Morning Commentary: Something Has to Give

Foreign Exchange - Morning Commentary
Something Has to Give
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The Bank of England (BoE) meets tonight and will leave rates unchanged.  The more interesting question will be what the bank does regarding its QE program. Technically, the bank doesn’t have to do anything this meeting as its £200 billion program should last until July.  Yet, it is likely the bank will make material changes this meeting. 

It is nearly a foregone conclusion that the UK’s QE program will have to run past July.  If the bank makes no change at tonight’s meeting, something will have to happen at the June meeting, which is likely to be “last minute” for the BoE to be comfortable with.  Additionally, June is a non-press conference month so making a change without being able to explain the plans isn’t an ideal scenario either.  Moreover, the BoE is unlikely to make an adjustment between meetings as it will need to explain how a different program remains consistent with hitting its inflation goals. 

Given the different options, reducing the monthly purchase amount but making the program open-ended seems like the most likely change.  Making this move should keep yields pinned near zero while giving the bank increased flexibility.  The open-ended aspect of the change can come through language such as “we stand ready to do more” or tying purchases to a target.  For example, the bank will continue to purchase until unemployment reaches a target level.  Alternatively, the BoE could opt for a yield curve control option similar to Japan and Australia. 

Regardless of what the BoE elects to do, expect the bank to also address its remaining ammunition as well as the prerequisite needed to use remaining tools.  Prior, the BoE has been unequivocal in its assertion that its lower bound was “close to but above 0.”  However, the bank has never faced an economic shock as large as this one.  While negative rates remain unlikely, reducing the BoE’s rate from 0.1% to 0.0% in the coming months is not out of the question.  In a world where the bank is out of ammunition, every little bit helps.   
  • The US will increase the amount of debt it plans to issue in its quarterly refunding auctions to a record high of $96 billion due to borrowing needs stemming from COVID-19 response measures.  Since the end of March, the US Treasury has raised $1.46 trillion.
  • News headlines suggest that Congress is pushing back on Trump’s call for a payroll tax cut.  With bipartisan opposition, this issue doesn’t look like it has much traction which might be for the best.  A payroll cut doesn’t do anything for the 35 million Americans that have lost their jobs making increased spending more effective than tax cuts.      
  • The ADP employment slightly beat estimates with the report showing a 20.23 million job loss in April.  Market consensus was for a 20.55 million job loss.  Despite the “beat,” the number of job losses remains unprecedentedly large.  The more important US government jobs report is due this Friday.
  • Euro area April PMI data confirmed a broad based collapse in economic activity.  Services PMI came in at 12.0 and composite PMI came in at 13.6 as activity froze due to lockdown measures.  According to the European Commission, Italy, Spain and Greece all face economic contractions of more than 9% this year.  Conversely the euro-region as a whole is forecasted to contract 7.7%, illustrating the uneven impact of the virus that will widen the gap between northern and southern countries and push European unity towards its breaking point.    
  • The GBP is under pressure as Brexit drama continues.  Most recently, the EU’s top negotiator told Brussels that the UK is not living up to its Withdrawal Agreement.  The UK continues to refuse an extension despite its struggles with the COVID-19 pandemic.  Talks will resume next week but not much progress is expected.  Data wise, UK construction PMI cratered to 8.2 versus estimates for a 21.7 print as economic activity grinded to a halt.  
  • The Chinese government is considering dropping its numerical GDP growth target given the uncertainty caused by the global coronavirus pandemic. Instead, China may move forward with a description of its goal for GDP growth compared to last year when it targeted GDP growth of 6-6.5%.   
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