The possibility of negative rates was a key theme in the markets last week with Fed funds futures showing negative rates in early 2021. On this point, the Fed has been crystal clear.
At its October meeting, the Fed noted that “all participants judged that negative interest rates currently did not appear to be an attractive monetary policy tool in the United States.” This is significant because the Fed is rarely unified on any potential policy stance. Further, Fed Chair Powell reiterated the Fed’s opposition to negative rates during his speech last week and highlighted the alternatives the Fed has to negative rates.
In the past, the markets have been able to “bully” the Fed into adopting certain policies, but in the case of negative rates, things are fundamentally different. Negative rates have meaningful negative implications for the financial system and financial intermediation. As such, it is unlikely that the markets will be able to “bully” the Fed into negative rates in the same way markets can force rate cuts above zero.
Beyond the question of the Fed’s preference for negative rates is the legal aspect. The Federal Reserve Act specifically states that banks can “receive interest on reserves.” There isn’t a specification on banks paying interest or on how negative rates would be implemented. Former Chair Yellen touched on this when she testified that negative rates “remain a question.”
To be clear, the Fed will be able to implement negative rates should it desire to. I’m simply making the point that negative rates are unlikely in the near term as the Fed doesn’t see much benefit to them as well as being operationally challenging to implement.
Beyond negative rates, next week should be an interesting week with minutes from the ECB, RBA and Fed meetings being released. Moreover, we will receive a fresh set of economic data points through retail sales and PMI prints to inform us on how the global economy is doing. Of course, hope remains for a unified fiscal response out of the EU via a common recovery fund. The European Commission (EC) will present its recovery plan this week but it remains unlikely that the EC will deliver a material breakthrough.
The overall picture remains unchanged with the bias for a weaker euro remaining in place. GDP data showed sharp contraction to the Eurozone economy with Germany entering into a recession. Conflict among EU members continues to be a key headwind. The German Constitutional Court ruling complicates the overall relationship between EU institutions and national courts, but the European Recovery fund is the more immediate concern. A weak fiscal response puts the European economy at greater risk than other economies (US, Australia etc.) that have had forceful fiscal responses. The EC is expected to present its recovery plan on May 20 but a game changing development is not expected.
The latest round of Brexit talks have concluded with little progress and contentions running high. Little progress has been made at the most recent round of talks and the EU has threatened a lawsuit on the UK over free movement. COVID-19 issues have slowed the progress of talks and the UK maintains it does not want an extension. Talks begin again in early June ahead of the end of June deadline to request an extension. Cable has dropped a lot so some near term support is possible but the overall bearish bias remains due to Brexit headlines, poor economic data and other structural issues.
The yen remains broadly range bound with risk being pushed and pulled by hopes around the reopening of economies and concerns around the possible ramping up of US-China trade tensions. On balance, the feeling is that too much good news has been priced in. Reopening of economies will not be easy as setbacks in South Korea, one of the most successful countries at controlling the infection, show. Overall, the view remains that US-China tensions will not materially ratchet up while global economies remain weak but proximity to US elections represents a risk to this. Expect further yen range trading with a bias for slightly stronger.
The loonie was a middle of the pack performer with the currency remaining range bound as the overall picture is unchanged. Global growth remains challenged and oil prices, while moving higher over the past week, are still under pressure. The expectation is still for the Canadian economy to be uniquely vulnerable given dependence on services and oil that should exacerbate the country’s weak BoP position.
US-China tensions hung over the market all of last week. There are two points of view on US-China tensions. A weak global economy and a weakened US economy suggest that the US would be hesitant to escalate tensions. However, growing anti-China sentiment among both Republicans and Democrats as well as proximity to the US election flags the risk for escalation. Domestically, economic activity is continuing to pick up with external demand for Chinese goods remaining weak. Expect currency stability.
Recently, the Aussie has been trading with overall risk sentiment as correlation with equities remains strong. On the positive side, the People's Bank of China said it will use "more powerful" policies to counter the economic fallout from the coronavirus outbreak. Conversely, the reemergence of harsh rhetoric between the US and China represents another headwind to risk appetite. Near term, the US’s options against China remain limited in the current recessionary environment. However, the incentive to take a tougher stance against China should gradually increase as the US presidential election gets closer.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
RBA Minutes Released
Expectations for a 0.25% rate cut to 0.75%
The European Commission will present its recovery plan
FOMC Minutes Released
ECB Minutes Released
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US Initial Jobless Claims
Expectations for 2.4 million claims
US Manufacturing and Services PMI
Expectations for a 38.0 and 32.0 print, respectively
Canadian Retail Sales MoM
Expectations for a -15.5% decline
EU Manufacturing and Services PMI
Expectations for a 38.0 and 24.0 print, respectively
UK Labor Market Report
Expectations for the unemployment rate to rise to 4.3%
UK Manufacturing and Services PMI
Expectations for a 35.0 and 22.1 print, respectively
UK Retail Sales MoM
Expectations for a 35.0 and 22.1 print, respectively
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