FX markets have been dominated this week by the return of no-deal Brexit risk and substantial volatility in GBPUSD. With another “final” deadline set for Sunday for negotiations to end, Monday is set to be another explosive day for the pound with many leaders stating that a no-deal outcome is the likeliest option now.
Whether this is political posturing or not is yet to be known, but more information on this matter should become readily available over the weekend. Markets will also pay close attention to the prospect of additional fiscal stimulus in the US, especially given the latest deterioration in the US labour market due to the effects of the third wave. While these events remain fluid by nature, market participants will also observe a flurry of central bank meetings in what is the last full trading week before the Christmas break. Following in the steps of the ECB on Thursday, additional stimulus or forward guidance may be released by the Bank of England and the Central Bank of Russia, while fresh projections will be released by the Federal Reserve and Norges Bank.
Eurozone industrial production released at 10:00 GMT on Monday is expected to have expanded by 1.8% in October after September printed a 0.4 contraction, largely due to the big drop in Italian output. National output data published in the past weeks have been generally upbeat with no contractions in any region and the countries with the most stringent lockdown measures (like France) showing a 0-1% rise in output. The relatively upbeat data may paint a picture of the overall eurozone output, assuming the national data are not revised. However, the fact remains that the second wave and following lockdown measure intensified across the majority of the eurozone this quarter, and weakness in demand is likely to weigh on recovery in November anyhow.
On Tuesday, several UK labour market data figures are scheduled for release as early as 7:00 GMT, creating potential for sterling volatility in the early morning. The UK ILO unemployment rate for October is set to print at 5.1% according to the median of forecasts submitted to Bloomberg, just above the prior reading of 4.8%.
The jobless claims for November do not come with a median forecast, but with the unemployment rate expected to rise and the prior jobless claims already having printed relatively upbeat at -29.8, markets may be setting themselves up for disappointment. On the other hand, the furlough scheme was extended in October and this is likely to be shown in the latest data.
In the later trading session, Canada housing starts from November are scheduled for release at 13:15. With the pandemic having had a limited effect on Canada’s house price growth to date, housing starts have started to normalise as the catch-up effect begins to fade. The release is followed by US industrial production at 14:15, which is expected to print at 0.3%, far below the October figure of 1.1%. To finish off the day, Bank of Canada Governor Tiff Macklem will give a speech to Vancouver Board of Trade at 19:30 GMT. After the Bank of Canada’s press statement continued to include references to the strength of the Canadian dollar, and Deputy Governor Beaudry speaking on Thursday about how important the loonie is as an input into the Bank’s outlooks, Governor Macklem may opt to jawbone the currency as it trades near multi-year highs.
While broad USD weakness has been the main dynamic behind the loonie’s recent strength, the trade weighted value is also starting to tick-up.
At some point, the strength of the loonie is likely to reach a tolerance threshold for the Bank of Canada, especially given the near-term deterioration in the economic outlook. Tuesday’s speech may be an opportune time for Macklem to lay the matter to bed and introduce a fresh near-term headwind for the loonie rally to contend with. Beyond FX markets, Macklem may have more to add on the BoC’s latest move to flatten the yield curve further as purchases start to target longer-dated bonds, while questions surrounding the effective lower bound may be addressed after Beaudry stated the Bank is looking into the viability of additional rate cuts.
The yearly CPI inflation figure from the UK at 07:00 GMT is set to remain unchanged in November at 0.7%, according to median expectations. For now, no big jumps or misses in CPI inflation are expected but the outcome of Brexit talks at the end of the year could determine how fast inflation accelerates going forward.
Eurozone flash Purchasing Managers’ Indices are on the agenda later in the morning. French and German services, composite and manufacturing PMIs are set to come in at 08:15 GMT. All estimates are expected to have fallen since November, with German manufacturing and composite figures being the only ones expected to print above the 50-threshold. The overall euro-area composite PMI is to be released at 09:00 GMT. With most of the eurozone still being in lockdown at the moment, markets will likely not be too spooked by dark numbers. Later in the evening, the Federal Reserve will come out with its latest policy decision at 19:00 GMT, the second meeting since the Presidential elections. A separate section is included on this below.
Sweden’s unemployment rate is on the agenda for Thursday 08:30 GMT and is set to print at 8.7%, just above the prior reading of 8.6%. The Swedish labour market has seen less of a fall-out in numbers compared to the rest of Europe following the almost non-existent containment measures they had during the initial outbreak. During the second wave however, when the government did impose tighter containment measures, employment held up well.
Just half an hour later at 09:00 GMT, markets move their attention to Sweden’s Western neighbour. The Norges Bank is expected to keep its monetary policy unchanged in December, according to forecasts submitted by Bloomberg. The short-term growth and inflation outlook may be revised downward from the central bank’s September projections, as Q4 saw a jump in virus numbers. However, the resurgence in virus cases is nowhere near some of the hardest-hit countries in the eurozone. A separate section on the Norges Bank decision is included below.
The eurozone final CPI inflation reading at 09:00 GMT is unlikely to throw a curve at markets as HICP inflation for the euro area was unchanged in November for three months straight at -0.3%. The core reading printed at a record low of 0.2%. Later at 12:00 GMT, the Bank of England meeting will be entirely dictated by the outcome of trade talks with the EU. A separate section on this, and the Banxico policy decision at 19:00 GMT, is included below.
The Bank of Russia and Bank of Japan take center stage on Friday and present their latest policy decisions at 10:30 GMT and overnight respectively. Friday is not the regular day for a Bank of Japan policy meeting, however the timings of some central bank meetings have shifted this month prior to Christmas. The policy decisions of the two central banks will be discussed below.
At 07:00 GMT, UK retail sales are expected to drop by 4.5% MoM, which is a significant fall but not anywhere near as severe as the initial lockdown in Spring. Early Christmas shopping and late Black Friday discount deals may have given the data a boost. The German IFO Survey at 09:00 GMT is set to show another discrepancy between the current situation and the expectations. The expectations index is expected to grow from 91.5 to 92.7, while the current assessment index is set to print just one point below the prior reading of 90.0. The growing discrepancy between the current and future index stems from the worsening virus situation and extended lockdown measures into January while news on vaccinations keep markets optimistic for the medium term.
FOMC PONDERS VACCINE BOOST FOR ECONOMY AND MATURITY OF PURCHASES
Although improving treatment and vaccination progress has underpinned the outlook for US and global growth in 2021 for some time now, positive vaccine trail data has added further weight to these expectations since November’s FOMC meeting. Next week’s meeting will therefore see the Committee take stock of the improved growth outlook with the release of new member projections, while also contemplating if further short-term policy actions are necessary.
September’s projections had a range of 3.6% to 4.7% for the central forecast for real Gross Domestic Product growth in 2021. The encouraging vaccine trial and distribution data released since then will likely lift the upper range of this bound somewhat. However, from a policy perspective the improved outlook will only partly alleviate the FOMC’s concern about the current state of the economy, particularly the labour market, which has seen a significant slowdown in its recovery over recent weeks. Many major forecasters now expect negative growth in Q1 2021, while new fiscal stimulus has yet to be passed by the deadlocked US legislature. In this environment, the improved 12-month outlook is unlikely to preclude discussion of policy action next week.
A number of viable options remain in the Fed’s toolkit for supporting the US economy…
Drastic actions such as yield curve control or explicit forward guidance regarding asset purchases are unlikely. However, the composition of asset purchases is a “live” aspect of next week’s meeting. The current pace of around $80bn a month in US Treasury purchases is likely to be maintained, although the amount of purchases is not currently subject to any forward guidance. Additionally, the maturity of purchases may be lengthened significantly. The weighted average maturity of the Fed’s recent purchases has been around 6-8 years by various estimates, consistent with the 2010 QE2 purchases at the beginning of the recovery from the 2009 financial crisis. Later QE purchases aimed at stimulating growth had a much longer average maturity, of above 10 years. The US Treasury curve has seen some steepening in recent weeks, and a lengthening in the maturity of purchases could counteract some of this move. The dollar could soften if this is presented as a signal that the FOMC remains willing to provide further easing in the near future.
NORGES BANK SET TO KEEP POLICY UNCHANGED AS NORWAY SEEMS IN GOOD NICK TO HANDLE SECOND WAVE
Christmas comes early this year with the Norges Bank presenting its latest projections and policy decision in On Thursday morning at 09:00 GMT. The Norges Bank has kept its benchmark rate at 0% since May after several cuts from 1.5% before the pandemic. Additionally, the Bank is offering extra stimulus through F-loans. Next week, the Norges Bank is set to keep its policy unchanged, similar to the November meeting.
Norway’s real GDP monthly SA sits just above pre-pandemic lows
Governor Oystein Olsen has flagged before that the central bank may raise rates from late 2022 onwards. Considering the latest vaccine news and possibly improved medium-term outlook, this could increase the likelihood for earlier policy normalisation, as the vaccines are expected to be rolled out earlier than the Norges Bank’s previous assumptions. For the short term projections, however, downward revisions may be on the agenda.
The latest resurgence in virus numbers may push the bank toward lowering its growth and inflation projections for the nearer-term, considering that the latest forecasts were published in September before the second wave worsened.
The case count in Norway however still remains far lower compared to most other European countries and it is unlikely that the central bank will take this meeting as a chance to move to negative rates or asset purchases, as it has never done so before. As Europe’s largest oil producer, Norway saw its currency slump along with oil prices in Q1, but Norway’s massive sovereign wealth fund has allowed for aggressive fiscal policy support during the pandemic. This allowed the central bank to stay away from unconventional monetary policy. For the time being, no big delivery is expected from the Norges Bank, although eventually they may be the first to return hawkish.
BOE MEETING WILL EITHER BE BORING OR SEISMIC
Depending on the outcome of trade talks with the EU, Thursday’s Bank of England Monetary Policy Committee meeting will either be a straightforward recitation of existing policy paradigms, or a leap into the unknown as the central bank scrambles to react to an impending no-deal Brexit.
Provided trade talks result in either a breakthrough or continued discussions, November’s £150bn QE expansion means that the MPC will have little new policy action to take at next week’s meeting. With the new QE program starting soon and expected to run until the end of 2021, the pace of asset purchases is comparable to the current level – described by Andrew Bailey as a step down from the “warp 10” purchases seen in March. In this scenario, talk of negative rates will remain closely looked-for by markets. Existing BoE communication has made it clear that policymakers viewed negative rates as a tool best used when Banks were less concerned about balance sheet risks, such as the initial upswing phase of a recovery. Furthermore, although the BoE is actively looking into how the tool could be used, there seems to be little impetus for its immediate use. However, Governor Andrew Bailey reiterated today that “extensive work” was underway with banks to address how the policy would be transmitted, if needed. With this review ongoing, next week’s meeting is an opportunity to share initial results, although January’s Monetary Policy Report seems a likelier date for a detailed explanation.
Fixed income markets have recently begun to price in a rising chance of negative rates at some stage over the next 12 months from the BoE. The timing of the latest move into negatives lines up with the recent deterioration in the tone of trade talks with the EU. However, given the BoE’s clear aversion to using negative rates during the initial stages of an economic shock, it seems that even if trade talks end and the UK heads for a no-deal Brexit, the MPC’s first policy action would be to return QE to its “warp 10” setting. While over the 12-month horizon negative rates are being baked into the GBP OIS curve, most bets tend to suggest that negative rates won’t be implemented until at least May 2021.
In this sense, market pricing of negative rates in the UK probably reflects the fact that the BoE has been relatively open to the policy.
Among peer central banks with currently positive rates only the Reserve Bank of New Zealand has been as receptive to the idea of a negative policy rate, although New Zealand’s world-leading domestic virus situation and soaring house prices have led markets to pare back bets on the policy being implemented there.
Selected G10 policy expectations from OIS forwards
BANXICO TO REMAIN ON HOLD WHILE ADDRESSING SENATE BILL CONCERNS
The last policy meeting by Banxico in 2020 is set to capture broad attention, as several topics alongside the monetary policy agenda will be on the table. In addition to a debated interest rate cut, Banxico will be faced with concerns over the recently approved Senate bill on excess dollars, dollar auctions from Fed swap lines, and the departure of one of the board directors. All of these factors have the potential to influence market sentiment, and therefore the peso. Crucially, stagnation on the US bipartisan talks on fiscal stimulus and uncertainty about vaccination domestic plans underlie on the currency weakness, but Banxico’s meeting next week will guide the path looking ahead.
In the last policy decision, Banxico halted the easing cycle undertaken since mid-2019, which accelerated after the pandemic outbreak. Over this period, Banxico cut 400 basis points from the overnight interest rate, which finally landed at the 4.25%. The pause came alongside high uncertainty around the inflation outlook, with the central bank standing by its rather conservative policy stance. Inflation data has recently shown signs of strong downward pressures, with the headline figure falling to 3.33% in November, from 4.09% in October, fundamentally driven by downward core inflation. The data pose questions regarding whether the Bank would resume the easing cycle, but even Jonathan Heath, who dissented on the pause earlier, mentioned that any further cut would be more appropriate by Q2. Market-based expectations and broad analyst consensus do not predict a rate cut for the upcoming meeting either, but Banxico´s assessment on future inflation dynamics will be determinant in fine-tuning forward guidance looking ahead. The event will also serve as a farewell to director Javier Guzman, who is meant to be replaced by former Treasury director Galia Borja. Although Borja´s stance on monetary policy is still unknown, she might tilt the board to a more neutral/dovish balance after one of the most hawkish members is gone.
A far more pressing concern in Banxico’s agenda is to do with the Senate-approved bill forcing Banxico to buy excess dollars from banks, which are banned from returning them to the financial system on the base of regulatory issues.
The bill ultimately exposes the central bank to money laundering risks, rising prospects for future sanctions from regulatory institutions and weighing on Banxico´s autonomy and credibility. Governor Alejandro Días de León said that the bill does not incorporate Banxico’s concerns on the proposed mechanism, while remarking that the Bank will continue talks with the lower house in order to prevent the bill from going forward and weakening Banxico’s mandate. On an apparently unrelated line, Banxico announced two additional auctions of Fed line swaps funds to avoid any potential stress stemming from year-end funding effects. The operations are scheduled for December 9th and 14th and $1.5 bn dollars will be offered in each one. Banxico seems committed to averting any major spike in FX volatility as the year-end approaches, but many questions must be answered before investors (and MXN) can relax and enjoy the upcoming holidays.
CBR TO HOLD AS A RATE CUT COULD BE “SELF-DEFEATING”, MONETARY EASING TO BE DELAYED UNTIL 2021
After cutting rates by 175bps in response to the Covid-19 pandemic, the Central Bank of Russia has recently opted to hold rates as transitory inflation effects keep inflation on an upward trajectory. While the CBR believes that disinflationary forces will begin to dominate over the medium-term, likely paving the way for further rate cuts in 2021, we deem December’s meeting too early for further stimulus to be released.
The recent rise in inflation itself isn’t sufficient to keep the CBR on hold. While inflation has risen above the CBR’s 4% target in recent months, the impetus behind the inflationary uptick is deemed to be transitory. A combination of positive base effects, pandemic induced food price inflation, and ruble weakness resulting in more expensive imports have all resulted in the recent rise in inflation despite domestic demand pressures remaining weak. The CBR can definitely look through the recent inflationary data for this reason, and even point to the flailing services sub-index. The price of the service sectors output is less sensitive to exchange rate effects and can therefore be viewed as a better underlying indicator of domestic inflationary forces. Services inflation slipped in November to print at 2.5%, nearly two percentage points below headline CPI of 4.4%. If the recent uptick in inflation isn’t sufficient to keep the CBR on hold in December, then what is?
Inflation rises above 4% target but that may not be enough in itself to keep the CBR from holding rates
Recent commentary by Governor Elvira Nabiullina suggests that the CBR will hold rates until financial markets become more stable, likely in an improved risk climate. Nabiullina recent stated “in an unstable situation in financial markets with elevated risks, a key rate cut could lead to an increase in interest rates on long-term financial instruments and a more pronounced reaction of the exchange rate than in steady conditions. As a result, monetary conditions could even tighten.” While the ruble has strengthened nearly 4% since October’s meeting, the tentative risk climate in financial markets is likely to keep the CBR on hold in December in a similar fashion to the last few meetings. With inflation already set to increase further in Q1 2021 as transitory effects continue to promote price growth in the short-run, the central bank is unlikely to cut rates and risk the prospect of another bout of RUB weakness, which would in turn promote even faster and more prolonged inflation than what is already projected.
It is worth noting that while we expect the CBR to hold the key rate at 4.25% in Friday’s meeting, the risk of a 25bp cut is prominent.
The central bank may view financial markets much more accepting of further rate cuts in order to promote growth and reduce the projected output gap without causing a substantial bout of RUB weakness, especially with the risk of the US election and a rise in US-Russia tensions out of the way.
BANK OF JAPAN TO SUPPORT LENDING CONDITIONS TO THE CORPORATE SECTOR
The Bank of Japan is likely to extend its pandemic lending programs towards the corporate sector, adding to fiscal efforts embedded in the recently announce third stimulus package. With little else to do regarding the main policy tools, the BoJ´s focus on assisting the corporate sector comes amid new virus infections taking a toll on the economy, as suggested by high-frequency indicators. At the next meeting, the BoJ´s lending support should be increased with an extension to the loans program past the current March deadline, in a similar move embarked upon by the ECB this week. The BoJ is poised to move in this direction going forward. Other emergency tools targeted at the corporate sector, like purchases of ETFs, REITs and corporate bonds, might be boosted in size in the January meeting. A shift toward medium-term performance and solvency criteria from an initial approach of short-term liquidity also seem to be firming in the BoJ´s strategy. This shift is already reflected in recent efforts to reduce systemic financial risks, in addition to an acceleration in corporate bond purchases while purchases of commercial paper slowdown.
BoJ shifts boost towards corporate bond purchases
Ranko Berich, Head of Market Analysis
Simon Harvey, FX market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, FX Market Analyst