News & analysis

It’s been a terrible week for the US dollar, which has fallen to fresh multi-month or multi-year lows against many major currencies, most notably the euro. The narrative that many observers have fit to this price move as a driver has been the progress of a new bipartisan proposal for $908 billion in fiscal stimulus. However, this week’s move has been entirely consistent with recent weeks – and even months – of dollar weakness on improving global risk appetite. These issues are discussed in depth in our latest USD Outlook, which was released this week. Looking ahead, in addition to the perennial subject of a breakdown or breakthrough in UK-EU trade talks, next week’s calendar will revolve around a high-stakes European Central Bank meeting. The ECB is low on ammunition and must choose how to construct, and sell, any additional easing measures carefully, especially in the context of the recent strength of the single currency. The ECB’s problems are mirrored with the Bank of Canada, who also contend with a near-term deterioration in the economic outlook, multi-year lows in USDCAD and an elevated loonie in trade weighted terms. In addition to considering the near-term issues under consideration by the Bank of Canada in today’s Week Ahead, we also took an in-depth look at the loonie in a recent CAD Outlook.

CALENDAR

Monday 07/12

A relatively quiet day of second-tier data kicks the week off, beginning with Chinese trade balance statistics released overnight. German industrial production figures for October will be released at 07:00 GMT but are unlikely to make much of a difference for the euro, due to the backward looking nature of the data and the looming ECB decision. UK Mortgage lender Halifax will release its house price data for November at 08:30. The release will be viewed in the context of surging UK house prices, and a 13-year high for mortgage approvals in November.

Tuesday 08/12

The British Retail Consortium will release its latest retail sales data just after midnight, a release to be viewed in the context of very strong consumer spending this year in the UK. Australian house price data and NAB business confidence will be released soon after at 00:30 GMT. Eurozone gross domestic product and employment data for the third quarter will be released at 10:00 GMT, but as with other lagged data will be of limited relevance for the euro. The latest vintage of research firm ZEW’s surveys of European and German institutional investors and analysts will be released at the same time, and will be a far more interesting release due to its forward looking nature. Of note is the fact that last month’s downbeat reading of 39 for the main ZEW expectations index in Germany was based on surveys taken before the recent wave of positive vaccine trial news. The key question, then, is if vaccine developments have significantly upgraded expectations for the Eurozone economy. Similarly, the National Federation of Independent businesses will release its own survey data of small businesses in the US, at 11:00. The employment sub index in particular is a reliable leading indicator of the US labour market.

Wednesday 09/12

Chinese producer and consumer price index data will be released at 01:30 GMT, with the producer price index likely the more interesting of the two readings due to its use as a leading indicator of global industrial demand and prices. Later in the day, the Bank of Canada’s latest rate decision will be announced at 15:00, alongside the US job openings and labour turnover summary.

Thursday 10/12

The Royal Institute of Chartered Surveyors will release its monthly report just after midnight, including the balance of surveyors reporting house price increases in their areas. The very high balances seen in recent months were tempered by anecdotal commentary from surveyors that the current pace of price growth may not be sustainable as unemployment rises and the UK Government’s stamp duty holiday tax expires. More UK data will be released later in the morning at 07:00 GMT, including gross domestic product for October and the relevant component data. These data are likely to reveal only hints of the full cost of the second wave of covid-19 restrictions in the UK, as the second national lockdown was only announced at the end of the month.

The week’s main event from a macro perspective will take place from 12:45 GMT onwards, as the ECB announced its latest policy decisions and explains its reasoning in a press conference at 13:30. US consumer inflation data will also be released at this time.

Friday 11/12

The Bank of England’s Financial Policy Committee will release its latest Financial Stability Report at 07:00 GMT, meeting minutes, and a statement. As usual, the report will be of less significance than monetary policy decisions, although with the amount of uncertainty remaining over trading relations with the European Union, the document may give some useful insight. For example, the precarious state of EU equivalence recognition for clearing of euro derivatives in the UK may receive some attention. Another batch of backwardlooking Eurozone data will be released over the course of the rest of the morning, including French consumer prices and Italian unemployment and industrial production. US producer price data will be released at 13:30.

 

CAD

BOC LIKELY TO JAWBONE LOONIE AT WILKINS’ FAREWELL MEETING

After recalibrating its monetary policy stance back in October, the Bank of Canada is unlikely to alter its policies at Senior Deputy Carolyn Wilkins’ last meeting as second in command on Wednesday. However, that doesn’t mean the meeting will be a non-event. Covid-19 cases have been steadily rising in Canada, suggesting localised containment measures will be in place through to the New Year. While the near-term deterioration has been offset by positive vaccine news adding upside risks to the Bank’s 2021 forecasts, the headwinds the economy currently faces won’t go unnoticed by the BoC. After referencing the loonie’s appreciation on the back of broad USD weakness back in October’s monetary policy statement, the Bank may look to hedge against the near-term economic deterioration by jawboning the currency as it trades at two-year highs against the dollar. While other central banks globally have been more vocal when talking down their currencies, notably the European Central Bank, Reserve Bank of Australia and Reserve Bank of New Zealand, the Bank of Canada is known for not referencing the FX rate until it becomes unpalatable. That being said, the art of jawboning wouldn’t come as anything new to the Bank of Canada. Prior to the pandemic, under Stephen Poloz’s tenure as BoC Governor, the central bank used external communications to talk down the loonie when USDCAD dropped close to the 1.30 threshold at a time when the domestic economy stagnated in 19Q4/ 20Q1.

 

Canada’s second wave shows no signs of flattening despite provinces tightening lockdown measures

Source: Government of Canada

With EURUSD also breaking psychological levels recently as it rallied above the 1.20 level, speculation increased over the ECB also jawboning the euro. However, many argued that other key trading partners also saw their currencies rally against the dollar, reducing the significance of this psychological level being breached as the trade-weighted value of the euro didn’t increase by as much as the EURUSD rally suggests. The same argument also rang true for CAD once it broke the 1.30 level earlier this week as CNY, MXN and JPY strength offset the effects of a CAD rally in trade weighted terms. However, as the Canadian dollar continues to drive higher against the dollar, breaking fresh two-year highs on a daily basis, the trade weighted value of the loonie has risen back up to levels that proved sensitive for the BoC under Governor Poloz earlier this year.

 

Loonie’s breach of 1.30 isn’t as significant as the rally in the CAD trade weighted index, which could force the BoC back into jawboning the currency

With an economic deterioration in the near-term outlook, the Bank of Canada’s stance towards a further risk to the economic outlook stemming from a strong loonie via the current account is likely to be tested.

Following October’s reference to the latest bout of CAD strength, which occurred at a much weaker trade weighted level and with USDCAD above 1.30, we expect the BoC to take their actions further. While the Bank will avoid explicit references to CAD levels, we expect Governor Macklem to reiterate the risks an overtly strong currency poses at a time of economic vulnerability. Additionally, the Bank could make the decision to explicitly highlight that near-term asset purchases will increase, as the current framework of C$4bn of weekly purchases is only a “minimum” requirement. This would take the emphasis away from investors having to monitor the weekly purchase data to assess the Bank’s stance, instead making their actions more explicit in the short-term. While more stimulus towards the recovery has been taken as a positive for markets, it must be noted that the dovish tilt witnessed in the BoC’s October meeting resulted in the loonie depreciating a percentage point vs the dollar. If the move to explicitly ramp up QE purchases is also coupled with concerns over the currencies strength, the result is likely to be another bout of BoC induced CAD weakness.

WILKINS TO ISSUE FAREWELL MESSAGE, BUT WHO WILL BE NEXT SENIOR DEPUTY GOVERNOR?

After tendering her resignation on the 5th November, Wednesday’s meeting will mark the end of Carolyn Wilkin’s 19-year stint at the central bank, six of which have been as Senior Deputy Governor after being appointed as Governor Poloz’s second in command back in 2014. After missing out on the promotion to Governor earlier this year, with authorities opting for Tiff Macklem instead, Wilkins’ decision means she will step down before her 7-year term officially ends on May 1st 2021. Speculation over who will be the next second in command has been rife ever since. A Bloomberg poll of economists highlighted Sharon Kozicki as the most likely option as the Governing Council is set to be all male for the first time in a decade due to Wilkins’ departure. This comes at a time when the central bank is pushing to redress the gender imbalances in senior roles. Kozicki would bring a wealth of experience to the position and would follow in Wilkins’ footsteps in being promoted to Senior Deputy Governor from governing council secretary.

Regardless of who is selected, the position is unlikely to be filled until the New Year. Additionally, the selection of individual candidates holds less impact at the Bank of Canada relative to other central banks as Governing Council members don’t outline individual views publically. Despite that, the communication skills of Wilkins’ replacement will be of key importance as the Senior Deputy plays an integral part during monetary policy meetings and external conferences. In this regard, Senior Deputy Governor Wilkins will be missed by those who regularly tune in to central bank press conferences.

 

EUR

ECB TO STEP IN WITH “RECALIBRATED” PEPP, WHILE ASSESSING THE ECONOMIC OUTLOOK UNDER VACCINE ROLLOUT PLANS

This week, the euro managed to break and hold above the critical 1.20 resistance level against the dollar, with the pair firming at a 32-month record high on Friday. The EURUSD rally has mainly been due to broad dollar weakness as vaccine optimism filters through and boosts global risk appetite. Euro strength isn’t just visible in EURUSD, however, as the currency has also strengthened overall according to the trade-weighted Deutsche Bank Index, which is only 1/3 USD-weighted. Crucially, the currency has navigated the impact of fresh restrictions measures in the area on the back of increased virus infections, which point at a double-dip recession in the euro-area this year. More importantly, tensions regarding the Hungary/Poland veto to the EU recovery package and common budget over the Rule of Law conditionality have failed to derail the euro´s rally. Heightened risks of a no-deal Brexit scenario have also had a muted impact on the single currency’s upward trend.

 

Euro rally is mainly, but not exclusively, driven by dollar weakness

The euro’s resilience is partly due to strong ECB communication, with the central bank effectively signalling monetary policy support throughout the recovery period and beyond. After several comments from executive board members over previous weeks, it has become clear that the ECB is poised to increase support at its last meeting of the year next week, even as vaccine plans become known. Disappointing growth momentum in Q4, subdued inflation expectations and uncertainty about the economic outlook in 2021 justify the need for additional easing, even as financial conditions relax from the October dip. Caution about the speed and timing of vaccine rollout plans and potential lifting of restrictions to economic activity, calls for pre-emptive action looking forward.

 

Financial conditions have recovered from the autumn dip but remain tighter compared to pre-virus levels (a below zero reading suggests a tightening of financial conditions)

Median expectations for the next policy announcement are set on a potential increase to the PEPP envelop by about €500 billion, to a total amount of €1.85 trillion. More importantly, the PEPP program, which has been the key tool of ECB response to the pandemic crisis, should be extended until at least the end of 2021, from the mid-year deadline currently set. This “recalibration” of PEPP would be consistent with a rollout of the current pace of average monthly purchases, of around €20 billion per week, which underpins recent Lagarde´s comments about the “quality” instead of “quantity” of the upcoming ECB decision. Numbers might disappoint market expectations, as purchases are likely to be subject to various assumptions on government´s issuance plans next year. But even so, the main takeaway from the announcement is yet another “whatever it takes” message from the ECB. The improvement of PEPP isn´t trivial as this instrument allows for more flexibility into mitigating the uneven impacts caused by the pandemic across sectors and jurisdictions. Along with PEPP, TLTRO conditions might be boosted in next ECB meeting, since the program has proven to have high efficacy as an ad hoc policy tool for the current crisis.

 

PEPP monthly and cumulative purchases

Given broad expectations on policy moves next week, investors will be rather anxious about the fresh economic projections to be presented. The second wave of infections has forced countries across the euro area to re-impose strict lockdown measures. France reintroduced a hard lockdown from Nov 28th until Dec 15th, with nationwide curfews and soft lockdown measures being extended until January 20th. Gyms, restaurants and cafes will reopen from January 20 onwards if the infections remain below 5,000 a day. Germany, Belgium and the Netherlands imposed a partial lockdown, with Germany extending measures into Q1 until Jan 10th. The Spanish government is planning to limit festive gatherings to six people and to set a 1am to 6am curfew for Christmas eve and New Year’s eve according to a leaked document. The reintroduction of all these stricter measures only occurred after the ECB published its latest projections from September, meaning that the central bank did not account for this in their base case scenario.The likelihood of a rate cut in next meeting is low, as it also is over the 2021 horizon. Cutting rates deeper into negative territory would have limited effect in boosting consumption and investment at this point. Additionally, political tensions faced by this policy option would be of paramount level, while the prospects of distress in the banking sector rise. However, the ECB will remarkably keep this option in its toolbox as a way to ascertain market confidence in the context of exhausted policy space. Moreover, the ECB is yet to show some dislike on a potentially rampant euro appreciation, for which rate cuts would be a last resort, at least verbally. Although, the ECB has remained muted over the latest euro strength, recent jawboning by Chief Economist Philip Lane still hangs in the air.

In the upcoming press conference, markets will be seeking assurance on ECB’s position towards the currency, even though Lagarde has clearly disregarded it as a policy target.

 

Lockdown measures may result in a downgrade in forecasts

The recent measures will undoubtedly weigh on activity through the last quarter of the year and the beginning of next. We therefore expect the ECB to lower its Q4 2020 real GDP growth projections. Medium-term growth forecasts are likely to remain unchanged, however. With recent headlines suggesting that vaccines will be rolled out in the eurozone next year, markets are warming up to the idea that most restrictions will be lifted in the coming months and demand should rebound fairly rapidly as a result. However, ECB policy makers have repeatedly communicated that the vaccine news does not change anything to the ECB’s policy. ECB member Isabel Schnabel stated that “the vaccine news basically puts us back in our baseline scenario… formulated in the middle of the year, which foresees a vaccine being rolled out in 2021”. President Christine Lagarde backed up her colleague at the Bloomberg New Economy Forum and stated the vaccine is no game changer for the ECB outlook.

 

2020 upwardly revised growth projections may be up for another revision after renewed lockdown measures across the euro area

As for the inflation outlook, the ECB communicated over the last couple of months that the decline in inflation is primarily due to temporary factors, such as the VAT cut in Germany and atypical timings of summer retail sales in Italy and France. November’s eurozone flash HICP, which was released earlier this week, printed at -0.3%, indicating no change from the October figure and signalling the decline in inflation since the summer is a more structural development than what ECB policy makers had hoped. The decline in core inflation has persisted for several months, with Germany not being much different from other countries. With this in mind, the ECB may alter the 2020 inflation outlook as well. Previously the central bank upwardly revised its 2021 inflation projection from 0.8% to 1.0%. This is likely to remain unchanged as upward pressure on core inflation should return as the vaccine is rolled out and the hospitality sector comes back to life.

Over the medium term, the ECB expects a recovery in demand supported by accommodative monetary and fiscal policies, which will put upward pressure on inflation. The fiscal front has been in focus recently after Poland and Hungary vetoed the rule of law conditions that come with the EU recovery fund. President Lagarde has urged EU countries to solve their disagreements as “the package should become operational without delay”. For now, markets have not been buying the idea that the EU recovery package will fall apart as a result of the veto, and the ECB is not likely to take this as their base case either. EU leaders are now preparing to get around the veto and cut Hungary and Poland out of the €750bn recovery package, if the nations show no signs of willingness to compromise.

 

 

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