Morning Commentary: Double Whammy

Foreign Exchange - Morning Commentary
Double Whammy
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The UK finds itself in the unfortunate position of having both the worst 2020 economic growth in Europe and close to the highest per capita death rate from COVID-19.  The resulting economic dislocation forms the economic background against which the UK is trending towards a harder Brexit.  This has led to a scramble among policy makers and raised the prospects of negative rates.  

As with numerous other countries, the UK has shifted from prioritizing the health outcome to prioritizing the economy.  The clearest illustration of this comes through the debate over whether or not to remove the advice to keep 2 meters (~6 feet apart).  This distancing guidance severely constrains capacity in restaurant and transportation but reducing it to 1 meter approximately doubles the chances of transmitting the virus.  

On the positive side, the labor market remains supported with the government’s intervention program preventing unemployment from sharply rising.  But this could change if the economy recovers slowly as government aid starts to be phased out in August.  While it is possible that additional fiscal support is provided over the summer, re-opening the economy should mechanically improve economic growth measures.  This positive skew to growth rates could reduce the urgency or magnitude of future stimulus.  

That puts the onus on the Bank of England (BoE).  Thus far, the bank has stepped up forcefully, but if the bank decides that risks are skewed to undershooting its inflation target, there are limited options left.  The BoE can still cut 10 bps, but after that, any future cut would be into negative territory. 

The base case still remains for the UK to avoid negative rates, but the central bank’s hand could be forced if it is dealt a hard Brexit and/or a second wave of infections that delivers another large shock to the economy.  
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Risk sentiment whipsawed overnight as conflicting headlines on US-China trade emerged.  Risky assets initially sold off and the USD strengthened after White House trade advisor Peter Navarro stated that the trade deal with China was “over.”  Risk sentiment quickly reversed course after President Trump tweeted that the deal was “fully intact” and Navarro walked back his comments, claiming they were taken out of context.  
  • Eurozone PMI numbers beat expectations across the board with manufacturing, services and composite numbers coming in at 46.9, 47.3, and 47.5, respectively.  While all the measures remain in contractionary territory, they do confirm that the pace of contraction is slowing.  On a country level, French and German composite PMI came in at 51.3 (46.8 expected) and 45.8 (44.4 expected), respectively.  UK composite PMI also beat at 47.6 versus expectations for a 41.2 print.   
  • Composite PMI numbers also improved in Australia (52.6 in June vs. 28.1 in May) and Japan (37.9 in June vs. 27.8 in May) with both countries posting numbers much improved from the prior reading.  
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