Morning Commentary: Communication is Key

Foreign Exchange - Morning Commentary
Communication is Key
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
In terms of policy action, tonight’s July ECB meeting should be a placeholder.  The Pandemic Emergency Purchase Program (PEPP) has been increased, monetary conditions remain easy, and markets remain calm.  But this doesn’t necessarily mean it will be an easy meeting.

The COVID-19 crisis has transitioned from an acute issue to a chronic one.  This means that policy action will also have to transition from pure emergency action toward the deteriorated medium term outlook.  It is possible that this transition, which will need to be very slow, could start at this week’s meeting.  Regardless of what the ECB does, it will have to be careful on how it communicates.   

Recent comments from ECB officials have expressed the view that the outlook is better than initially feared and all of the PEPP does not have to be used.  While on the surface this is a good thing, as it signals that the economic hit/virus spread is not as bad as initially thought, the risk is for markets to be spooked by the perception of a complacent ECB. 

To this point, recent economic data has been, and should remain, positive due to mechanical factors and base effects.  This improvement in activity could potentially drive complacency from policymakers, making comments around the ECB’s outlook worth watching. 

Further, markets will be listening for signs of if the bank is done.  Accounts from the ECB’s June meeting suggests that the PEPP envelope represents a ceiling.  If there are upside surprises, the entire PEPP amount will not need to be used.  Along the same lines, executive board members have started talking about exit strategies. 

The view remains to fade these comments as the markets have.  It is quite possible that the German Constitutional Court “issue” could be behind these comments.  Once again, this highlights the importance of communication.  The ECB is walking a thin line as its comments could be interpreted as complacency and vigilance to legal matters at the expense of central bank independence
  • Market sentiment took a 180 degree turn on positive vaccine news from Moderna.  The company reported that all patients from its recent trial were able to produce antibodies for COVID-19.  While this is good news, it should be noted that many of the patients experienced significant side effects.  Additionally, AstraZeneca’s stock moved up after it also received positive new on its vaccine trial. 
  • One of the key drivers for recent USD weakness has been the market’s risk on mentality.  This has continued with the USD index (DXY) moving to its lowest level since the beginning of June. 
  • The Bank of Canada left its policy rate unchanged at 0.25%.  Overall there were no big surprises with the outlook relatively close to consensus.   
  • The Bank of Japan left its policy parameters unchanged as expected.  BOJ Governor Kuroda sounded a bit more optimistic than before as he noted the country is likely past the worst but also noted the recovery will be slow. 
  • OPEC+ meets today to discuss whether or not to extend its full production cuts.  In June, the group delayed tapering these cuts by one month to the end of July.  Should the group decide to taper, which is supported by Saudi Arabia and Russia, expect market reaction to be relatively muted as this possibility has been signaled for a while. 
  • The White House issued an order to end Hong Kong’s special status with the US and signed legislation that would sanction Chinese officials involved with cracking down on political dissent in the city.  Overall, none of these developments are anything new but does confirm that US-China tensions are not going away.
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