Will the ECB Spark Big FX Moves Like BoC?
Daily FX Market Roundup 01.22.20
By Kathy Lien, Managing Director of FX Strategy for BK Asset Management
After Tuesday’s broad based decline in equities, currencies and Treasury yields many investors believed that further losses were likely. Increased risk aversion is a serious possibility but today there was a semblance of calm in the financial markets. China’s coronavirus is spreading but with the country’s transparency and their dramatic decision to cease all outbound travel from Wuhan, a move not taken during the SARS epidemic, investors are hopeful that the virus can be contained. Many Chinese have already canceled their travel plans and in Wuhan a city of 11 million people, it will be nearly impossible to leave. The number of infected cases will most likely rise before falling but the latest developments prevented a deeper collapse in USD/JPY, leaving the pair at a standstill. With that said, we continue to look for USD/JPY to drop to 109.50 with a possible slide to 109. The Dow held onto its gains but all signs point to an imminent correction that could take USD/JPY to our targeted levels.
Meanwhile the Canadian dollar was hit hard today by the Bank of Canada’s monetary policy announcement. Although interest rates were left unchanged, the BoC made it clear that easing is on the table. They lowered their 2020 growth forecast and removed the language that describes interest rates as being “appropriate.” Consumer spending has been “unexpectedly soft” and the output gap is wider. Therefore the central bank needs to watch closely to see if the slowdown is more persistent. According to Governor Poloz, a rate cut is not warranted “at this time” but one could be needed in the future. He sees downward pressure on inflation and indicated that the “door is open to rate cut” if there is a meaningful miss on forecasts. This outlook is a dramatic change from December when the central bank focused on the resilience of the economy. USD/CAD surged above 1.31 in response and could extend its gains to 1.33.
Looking ahead, one of the key questions on everyone’s minds is whether Thursday’s European Central Bank monetary policy announcement will ignite as many fireworks as today’s Bank of Canada rate decision. When the ECB last met in December, EURO soared on the back of the central bank’s brighter outlook. Christine Lagarde presided over her first central bank meeting where she talked about lower risks and signs of a mild increase in core inflation. They backed that outlook with upgrades to their 2020 GDP and inflation forecasts. Since then, we have seen continued improvements in the Eurozone economy. The table below shows increases in consumer spending, inflation, economic activity, business and consumer confidence. While the geopolitical picture is mixed, these numbers should give the central bank the confidence to maintain their brighter economic outlook.
However the more interesting development will not be the central bank’s outlook but plans to change to their inflation target. Earlier this month, ECB President Lagarde made it clear that they will formally launch a review of their monetary policy strategy – a move that could lead to the first major policy change in 17 years. The main focus will be to determine whether their “near but below 2%” target remains appropriate. It is widely believed that they could unveil a new range to guide their efforts. Regardless, this is a major initiative and no decisions will be made on Thursday. The ECB will formally kick off the process that could take months if not years to finalize.
The Australian and New Zealand dollars will also be in focus with Australian labor data and New Zealand inflation data scheduled for release. According to the PMIs, employment conditions weakened in the service and manufacturing sectors last month. AUD has been trending lower for the past 7 days and a disappointing report could drive the pair to fresh 2 month lows. Softer price pressures are expected for New Zealand as food prices fall for the third month in a row. Between the wildfires, China’s respiratory virus and weaker data, the downtrend for AUD and NZD may just be beginning.