Morning Commentary: Ready, Set, Hold

Foreign Exchange - Morning Commentary
Ready, Set, Hold
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The Reserve Bank of Australia (RBA) returns from its summer break and will deliver its reassessment of the Australian economy as well as its latest rate decision tonight. 

While better weather has helped with the bushfire crisis, many large fires remain burning.  So far, the land burned is already 10 times larger than what was burned during the Amazonian fires in 2019.  The ongoing drought that Australia has been in for 2 years as well as the coronavirus outbreak only amplifies the negative near term headwinds, and skews the actual slowdown towards the upper end of analyst estimates. 

Given these factors, it would be understandable if the RBA were to cut rates in order to support growth and sentiment.  After all, the board did have an easing bias at its December meeting.  However, there are reasons to believe the bank will hold steady. 

From a historical point of view, the bank has looked through natural disasters in the past as the hit to growth and sentiment has been relatively short lived.  Case in point, the Queensland floods and cyclone in Yasi.  Moreover, the fact that we are still in early innings makes it difficult to assess, with confidence, the magnitude and duration of drag on growth.  If anything, data was actually on the upswing at the end of 2019 and the drop in Chinese tourists due to the bushfires could limit the impact from the coronavirus. 

Pulling away from the data, the RBA’s cash rate is near the effective lower bound.  Cutting rates further would make unconventional measures more likely at a time when housing prices and debt levels are already a concern.  Of course this doesn’t preclude a cut but does raise the hurdle. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • China’s equity markets returned from its Lunar New Year break last night.  The Shanghai index traded down by ~8% and USDCNH is currently above the 7 to 1 level.  However, this sell off was expected as China’s index needed to catch up to indexes around the world.  News reports indicate that Chinese authorities are considering lowering their 2020 growth expectations due to the virus outbreak.  As of this writing, there have been 17,390 confirmed cases around the world with the death toll hitting at least 362.  In positive news, there have been encouraging reports regarding virus-treatment developments.
  • China’s oil demand has fallen by 20% since the outbreak, prompting OPEC+ to consider an emergency meeting as well as another round of production cuts.  In an effort to stabilize markets, the PBoC delivered its largest one-day injection of liquidity since 2004.
  • The GBP is the biggest mover in the G10 space as markets react to trade brinksmanship.  To be honest, comments from UK PM Johnson taking a hardline on trade isn’t much of a surprise.  Brinksmanship was used by PM Johnson during the second half of 2019 and some would argue that this strategy worked well.  While the expectation remains for the 11 month transition period to be extended, this will likely be a last minute decision.  As such, headline risk will remain for the GBP for the balance of the year.  With regards to data, UK manufacturing PMI beat expectations at 50.0 against 49.8 but trade news is the dominate driver today. 
  • Eurozone manufacturing PMI beat expectations but remains in contractionary territory at 47.9.  Spain and Italy picked up significantly with France and Germany also rising but to a lesser extent. 
  • US ISM manufacturing PMI beat expectations and moved back into expansionary territory at 50.9 versus expectations for a 48.5 print.
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