Since the ECB's last meeting, where it announced a policy review to be completed by the end of this year, markets have assumed the central bank to be on autopilot until its strategic review is complete. Conversely, ECB President Lagarde continues to insist this isn't true. Is it possible that both are right?
The key difference in the market's view versus the ECB's view likely revolves around each side's definition of autopilot. Clearly, how the economy evolves will determine what the ECB does, so in this way, it isn't on autopilot. But, the markets are concerned about market moving policy changes to QE and negative deposit rates before the conclusion of the ECB's review this December and not technical adjustments.
Any major change to ECB policy will likely be controversial with Germany, France and Italy already criticizing the ECB's reintroduction of unconventional policy measures at its meeting last September. With the ECB's common monetary policy appropriate for the Eurozone as a whole but inappropriate for select individual countries, Lagarde will need buy in.
This is likely why Lagarde announced a policy review. She needs the intellectual backing of the policy review to justify any major policy changes. Sustainability of any policy change is critical to the effectiveness of that new policy. Case in point, the Fed's QE program was more effective than the ECB's because the Fed's program was open ended. Without the support of major Eurozone economies, any policy change will lack credible sustainability. As such, absent a material degradation in data, the bar for material change is high meaning the market's autopilot view could also be right.
The euro remains a balance between unconvincing near term economic performance countered by structural support via its low valuation and current account surplus. Economic data out this past week did nothing to change this dynamic. While it is premature to write off the prospect of an upswing in EZ economic activity, near term headwinds (coronavirus, poor economic data, USD momentum) argue for EURUSD to move sideways with a bias for lower.
After a period where the markets looked through Brexit risks, brinksmanship has brought the prospect of a hard Brexit back into focus. Price action after the election focused more on the narrative of an uptick in UK growth due to the removal of some political risks and expected tailwinds from fiscal stimulus. Ultimately, the UK's exit from the EU didn't resolve the uncertainty around the future trading relationship. Without this known, businesses will continue to be hesitant to invest. Expect the GBP to continue to be pressured.
USDJPY has moved up this past week as Chinese stimulus and hopes for a virus vaccine breakthrough have improved market sentiment. Given this, the near term outlook remains uncertain with the length, severity and ultimate impact of the virus unknown. Safe haven demand has been balanced by continued investment outflows which has been a persistent theme. Expect consolidation until the markets gain greater clarity on the coronavirus.
The Bank of Canada's dovish pivot has opened the door to a cut and put increased importance on incoming data. While last week's jobs report was a beat, the preferred measure for the BoC is monthly growth and the output gap rather than the employment report and the unemployment rate. With the recent downgrades to the global economy, as well as downside risks from the coronavirus still looming, the BoC is unlikely to shift from its dovish tilt.
The coronavirus outbreak continues to dominate the headlines. Chinese stimulus, as well as hopes for a vaccine, has helped markets brush off coronavirus concerns. However, we are certainly not out of the woods. With testing kits in short supply, the reported number of cases is sure to rise as the supply of kits catches up to demand. Many workers are scheduled to return to work February 10, but it is likely many will not out of fear of contracting the virus. With China reportedly combining January data with February data, we won't get a picture of the economic impact until March. Expect the yuan to remain pressured but with modest downside risks.
The RBA was not expected to cut this past week, so its decision to hold wasn't a surprise. The RBA's relatively optimistic outlook, in the face of recent developments that argue otherwise, provides support for the AUD as it has pushed back market expectations for when a cut will happen. Countering this has been the concerns over the economic impact of the coronavirus. Near term, expect coronavirus developments to be the more influential factor.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to be unchanged at 0.0%
Expectations for rates to be cut by 0.25%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US CPI MoM
Expectations for a 0.2% increase
US Retail Sales MoM
Expectations for a 0.3% increase
US Industrial Production MoM
Expectations for a -0.2% decrease
Canadian Housing Starts
Expectations for 205K starts
EZ Industrial Production
Expectations for a -1.7% decline
EZ Q4 GDP QoQ
Expectations for a 0.1% increase
German CPI MoM
Expectations for a -0.6% decline
German GDP QoQ
Expectations for a 0.1% increase
UK GDP QoQ
Expectations for a 0.0% print
UK Industrial Production MoM
Expectations for a 0.3% increase
Asia/Japan, and New Zealand
Chinese CPI & PPI YoY
Expectations for a 4.9% and 0.0% print, respectively
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