News & analysis

A sustained increase in US coronavirus cases, combined with benign global new flow, has contributed to a moderate risk-on tone in FX over the course of this week as a whole. Most major currencies were higher against the dollar, with a few exceptions.

This week’s busy data and event calendar offers multiple opportunities for both idiosyncratic moves in individual currencies, as well as broad thematic changes in risk appetite, which will be influenced by the trajectory of the global coronavirus pandemic itself, especially in the US.

  • Tuesday, 14th July. The ONS will release UK monthly GDP data for April, the first month spent fully under the strictest lockdown measures in the UK. A hair-raising number is all but assured, with forecasters’ guesses centering around a 20% month on month decline.
  • However, the Bank of England has recently highlighted some evidence from alternative data that the initial contraction may not be as severe as anticipated. The detail of the data will therefore be highly relevant for sterling. Eurozone industrial production for April will also be released, alongside ZEW survey data. Eurozone purchasing managers indices recently improved dramatically but remained below the 50 level that indicates overall growth. We were willing to overlook this as a quirk of the data and view May as a month where the Eurozone economy stopped contracting – the ZEW survey, which rose into positives in June, will either confirm or seriously challenge this view.
  • Also on Tuesday, the Office for Budget Responsibility will release its 2020 Fiscal Sustainability Report. This week’s approximately £30bn fiscal expansion from the government will be an additional factor, but the medium term nature of the report means that assumptions about factors such as the persistence of “scarring” to consumer and business behavior from covid-19 will be more interesting. This is particularly true in light of the Bank of England’s own optimistic “illustrative scenario”, in which the economy will regain pre-covid levels by 2021. Assumptions will also need to be made about the nature of future trading arrangements with the EU, as well as the drag on productivity growth from leaving the EU. In March, the Government somewhat evaded OBR questioning about future trading relationships by giving a high-level white paper. Such evasion may be more difficult this time around. Echoing the Bank of England’s move to scenario-based forecasting, the OBR will present three alternative medium term scenarios.
  • Wednesday, 15th July. The Bank of Japan’s Monetary Policy Statement and rate announcement will begin the day during Asian trading hours, followed by the Bank of Canada’s equivalent releases at 15:00 BST, with a press conference at 16:00. Both are discussed in depth below.
  • Thursday 16th July: China Q2 GDP will be the week’s most significant data release, and is discussed in depth below. Australian labour market data will also be released in the early hours of the morning, followed by UK labour market data at 07:00 BST. Due to lags in the release of the data, the UK release is unlikely to fully reflect the severity of the covid-19 shock to employment, although expect an eye-catching increase in the total claimant count rate. The ECB policy announcement and press conference will follow from 12:45 BST onwards. The ECB’s handling of the German Constitutional Court’s recent challenge to asset purchases will be in focus – the ECB is discussed in depth below. US Retail Sales for June are due at 13:30 BST, following a 16.4% contraction in April and a 17.7% rebound in May.
  • The European Council beginning on Friday 17th is also discussed in detail.

JPY

BoJ to stand on hold while assessing the coronavirus impact

The next BoJ policy meeting on July 14-15th is likely to deliver little action as the central bank assesses the impact of measures implemented since early March. After a series of steps to stabilize financial conditions both in public and corporate debt markets, there are barely any additional measures left in BoJ´s toolkit that could prove effective from a cost/benefit standpoint. Even though the BoJ has continued to pledge necessary extra monetary easing, cuts to interest rates seem unlikely in the face of currently stable market conditions. However, investors will keep a close eye on two main issues. Firstly, the Bank is set to update its latest economic projections while new infection cases reportedly increase in the country. Additionally, questions may arise on the prospects of a nascent bear steepening of the JGBs yield curve, at a time when other major central banks cast an eye on Japan-like yield-curve control policies.

A recent surge of new coronavirus cases in Tokyo, which has seen over 100 daily new cases for seven consecutive days, has given rise to speculation the government will re-impose a state of emergency.

With targeted testing contributing to more cases and medical facilities under no capacity stress, lockdown measures as those reinstated in Melbourne, Beijing and southern US cities are not in sight at the moment. Regardless, a downgrade to fresh quarterly projections is likely, after the bank recently cut the economic assessment of all of Japan´s 9 regions. Back in April, the board estimated a 3%-5% economic collapse in the current fiscal year to March 2021, followed by a potential 2.8%-3.9% recovery through March 2022. These estimates already contrast with the IMF´s, which foresees a deeper 5.8% recession in 2020 and a slower 2.4% recovery in 2021. There is little that downgraded economic forecasts can do to change the BoJ´s ultra-loose guidance, after the bank has already accounted for an extremely severe economic situation and the prospects of negative prices in the following months. However, a worse-than-expected economic outlook may place further pressure on the recently observed bear steepening of the JGBs yield curve.

By contrast, major central banks like the Federal Reserve have started to mull the idea of strengthened forward guidance or some direct form of yield capping, similar to BoJ´s approach on 10-year maturities. Speculation on the back-end narrowing of USTs-JGBs yield spread may arise as a source JPY´s strength, especially since governor Kuroda said after the June meeting that Japan´s super-long yields weren´t high compared to its peers in other nations. Strong bond auctions in July relaxed concerns on the reduced appetite for super-long tenors, as bond sales over 25 years saw a spike in bid-to-cover ratios. However, any market comfort provided by these results could prove temporary as the grim outlook leaves few reasons to life insurers to quicken the pace of buying as bond supply grows.

 

Relatively strong bid-to-cover ratio for super-long JGBs might prove short-lived in the face of bleak economic outlook projections

Given the markedly subdued volatility in the USDJPY pair in the aftermath of the pandemic peak, both the fresh economic projections and BoJ´s approach to back-end yields could drive price action. The yen has been trading in a very tight range despite the varying sentiment waves worldwide, with 1-month implied and historical volatility close to its record low. Risk reversals on USDJPY options show that net long positions in favor of the yen have retreated to nearly pre-virus levels. However, dispersion between 1-month, 3-month and 6-month net positions has widened to the standards of the financial crises, indicating investor´s concerns on future volatility outbreaks. Looming risks on the coronavirus situation, plus increasing uncertainty on the November US elections feed this narrative looking ahead.

Options market foresee increasing volatility risks in the barely flat USDJPY pair through the second half of the year, similar to warnings during the financial crisis.

CAD

BoC preview: expect forecasts and forward guidance

The Bank of Canada is due up to release its latest economic assessment on the 15th July at 10:00 ET.

Newly appointed Governor Tiff Macklem will face the media at his first monetary policy meeting as the chair of the Governing Council on Wednesday after spectating the last meeting on 4th July. Since the last BoC meeting, testimony to the finance committee and a few public speeches have given market participants a better grasp over the new Governor’s stance on monetary policy. We have observed two stark differences relative to Poloz;

  • Macklem is more cautious on reading the economic data to date, but this could be more of a product of the current environment than his actual stance on monetary policy. The previous Governor Stephen Poloz was known for reading the data in a glass half full manner, opting against an insurance rate cut in Q4 2019 despite the Fed’s actions in 19H2.
  • Macklem wasn’t against calling the bank’s large scale asset purchases (LSAPs) what they are; quantitative easing. This is a big shift for the BoC in our opinion and shows a move from viewing the LSAPs as a measure to improve market functionality to sustaining the expansion. Macklem made this shift explicit in his speech on the 22nd July when regarding LSAPs as QE and stating that “these purchases are working through more channels to deliver stimulus” to the economy.

With LSAPs in place until the economic recovery is “well underway”, market participants continue to scratch their heads on what the vague comment truly means going forward. During the early stages, such vagaries were acceptable due to the fluid and highly uncertain nature of the shock, but as time elapses the market’s patience for delaying further details is dwindling. Since the June statement, the Bank has witnessed two key labour market reports, along with a fiscal snapshot from the Treasury. Additionally, the growth in case counts has stabilised and lockdown measures have begun scaling back.

We believe the bank has recognised this improvement in conditions and increasing need from market participants for further guidance by opting to release a central scenario in the accompanying monetary policy report.

This compares with the last MPR where two illustrative scenarios were given. With the central scenario starting to look more like a normal set of bank forecasts, just with increased caveats to its accuracy, we believe the Bank may go one step further and give markets forward guidance on their plan for LSAPs.

The fiscal snapshot outlined a budget deficit of 15.9% for FY20, with issuance in longer-dated debt set to rise. While the Bank continues to hoover up at least C$5bn a week in the government bond markets until the recovery is “well underway”, the loading of issuance towards the back-end of the curve raises questions about their exit strategy.

Memories of the Fed’s 2013 taper tantrum remain fresh in the global bond market’s memory, and should the BoC exit not be met with sufficient demand conditions, the central bank may be forced to remain in the market for “market functionality” reasons. The waters get murky here, but for this reason the Bank may want to set its stool out early to limit the consequences of any future tapering from the current pace of purchases. This could either be met with time-limited or data-driven forward guidance.

Government plans issuance of debt targeted towards back-end to lock in lower financing rates, but this puts the BoC’s LSAP programme in a tricky spot. (Source: Bloomberg)

CNY

China Q2 GDP will print positive, but the message it gives markets is important

An in-depth preview of China Q2 GDP will be published separately of The Week Ahead.

Estimates for Q2 GDP growth range from -3.1% to 3.0% YoY with the median expectation sitting at 2.5%. Excluding ING bank, all forecasts supplied to Bloomberg expect a positive GDP reading. Notably, Pantheon Economics outline that there are incentives for Chinese authorities to underreport the Q2 GDP figure to avoid sending the wrong signal. Pantheon see an official release of 1% YoY as enough to signal that authorities have stemmed the hemorrhaging of the economy in the second quarter, while being low enough to maintain expectations that further stimulus will be incoming should another substantial threat to the recovery materialise.

A strong GDP figure, on the other hand, could signal that monetary and fiscal stimulus has played out given the strength of the economic recovery, while a negative figure would prompt a global market rout and pressure on USDCNY.

Given the fact that the PBoC are set to wind down their support measures after the 1Y MLF was held in May and June at 3%, while total social financing is due to slow, we don’t expect the official GDP print to be revised down into negative territory for the risk of stoking expectations of further stimulus.

n.b. June’s CPI, Money Supply and Aggregate Financing data is due this week, along with June’s trade balance set to be released on the 14th. Industrial production, retail sales and the surveyed jobless rate will be released alongside GDP on the 16th at 03:00BST.

Year-to-date China’s economy is expected to be 2.4% behind 2019’s growth rate in Q2 after factoring in the 2.5% median estimate. This sets the pace of growth substantially below the post-financial crisis trend.

EUR

The ECB awaits for the recovery plan decision as EU leaders struggle to find common ground.

The 27-EU leaders gather in Brussels on July 17th-18th to discuss the bloc´s proposal of the 2021-2027 budget and emergency recovery plan in response to the current coronavirus-driven economic crisis. Expectations for a breakthrough next week are fairly low since interim negotiations have exposed major disagreements.

In an interview with the Financial Times last weekend, Christine Lagarde downplayed hopes of a resolution by the mid-July summit, although the ECB President seemed confident on a potential agreement by the end of the summer. The prospective response to the biggest recession in EU history has created stringent divisions between fiscally conservative states led by the Netherlands and anti-austerity governments aligned to the European Commission proposal. The main objections by the frugal countries focus on the size and composition of the proposed €750 billion recovery plan, as well as the conditions attached to it.

European Council President Charles Michel recently unveiled a revised draft of the recovery plan to the European Commission aiming to facilitate an agreement. The new proposal still conceives the same overall size for the recovery plan, while the balance between loans and grants remains unchanged at €250 and €500 billion respectively. In turn, a package of concessions looks to throw an olive branch to opposing countries, including earlier repayments and the continuation of the complicated existing system of budget rebates. Additional concessions go along the lines of more money for green projects and a faster distribution of funding. It remains unclear, however, whether these ´soft´ concessions will be enough to bring the frugal members aboard, while the headline figures of the package – especially the amount allotted to grants- remain untouched. Charles Michel himself claimed that “these are very complex negotiations” and an unknown EU official reportedly said it wasn´t a given that a deal would be reached this month.

The budget and recovery fund proposal marks a new era in the joint approach to debt issuance in the European Union. Previously, the lack of fiscal integration has filtered negatively into investor’s confidence in the monetary union. The plan is designed to shrink spreads on financing costs in peripheral bond markets, while boosting confidence in the European project.

The proposal not only represents a solid joint EU response to the unprecedented coronavirus crisis, but also creates an important precedent into an integrated fiscal policy.

The proposal is controversial, however, since it drastically limits the government’s control over national finances. A consensus view among experts signals that a final agreement will not be reached as soon as next week and that some reduction to the overall package will be necessary for a compromise. 1-month options in EURUSD trades are only slightly net long on the euro, while spot pricing recently traded near the top of the pair’s 12 month range.

Meanwhile, the ECB is expected to take a breather at the July 16th meeting after almost doubling the size of its Pandemic Emergency Purchase Programme (PEPP) in June. In the same FT interview, Lagarde stated that she is in no rush to ramp up stimulus in the upcoming meeting as the current measures unfold and until the economic data further reveals the pace of recovery. Instead, much of the discussion next week might center on the shape of the economic rebound in the Eurozone, after the European Commission recently downgraded GDP growth forecasts.

Lagarde is likely to remain agnostic on a given V or U shape of the recovery, while highlighting that growth would be uncertain, constrained and uneven across domestic economies. Lagarde might also be asked about the apparent split within the Council, especially regarding the speed and form of PEPP purchases. Breakout data on March to May purchases showed the great flexibility embedded in the program, which could raise some additional vigilance by national institutions like the German Constitutional Court.

Deviation from capital key on March-May PEPP purchases leaves room for concern as the Eurozone heads to an uncertain economic recovery.

In a survey conducted by Bloomberg, more than half of the economists predicted that the ECB would increase the current €1.35trn PEPP by another €500bn by December while also extending the duration of the programme, which is currently expected to hold until the middle of next year. The survey responses highlight the unprecedented uncertainty of the pandemic’s aftermath and the recovery from the crisis as a whole, especially in the context of the eurozone economy still being on course for a contraction of 9% this year.

 

Authors:
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, Junior FX Market Analyst

 

 

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