Morning Commentary: Sending in the Cavalry

Foreign Exchange - Morning Commentary
Sending in the Cavalry  
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Since last week, the PBoC has been giving the markets strong signals that further support could be on the way, with guidance this week of specific note. 

From a historical perspective, the PBoC has shown a tendency to act when PMI readings fall sharply.  With the PMI reading set to be released this weekend reflecting the extent of the disruption for Covid-19, there is a strong chance that Chinese officials will take action this weekend in order to support the economy that has been rocked by Covid-19 concerns.  Broadly speaking, there are two channels that the PBoC can use to support the economy—benchmark deposit rate cuts and reserve requirement ratio (RRR) cuts. 

Support through cutting deposit rates would support the economy through direct and indirect ways.  Directly, cutting the deposit rate would lower corporate borrowing costs.  Indirectly, a lower deposit rate would also lower interbank rates and yields on bank bonds.  These two measures are important as they account for ~15% of banks’ total liabilities. 

By cutting the RRR, China would be attempting to do three things.  Cutting the RRR lowers bank funding costs similar to cutting the deposit rate.  Additionally, cutting the RRR increases liquidity and fosters credit growth. 

Bigger picture, there is validity to the argument that the virus represents a supply side shock driven by uncertainty.  Therefore, there isn’t much that stimulus can do.  However, this is a discussion for a later day and this fact should do little to stop further Chinese stimulus this weekend should PMI readings disappoint.
  • Covid-19 headlines continue to dominate the markets.  Moody’s has warned of the risk of a global recession and the WHO has signaled that it may call the current outbreak a pandemic.  Overnight, reports emerged that 1,000 people were quarantined in Germany, adding to the intense pressure already on Europe.  
  • Global equity markets continue to sell of steeply.  The S&P 500 index just entered into its fastest correction (falling more than 10%) in its history.  It has taken only 6 days for the index to fall 12% with the brutal selling continuing today. 
  • The US 10-year yield has hit a new all-time low, falling to ~1.1535%.  Markets are now pricing in ~35 bps of cuts for the Fed’s March 18 meeting and ~90 bps of total cuts for the year. 
  • Tensions between Turkey and Russia flared up after an airstrike killed 33 Turkish soldiers in Syria.  Russia has denied involvement in the attack by Russian backed Syrian forces. 
  • OPEC appears to be moving closer to a supply cut.  The cartel will meet next week in Vienna with Saudi Arabia expected to ask for a joint 1 million barrel cut. 
  • Canada’s GDP came in better than expected, printing a 0.3% increase against expectations for a 0.1% increase.  Looking at the details, stronger consumption was one of the key drivers.  
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