Dollar Soft as BOE Surprises Ahead of UK Budget

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Win Thin
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• The dollar is stabilizing but remains vulnerable to disappointment as markets await details of US fiscal measures
• US reports February CPI; Joe Biden moved closer to clinching the Democratic nomination
• BOE delivered a surprise 50 bp rate cut to 0.25% and initiated a new lending scheme; UK government releases its budget today; UK reported weak data
• RBA Deputy Governor Debelle laid out the likely path for unconventional policy; China reported disappointing money and loan data

The dollar is mostly weaker against the majors after the BOE surprised markets with an emergency rate cut.  Kiwi and yen are outperforming, while Nokkie and Loonie are underperforming.  EM currencies are mixed.  INR and RON are outperforming, while ZAR and MXN are underperforming.  MSCI Asia Pacific was down 1.7% on the day, with the Nikkei falling 2.3%.  MSCI EM is down 0.6% so far today, with the Shanghai Composite falling 0.9%.  Euro Stoxx 600 is up 1.3% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 10 bp at 0.70%, while the 3-month to 10-year spread is down 5 bp to stand at +32 bp.  Commodity prices are mixed, with Brent oil down 3.1%, copper flat, and gold up 0.9%.

The trend over the last few days continues for the coronavirus. Confirmed cases in Italy continue to rise and those in China continue to decline. There hasn’t been any huge change in the US, Germany or France yet, but many expect a sharp increase soon.

Global financial markets have stabilized as policymakers continue to roll out stimulus measures.  This is all well and good.  However, we are bracing for the likely scenario where the economic data continue to worsen after stimulus has been exhausted.  For now, however, markets seem to be embracing the efforts to counteract the impact of the coronavirus.

In that regard, the dollar remains vulnerable to disappointment as markets await details of US fiscal measures.  DXY has retraced nearly a third of its drop from the late February peak.  Major retracement objectives from that rally come in near 96.66 (38%), 97.28 (50%), and 97.90 (62%).  The 200-day moving average comes in near 97.80 currently.  Sterling is firm despite the surprise BOE cut (see below, while the euro is holding above $1.13 ahead of the ECB decision tomorrow.  The yen remains hostage to risk sentiment, with USD/JPY trading around 105 and well off yesterday’s low near 101.20.

AMERICAS

Yesterday, President Trump failed to announce “very dramatic” action to support the economy at a White House briefing.  Reports suggest his aides were taken aback by his promise to deliver, as discussions on fiscal stimulus were still ongoing.  Trump made some brief remarks but did not announce any specific measures.  Economic adviser Kudlow limited himself to saying that they will outline the measures at “some point in the near future.”  Trump reportedly then met with Republican Senators and said that he wants payroll taxes waived through the November elections, but it is not clear that Democrats will support this. 

US reports February CPI.  Data have taken on even less importance in light of last week’s surprise Fed rate cut and growing coronavirus fears.  To wit, last Friday’s blockbuster jobs report (+273k) had very little impact on markets.  Headline inflation is expected to ease to 2.2% y/y from 2.5% in January, while core inflation is expected to remain steady at 2.3% y/y.  February budget statement will also be released today, where a -$236.8 bln deficit is expected.  If so, the 12-month total would rise to a new cycle high of -$1.077 trln.

Joe Biden moved closer to clinching the Democratic nomination.  Biden won Michigan, Missouri, Mississippi, and Idaho to extend his delegate lead over Bernie Sanders.  As of this writing, North Dakota and Washington remain too close to call.  Next Tuesday brings the next big round of primaries.

Brazil reports February IPCA inflation, which is expected to rise 3.90% y/y vs. 4.19% in January.  If so, it would be the lowest since November and back below the 4% target for this year but well within the 2.5-5.5% target range.  After the Fed’s surprise cut, Brazil’s central bank issued a statement that it’s closely monitoring the effects of the coronavirus on financial markets and on the economy, calling it a threat.  CDI market went from pricing in no cut at the next COPOM meeting March 18 to pricing in 25 bp of easing.  The real has been underpinned by aggressive BCB intervention but remains vulnerable to the bank’s more dovish tilt.

EUROPE/MIDDLE EAST/AFRICA

Bank of England delivered a surprise 50 bp rate cut to 0.25% in an extraordinary meeting and initiated a new lending scheme. The so-called term funding scheme (TFSME) is directed towards small and medium-size companies and financed by the issuance of central bank reserves. The plan intends to: (1) reinforce the transmission mechanism of monetary policy; (2) provide cheap funding to support the real economy; and (3) incentivize banks to expand credit and support SMEs. Separately, the BOE also reduced the countercyclical capital buffer rate from 1% to 0% of banks’ exposure. This is the rainy day capital banks are required to hold during good times to be used in bad times like these. There was no change to its asset purchase program.

Governor Carney thus goes out with a bang.  The next scheduled meeting is March 26 and will be first under incoming Governor Bailey, with WIRP suggests another cut then is partially priced in.  All in all, we found the measures strong and appropriate. Sterling took a small hit from the headline rate cut, but this is just a kneejerk reaction. All major CBs are easing and ultimately what matters at this point for FX is growth differentials. As such, we are encouraged by the BOE measures and think they should be medium-term positive for the UK.

The UK government releases its budget today at 830 AM ET.  Carney said the cut was done on the same day as the budget in order to get “maximum” impact.  We expect an aggressive budget as well.  Indeed, with Javid gone, markets were already looking for more expansionary budget.  Officials said recently that the budget would reflect the economic impact of the coronavirus.

After the BOE cut, the UK reported weaker than expected January data.  GDP was flat m/m vs. 0.2% expected, IP fell -0.1% m/m vs. +0.3% expected, and construction output fell -0.8% m/m vs. +0.1% expected.  The only bright spot was the trade balance, which came in at GBP4.2 bln vs. -GBP356 mln expected.

After the BOE move, all eyes are on tomorrow’s European Central Bank decision.  Please see our ECB Preview for our thoughts on what the ECB could do.  We expect a similar package of measures, with the exception being a potential increase in QE from the current EUR20 bln per month.  The problem, however, is that fiscal policy is still the purview of the member governments.  As such, eurozone policymakers cannot announce broad fiscal stimulus as the UK government is likely to do later today.

ASIA

RBA Deputy Governor Debelle laid out the likely path for unconventional policy.  He felt that BOJ-type yield curve control was the preferred approach over buying a set amount of securities very month.  Debelle added that the negative impact to tourism and such would shave 0.5 ppt off Q1 GDP growth, but warned that it’s “just too uncertain to assess the impact” of the virus any further out.  WIRP suggests nearly 100% odds of a 25 bp cut April 7, which would take the policy rate to the effective lower bound of 0.25%.

China reported disappointing money and loan data for February.  Aggregate financing came in at CNY855.4 bln vs. CNY1.6 trln expected, while new loans came in at 905.7 bln vs. CNY1.1 trln expected.  Both declined sharply from January but quite frankly, it could have been much worse. The government’s decisive measure and strong grip on the financial system should ensure that lending continues to flow throughout the virus crisis.