stopped out of USDJPY shorts – still like lower but holding for now – limit sell interest above 106.00 with stops above 108.00.

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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.