Central Banks and Governments Act To Combat COVID-19. Will It Be Enough?

In just a few weeks the world has changed dramatically.  What was initially seen as a virus localised in Asia has spread throughout the world with frightening speed.  The shocking destruction that COVID-19 has wrought globally in both health and economic terms will not fade quickly.  The virus is destroying complacency in all areas.  Total and complete lock down is becoming key to arrest the virus’ ascent, but many have yet to change their ways, believing that they will be ok.  How naïve is that!

Governments and central banks are finally coming to grips with the economic and health costs, but also the realisation that even in many developed countries, they are woefully unequipped to deal with the health crisis that is unfolding.  Global policy makers and the public at large has gone from a phase of denial, to outright panic and increasingly into fear, which then brings forth the most aggressive responses.

Unfortunately, the lack of global cohesion amongst policy makers has meant that responses have largely been piecemeal and uncoordinated.  Two of the biggest super powers, the US and China, have despite a now forgotten about Phase 1 trade deal, become increasingly acrimonious in their dealings with each other.  This, at a time when the world is looking for leadership, is proving to be major impediment to dealing with the effects of the virus.

It is not all bad news in term of co-ordination.  Central banks globally appear to be acting in unison, even if accidently, in terms of slashing interest rates, aggressively increasing quantitative easing, flushing the financial system with US dollar liquidity and easing some of the regulatory burden on banks.  This has helped to improve market functioning, which increasingly appeared to be breaking down over recent weeks.  It may not however, prevent further pressure on asset markets given the destruction in economic  activity globally.

Unprecedented times call for unprecedented measures.  Governments are now stepping up to the plate.  Massive fiscal stimulus plans are being ramped up around the world.  G7 economies have pledged to do “whatever is necessary” and to co-ordinate actions though much has been un coordinated.  US lawmakers are currently deliberating on a stimulus package worth over a $1tn though this could rise significantly in the weeks ahead, Germany is planning to create a EUR 500bn bailout fund, and the UK has announced an “unprecedented” multi billion pound package of measures.  These are but a few of the various stimulus measures being undertaken globally.

China has yet to announce a major stimulus package, but has instead opted for more incremental measures as its economy begins to recover following a major lockdown.  However, just as China’s supply constraints are easing, demand is weakening sharply as economies globally shut down.  The implication is that China’s recovery will not be a quick one either.  More stimulus is likely.  Recent reports suggest China will step up special bond issuance for infrastructure spending, but more is likely.

Overall, the economic shock is just beginning as the health shock is intensifying.  We will need to brace for more pain in the weeks and months ahead.  We can only hope that the measures announced so far and yet to be announced alongside with strict adherence to health recommendations will be sufficient to prevent deeper and longer lasting damage.  The jury is still out.

Confidence Dives, Markets Shattered

COVID-19 fears have proliferated to such a large extent that confidence is being shaken to the core.   Confidence in markets, policy makers and the system itself is being damaged.  Today’s moves in markets have been dramatic, continuing days and weeks of turmoil, as panic liquidation of risk assets and conversely buying of safe assets, is leading to intense asset market volatility.  Economic fears are running rampant, with the failure of OPEC to agree a deal to prop up oil prices over the weekend adding further fuel to the fire.  Consequently, oil prices dropped a massive 30%, leading to a further dumping of stocks.

When does it end?  Confidence needs to return, but this will not be easy.  Policy makers in some countries seems to have got it right, for example Singapore, where containment is still feasible.  In Italy the government has attempted to put around 16 million people in quarantine given the rapid spread of the virus in the country. However, in many countries the main aim has to be effective mitigation rather than containment.  I am by no means an expert, but some experts predict that as much as 70% of the world’s population could be infected.  Washing hands properly, using hand sanitizers, social distancing and avoiding large gathering, appears to the main advice of specialist at least until a cure is found, which could be some months away.

In the meantime, markets look increasingly shattered and expectations of more aggressive central bank and governmental action is growing.  Indeed, there is already significantly further easing priced into expectations for the Federal Reserve and other major central banks.  This week, the European Central Bank is likely to join the fray, with some form of liquidity support/lending measures likely to be implemented.  Similarly, the Bank of England is set to cut interest rates and implement other measures to support lending and help provide some stability.  The UK government meanwhile, is set to announce a budget that will contain several measures to help support the economy as the virus spreads.

It is also likely that the US government announces more measures this week to help shore up confidence, including a temporary expansion of paid sick leave and help for companies facing disruption.  What will also be focused on is whether there will an increase in number of virus tests being done, given the limited number of tests carried out so far.  These steps will likely be undertaken in addition to the $7.8bn emergency spending bill signed into law at the end of last week.

All of this will be welcome, but whether it will be sufficient to combat the panic and fear spreading globally is by no means clear.  Markets are in free fall and investors are looking for guidance.  Until fear and panic lessen whatever governments and central banks do will be insufficient, but they may eventually help to ease the pain.  In the meantime, at a time of heightened volatility investors will need to batten down the hatches and hope that the sell off abates, but at the least should steer clear of catching falling knives.

Oil Surges, Central Banks Galore

Oil prices jumped following drone attacks on Saudi Arabian oil facilities over the weekend.  Oil rose by around 20% to just shy of $72, before halving its gain later.  Even after failing to hold onto initial gains the rise in oil prices still marks one if its biggest one day gains.  Concerns about reduced oil supply have risen as a result of the attacks as they could reduce Saudi oil production for a prolonged period, with around 5% of global oil supply impacted.  Additionally the attacks could raise geopolitical tensions in the region.

As markets digest the impact of the drone attacks, there will also be several central bank decisions globally to focus on this week.  The main event is the Fed FOMC meeting mid-week, where a 25bp cut is largely priced in by the market.  Given that a rate cut is well flagged markets will pay close attention to the Fed’s summary of economic projections, in particular the Fed’s dot plot.  It seems unlikely that Fed Chair Powell is going to sound too dovish, with little to suggest that the Fed is on path for a more aggressive easing path.

Another major central bank meeting this week is the Bank of Japan (BoJ) on Thursday.  While a policy move by the BoJ at is unlikely this week BoJ policy makers have sounded more open to easing.  A consumption tax hike planned for next month together with a strong JPY have increased the pressure for the BoJ to act. Separately easier policy from other major central banks amid slowing global growth are unlikely be ignored.  However, policy is already ultra- easy and the BoJ remains cognisant of the adverse secondary impact of policy on Japanese Banks.

The Bank of England deliberates on policy this week too but it seems highly unlikely that they would adjust policy given all the uncertainties on how Brexit developments will pan out.  Until there is some clarity, the BoE is likely to remain firmly on hold, with the base rate remaining at 0.75%.  GBP has rallied over recent weeks as markets have stepped back from expectations of a hard Brexit, but this does not mean that a deal is any closer than it has been over the past months.  Elsewhere the SNB in Switzerland and Norges Bank in Norway are also expected to keep policy rates on hold this week.

Several emerging markets central banks will also deliberate on policy this week including in Brazil, South Africa, Indonesia and Taiwan.  The consensus (Bloomberg) expects a 50bp rate cut in Brazil, no change in South Africa and Taiwan and a 25bp rate cut in Indonesia.  Overall many emerging markets continue to ease policy amid slowing growth, lower US policy rates and declining inflation pressures.

 

Central Banks Galore

It’s a big week for central banks.  Several central banks globally meet to decide upon monetary policy this week.  The biggest focus will be on the Fed FOMC but this week also sees Norges Bank, Bank of England, Bank of Japan and central banks in Indonesia, Philippines, Taiwan, and Brazil meet.

Markets are already aggressive in pricing in Fed rate cuts.  As US-China trade tensions have worsened markets have intensified their expectations of Fed easing, with around 75bps of easing already priced in.  Given how much is priced in in terms of Fed easing, if the Fed does not validate this with a dovish statement and/or shift in the dot plot there could be a significant risks of disappointment, which could weigh on equities, but leave the USD on a firmer footing.

Admittedly the Bank of Japan is more constrained than the Fed in terms of policy room, but their rhetoric has become more dovish.  I don’t expect easing anytime soon but the BoJ is likely to sound dovish and could offer some enhanced forward guidance.  BoJ governor Kuroda outlined four options in terms of more policy stimulus, with one being a further cut in the deposit rate.  However, BoJ would need to outline how they plan to alleviate the pressure on bank profits from such a move.

Bank of England is unlikely to move.  Data in the UK has been mixed, with softening in Q2 growth but ongoing pressure on inflation given the tightness of the labour market.  It’s also difficult for the BoE given the large amount of Brexit uncertainty. GBP risks remain to the downside over the short term especially given the heightening political noise in the UK.  The Norges Bank is likely to stand out amongst the crowd, with a rate hike expected, its second in just three months.

Elsewhere in Asia I expect no change from Bank Indonesia, BSP in the Philippines, and CBC in Taiwan. Bank Indonesia is edging towards a rate cut amid low inflation and slowing activity, but will likely want to see further signs of IDR stability before pulling the trigger to begin reversing the 175bp of hikes implemented in 2018.

Weaker activity in Taiwan calls for some sort of stimulus but the reality is that a rate cut will do little to alleviate the pain given that much of the problem is due to external factors.  Instead much of the adjustment may take place on the currency front.

I expect the BSP in the Philippines to maintain its overnight borrowing rate at 4.50% at this week’s meeting while signalling more RRR cuts ahead. Although CPI came in above expectations in May, at 3.2% y/y, it remains close to the midpoint of the BSP’s 2-4% band and I don’t expect it to stand in the way of further easing, but think BSP may wait until at least August to move again.

 

 

Turkey hikes, ECB and BoE don’t. Trump dampens trade hopes

Despite comments from Turkish President Erdogan railing against prospects for a rate hike, Turkey’s central bank, CBRT hiked the repo rate to 24%, a much bigger than expected 625bp increase.  This may not be sufficient to turn things round sustainably but will at least prevent a return of the extreme volatility seen over past weeks.  The decision saw USDTRY drop by about 6% before reversing some of the move.  Undoubtedly the decision will provide support to EM assets globally including in Asia today.

Elsewhere the European Central Bank (ECB) delivered few punches by leaving policy unchanged and reaffirming that its quantitative easing will reduce to EUR 15bn per month (from EUR 30bn) from October while anticipating an end after December 2018.   The ECB also downgraded its growth outlook but kept the risks broadly balanced.  The outcome will likely to help put a floor under the EUR.  Unsurprisingly the Bank of England (BoE) left its policy on hold voting unanimously to do so, leaving little inspiration to GBP.

President Trump poured cold water on US-China trade talks by denying a Wall Street Journal article that he faces rising political pressure to agree a deal with China.  Trump tweeted, “They are under pressure to make a deal with us. If we meet, we meet?” . Meanwhile US CPI missed expectations at 0.2% m/m, 2.7% y/y in August, an outcome consistent with gradual rate hikes ahead.   The data will also help to undermine the USD in the short term.

China Trade talks, ECB, BoE and CBRT

Today marks the most interesting day of the data calendar this week.  Central banks in the Eurozone (ECB), UK (BoE) and Turkey (CBRT) all announce policy decisions while US CPI (Aug) is released.  The ECB and BoE meetings should be non events.  The ECB is likely to confirm its €15 billion per month taper over Q4 18.  The BoE monetary policy committee is likely have a unanimous vote for a hold.

The big move ought to come from Turkey.  They will need to tighten to convince markets that the central bank it is free from political pressure and that it is ready to react to intensifying inflation pressures.  A hike in the region of 300 basis points will be needed to convince markets.   This would also provide some relief to other emerging markets.

The big news today is the offer of high level trade talks from US Treasury Secretary Mnuchin to meet with Liu He (China’s top economic official), ahead of the imposition of $200bn tariffs (that were supposedly going to be implemented at end Aug).  This shows that the US administration is finally showing signs of cracking under pressure from businesses ahead of mid-term elections but I would take this with a heavy pinch of salt.

Mnuchin appears to be increasingly isolated in terms of trade policy within the US administration. Other members of the administration including Navarro, Lighthizer, and Bolton all hold a hard line against China.  Last time Mnuchin was involved in such talks with China in May they were derailed by the hawks in the administration.  So the talks could mark a turning point, but more likely they are a false dawn.  That said it will provide some relief for markets today.

Eurozone contagion spreading quickly

Contagion from the eurozone debt crisis is spreading quickly, threatening to turn a regional crisis into a global crisis. As highlighted by Fitch ratings further contagion would pose a risk to US banks. Consequently risk assets continue to be sold but interestingly oil prices are climbing. Taken together with comments earlier in the day from the Bank of England that failure to resolve the crisis will lead to “significant adverse effects” on the global economy, it highlights the risks of both economic and financial contagion.

Predominately for some countries this is becoming a crisis of confidence and failure of officials to get to grips with the situation is resulting in an ever worsening spiral of negativity. Although Monti was sworn in as Italian Prime Minister and Papademos won a confidence motion in the Greek parliament the hard work begins now for both leaders in convincing markets of their reform credentials. Given that there is no agreement from eurozone officials forthcoming, sentiment is set to worsen further, with safe haven assets the main beneficiaries.

EUR/USD dropped sharply in yesterday’s session hitting a low around 1.3429. Attempts to rally were sold into, with sellers noted just below 1.3560. Even an intensification of bond purchases by the European Central Bank (ECB) failed to prevent eurozone bond yields moving higher and the EUR from falling.

Against this background and in the absence of key data releases EUR will find direction from the Spanish 10 year bond auction while a French BTAN auction will also be watched carefully given the recent increase in pressure on French bonds. Having broken below 1.3500, EUR/USD will aim for a test of the 10 October low around 1.3346 where some technical support can be expected.

US data releases have been coming in better than expected over recent weeks, acting to dampen expectations of more Fed quantitative easing and in turn helping to remove an impediment to USD appreciation. While the jury is still out on QE, the USD is enjoying some relief from receding expectations that the Fed will forced to purchase more assets. Further USD gains are likely, with data today including October housing starts and the November Philly Fed manufacturing confidence survey unlikely to derail the currency despite a likely drop in starts.

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