This week’s major theme has been a deterioration in broad market optimism about growth and reflation, with the US dollar and back-end sovereign bonds the main beneficiaries of the move.
Considering rising coronavirus case counts and the resulting increases in restrictions on economic activity being seen across many western economies, the deterioration in overall risk appetite makes sense. The other major change in market pricing over the past fortnight has been in expectations of a win for Joe Biden in next month’s US Presidential election. Judging the reaction of the dollar to various scenarios from November onwards is a difficult task that we will undertake in an upcoming note. For now, a pertinent observation is that the recent increase in Biden’s odds has not been accompanied by a sudden reflationary steepening in US rates, or dollar weakness – although there has been a tentative correlation between his market-implied odds of victory and the steepness of the US yield curve.
Biden’s perceived election chances loosely correlated with steepness of US sovereign curve
While this repricing has taken place in global macro markets, the key parameter of Brexit news flow – the ratio of signal to noise – has remained unchanged at a very low level. As of the time of writing, Boris Johnson has not withdrawn from talks with the EU, but following EU leaders’ unyielding statement following yesterday’s summit, the UK Prime Minister has attempted to raise the stakes of the next few negotiations by calling on the UK to prepare for no deal, euphemistically dubbed an Australia-style trading arrangement. Following comments earlier in the month from David Frost that the UK is willing to “go further than you’d expect” on state aid, our base case remains that a narrow free-trade deal will be struck this year between the UK and EU.
The events of the last few weeks have shown that sterling retails a high sensitivity to Brexit news flow, and so if Johnson’s posturing s leads to a collapse in talks the pound likely has further to fall.
China’s economy is expected to grow 5.5% YoY in Q3 when the data is released on Monday at 03:00 BST. This would place China’s economy in expansionary territory, with growth at around 0.7% year-to-date. Posting positive growth figures for 2020 is no mean feat and highlights the robustness of China’s economic recovery from the pandemic. While much of this has been driven by China’s economy being the first in and first out of the global pandemic, unlike other major economies China hasn’t battled with a rising second wave. The data in Q3 is reflective of this, and will likely see manufacturing investment and a rebound in consumption take over from industrial production in driving the next stage of the recovery. Investors will keep a close eye on whether external demand conditions are starting to drag on China’s rebound, however. The afternoon will feature six speakers from the Federal Reserve, ECB, and Bank of England. The highest profile speakers will be Fed Chair Jerome Powell (13:00 BST) and ECB President Christine Lagarde (13:45), with the latter’s speech coming after interesting this week on the ECB considering climate impact as a factor in bond-buying.
A busy morning for the Australian dollar, with Reserve Bank of Australia Assistant Governor Christopher Kent speaking at 00:00 BST, followed at 13:30 by minutes from the Bank’s latest meeting. Both are discussed below in the context of recent AUD moves and RBA policy signaling. Several mid-tier releases will dot the rest of the morning, including German producer prices at 07:00 and the Eurozone’s current account at 09:00. Headline inflation was -0.3% in the Eurozone in September, while core inflation was a mere 0.2% – although this is not quite enough to force new stimulus from the ECB, producer prices are a major leading indicator for headline inflation, and Germany is the Eurozone’s largest economy. A miss here will not go unnoticed by policymakers. US housing starts and building permits will be released at 13:30 BST.
Beneath the surface of the attention vortex that is Brexit, anticipation of negative interest rates from the Bank of England has been developing as a relevant theme for sterling.
Inflation data will be released at 07:00 BST, with the median forecast submitted to Bloomberg expecting a solid pickup from August’s 0.4% contraction in the headline consumer price index. Another contraction will undermine the BoE’s expectation for a relatively rapid rebound in prices, as would a miss in the core index. At 13:10, the Bank of England’s David Ramsden will give a speech entitled “UK Monetary Policy: Issues and Outlook”. The Deputy Governor for Markets and Banking recently commented that “at present, negative policy rates would be less effective as a tool to stimulate the economy”. The comment belies the fact that according to August’s Monetary Policy Report, the committee believes negative rates may be effective during the ‘upswing’ phase of economic recovery, when banks were less concerned about balance sheet risks. At 13:30, Canadian inflation data will be released alongside monthly retail sales.
Germany’s GFK consumer climate survey will be released at 07:00 BST, followed by speeches from the Bank of England’s Chief Economist Andy Haldane at 09:30 BST and Governor Andrew Bailey at 10:25. Both are regular speakers, and neither speech appears to be an opportunity for major enlightenment on the Bank’s policy path. The Central Bank of the Republic of Turkey will release its latest rate decision at 12:00 BST. The previous policy meeting saw the benchmark one-week repo rate rise by 200 basis points, but ongoing economic and geopolitical risks have continued to weigh on the lira, which has regularly reached new all-time lows over the past month. Further rate hikes seem likely, after the central bank unsuccessfully attempted to arrest the lira’s slide using only liquidity tightening measures earlier in the year. Weekly initial jobless claims will be released in the US at 13:30 BST and will remain a highly relevant data point after last week’s print showed an unexpected increase in claims, to almost 900,000. Weekly claims are a noisy series, and one high print is not enough to draw inferences from – but a second miss may start to seriously weigh on expectations for net job creation in October.
Eurozone Purchasing Managers’ Indices from October are scheduled for release on Friday morning from 08:15 BST onwards, and will paint a narrative of whether the risk of a contracting economy is rising amid the resurgence in case counts throughout the bloc. The composite PMI fell to 50.4 in September, down from August’s 51.9, and is expected to continue to fall to 49.5, bringing the index into contractionary territory. The lion’s share of the fall is likely to come from the services PMI as renewed lockdown measures throughout the eurozone have made the services sector face a difficult reality, with risks of decreased turnover looming. Additionally, the arrival of lower temperatures make it difficult for restaurants, bars and cafes to arrange seating outside, limiting the number of guests to the indoor space that allows for safe social distancing. Any downside surprises to the reading may not startle FX markets too much, as much of it may already be priced in by markets given the recent uptick in virus cases, both globally and in the eurozone. German and French PMIs are set to show a similar discrepancy between the services and manufacturing sector, with services expected to print below the 50-mark and manufacturing set to print just above. Equivalent indices will be released for the UK at 09:30 and US at 14:45, while the Central Bank of Russia will announce its latest rate decision at 11:30 – discussed below.
GOING BEHIND THE SCENES OF THE RBA’S DOVISH TURN
Recent speeches from Governor Philip Lowe, Deputy Guy Debelle, as well as the latest official policy statement all signal that that Reserve Bank of Australia is considering options for enhancing accommodative monetary policy. Lowe, who previously emphasized the limits of monetary policy in speeches and voices opposition to negative interest rates, gave a speech last week clearly signaling greater openness to more easing. The Governor pointedly noted that Australian 10-year sovereign yields were among the highest in the world. Debelle helpfully outlined possible policy options, such as more asset purchases, purchases of longer-dated assets, as well as the obvious option of further rate cuts. AUD has been among the worst performers in the G10 space so far this week, partly due to general risk dynamics but perhaps also due to the RBA’s increased willingness to look at further easing. The RBA’s Assistant Governor Chris Kent will give a speech at 00:00 BST on Wednesday morning, followed 90 minutes later by official meeting minutes. Both will give further colour on the nature and timing of any potential policy action from the RBA.
Aussie yields plunge amid dovish RBA pivot
CBR TO HOLD RATES DESPITE WORSENING VIRUS OUTLOOK
The Central Bank of Russia cut its benchmark interest rate from 6.00% to 4.25% over the course of the pandemic, but left rates unchanged in its September meeting for the first time in four meetings as the economy had outperformed its forecasts and inflation had firmed. The MPC did stick to guidance that allows for more monetary easing, which would be contingent on both political and viral developments.
For this week’s meeting, another hold is expected by the majority of economists who submitted their forecasts to Bloomberg, with only 20% of the submitters expecting a 25 bp rate cut.
Another quarter-point reduction at this week’s announcement may not be ruled out entirely, especially as the economic recovery in Russia is losing momentum amid a worsening virus situation. The nation repeatedly reported record daily increases in both cases and deaths over the past week, with the total case count now standing at 1.36 million. In terms of data, Russian industrial output showed no improvement in September with a drop of 5.0% year-on-year. The risk of a continuation of negative surprises in output may be a reason for the Bank of Russia to maintain a dovish stance, especially in combination with the worsening virus outlook.
Despite the recent developments however, we expect the CBR to hold rates for now. The finalisation of the Russian budget drafting process which is scheduled for December and the ongoing uncertainties around the US elections could stand in the way of the CBR’s forecasts. We do believe another rate cut by year-end is possible given the virus outlook and global growth concerns, but the CBR may want to clear the current uncertainties before considering further easing.
CBR’s market implied policy rate broadly unchanged since the September meeting
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Ima Sammani, FX Market Analyst