RECAP: Three key fundamental themes from this week
1) USD slides as US Covid-19 cases rise
By and large it has not been a good week for USD. Let’s examine two main reasons why…
The number one reason in my mind is the continued rise we have seen in Covid-19 cases this week. The US has seen cases rise by above 60k every single day so far this week, including a fresh record high number of cases yesterday of 67k. More alarmingly, deaths are finally catching up with the recent increase in Covid-19 cases and hospitalisations.
Looking at things on a state by state basis; cases are increasing now in most states, though the steepest curves are in Florida, Texas, Louisiana, California and Idaho (the same hotspots we have been talking about for the past few weeks). Deaths are at or close to record highs in these states also.
The worsening Covid-19 outbreak in the US is clearly going to act as a drag on the country’s economic recovery. Looking at other major economies such as China and the Eurozone, who are showing signs of continued economic improvement, the US economy is looking much more fragile. Faster global vs US economic growth is a recipe for a weaker USD, hence this week’s price action.
The number two reason, which is closely linked to the first reason is the Fed. More specifically, the Fed’s recent dovish shift. Over the last week, commentary from key Fed speakers has become increasingly dovish, starting with Fed Vice Chair Clarida said that the Fed WILL do be doing more stimulus in the near future.
Since then, numerous more FOMC voting members have expressed concern about a slowdown in US economic activity and the labour market in recent weeks amid the recent uptick in Covid-19 cases seen since mid-June.
Another concern being raised by some Fed members is the fact that the US government is yet to get its act together regarding further fiscal stimulus. Most importantly, emergency unemployment insurance measures are set to expire at the end of the month; many millions of Americans currently depend on this income support for their livelihoods – should it be pulled away, the Fed is becoming increasingly concerned about the devastating effect this would have on the US economy.
While the Fed are sounding more and more dovish, other major central banks (such as the ECB yesterday and the BoC on Wednesday) seemingly have less to worry about. Their countries have contained the virus comparatively better, and are feeling the economic benefits of this at the moment.
This central bank divergence: i.e. an increasingly dovish Fed, while ECB, BoC, BoE, RBA, RBNZ stay on hold/become less dovish is a BIG USD negative.
2) Bank of Canada – CAD liked the dovish tone
As expected, the Bank of Canada left rates on hold at the effective lower bound of 0.25%. Given uncertainty over the outlook, the bank did not release economic forecasts as most had expected it would. The key points of the statement were as follows;
On the economy…
- The BoC’s central scenario assumed that there would not be a second Covid-19 wave in Canada or the world, but it will still take the Canadian economy not likely to return to pre-Covid-19 levels until 2022.
- The BoC noted that the economic outlook is extremely uncertain, largely because of the unpredictable course of the virus (hence why they didn’t post updated economic forecasts).
- Compounding this uncertainty, the BoC expects that, as reopening progresses, many people will probably continue to fear contracting the virus and uncertainty about job security is likely to persist.
- As a result, both consumer and business confidence are therefore expected to remain subdued, restraining spending and employment, particularly in activities that involve in-person interaction.
- Moreover, the BoC said it expects economic slack to persist as the recovery in demand lags that of supply, which will likely create significant disinflationary pressures.
- In the press conference, Macklem noted that the bank is seeing flare-ups in the US, which, if it leads to the re-imposition of lockdowns, would impede the economic recovery in Canada.
On future policy…
- The BoC said that it would hold the policy interest rate at the effective lower bound (0.25%) until “economic slack” is absorbed and so that the 2% inflation target is sustainably achieved.
- Moreover, the BoC will continue with its LSAP (the bank’s QE programme), in which it will buy at least CAD 5bln per week.
- To support the recovery and achieve the inflation objective, the Bank is prepared to provide further monetary stimulus as needed and the Bank stands ready to adjust its programs if market conditions warrant.
By and large then, a very dovish tone to the meeting, both in the outlook on the economy and on assurance that the bank is ready to do more if needed.
However, CAD appears to have largely reacted positively, perhaps the mindset of the market is that a more cautious/dovish BoC will ultimately be a positive for the Canadian economy, hence the flows into CAD.
3) ECB Rate Decision – On hold, but cautious optimism
- The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.50% respectively.
- The ECB reiterated that it “expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics”.
- No changes were made to its QE programmes; the ECB said it “will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of EUR 1,350 billion. These purchases contribute to easing the overall monetary policy stance, thereby helping to offset the pandemic-related downward shift in the projected path of inflation.” PEPP purchases will continue until at least the end of June 2021 or until the ECB judges that the coronavirus crisis phase is over.
- Moreover, net purchases under the asset purchase programme (APP – this is the ECB’s pre-Covid-19 QE programme… it has two QE programmes for those confused) will continue at a monthly pace of €20 billion, together with the purchases under the additional €120 billion temporary envelope until the end of the year.
- Finally, the ECB said it “continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner, in line with its commitment to symmetry”.
In the Press Conference, as many had expected, Lagarde struck a cautiously optimistic tone, saying that incoming data signals a resumption of activity, although activity is still well below pre-Covid-19 levels. Moreover, she said that the Q2 GDP decline looks to be in line with ECB projections and that activity is now expected to pick up in Q3, though there is high uncertainty about the speed and scale on the rebound.
EUR was unresponsive, given that the meeting pretty much went down exactly in line with expectations. EUR traders have this week been much more focussed on the EU Council Summit, which started today and finishes tomorrow – if the EU can make progress towards a deal, this ought to trigger some decent gains for EUR.
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