The Chairman explained to the House
The virus could truthfully dowse
Their growth expectation
As well as inflation
Thus rate cuts they may soon espouse
Chairman Powell testified before the House Financial Services Committee yesterday and there were absolutely no surprises. According to him, the economy remains in a “good place” and current policy settings are appropriate. He did, however, explain that the coronavirus outbreak in China did pose a new risk to their forecasts and has added significant uncertainty overall. He also left no doubt that in the event the economic data started to turn lower due to virus linked issues (or arguably any other issues), the Fed was ready to act as appropriate to support the economy. In other words, they will cut rates in a heartbeat if they think their targets are in danger of being missed. In the meantime, they continue to buy $60 billion of T-bills each month and will do so at least until April, and they continue to expand the balance sheet further via term repos, pumping ever more liquidity into the system and ultimately supporting global equity markets.
If you think about it, that is really what defines the market these days. It is the battle between questions and fears over the spread of the coronavirus and its negative impacts on Chinese and global economic activity vs. central bank largesse and the positive impacts of ever more cash being created and seeking a home by investors. And let’s face it, up until now; except for two days in late January, bookending the Lunar New Year when equity markets fell sharply, the central banks have been dominant.
Will they continue to have success? At this point, there is no reason to believe they won’t in the short run, but ultimately, it will depend on just how deep the shock to China’s economy actually turns out to be. Remember, a key discussion point about China prior to the virus outbreak was the fragility of a large swathe of Chinese industries given their highly leveraged stance. While I imagine we will never learn the true extent of how much the economy there slows, analysts will infer a great deal based on how many companies wind up failing, or at least restructuring their debt. As I have said before, interest remains due even when revenues cease to occur. But for now, the market is backing Powell and his central bank comrades and thus risk appetite continues to grow.
Thus, turning out attention to this morning’s market activity, equity markets are in the green everywhere after solid overnight performance in Asia. Haven assets, notably Treasuries and the yen, are under pressure, and overall, the dollar is on its back foot.
Last night, the RBNZ left rates on hold at 1.0% and explained that while the virus could well have a longer term negative impact, for now, they see no reason to cut rates any time soon. Interest rate markets, which had been pricing in a 40% probability of a rate cut this year, rebalanced to no rate changes and the kiwi dollar jumped 1.2%. Not surprisingly, Aussie is also performing well, up 0.5%, as investors recognize that the two nations are inextricably linked economically, and if New Zealand is feeling better, odds are Australia will be soon as well.
Last night the Swedish Riksbank also left rates on hold, at 0.0%, as widely expected, despite lowering their inflation expectations. You may recall Sweden raising rates by 25bps in December as they sought to exit the NIRP world after concluding it was doing more harm than good. While lowered inflation expectations might seem a reason to reduce rates, the fact that the catalyst for that has been the sharp decline in energy prices due to the virtual closure of China’s economy, allows Riksbank members to cogently make the case that this is a temporary shock, and they need to look through it. This morning, SEK is firmer by 0.2% vs. the dollar after the Riksbank announcement. NOK is higher by 0.4% as oil prices firm up again on a more positive general tone, and the pound is higher by 0.2% as it continues its rebound from last week’s sharp decline, and there was nothing new from the PM regarding a hard Brexit.
You may have noticed that I failed to mention the euro, which is essentially flat on the day, arguably the second biggest underperformer vs. the dollar. Early in the session, it too was firmer as the dollar has few friends during a risk-on session, but then they released Eurozone IP at -2.1%, worse than expected and the worst print in four years. Subsequent trade saw more sellers emerge, weighing on the single currency, which has been under pretty steady pressure for the past week and a half. Madame Lagarde testified to the European Parliament yesterday and basically begged countries to step up their fiscal response as it becomes ever clearer that the ECB has no more bullets.
In the emerging markets, the Russian ruble is the leader of the pack, up 0.5%, also benefitting from oil’s rebound from the lows seen earlier this week. Away from this, there are far more gainers in the space (CLP +0.4%, THB +0.35%, ZAR +0.3%) than losers (TRY -0.4%, HUF -0.3%), but as you can see by the magnitude of the movements, there is not much of interest ongoing. Ultimately, as long as the risk-on attitude prevails, I expect the higher yielding currencies (ZAR, MXN, INR, etc.) should perform well as investors continue to hunt for yield.
There is no data to be released today, but we do hear Chairman Powell in front of the Senate, as well as some comments from Philly Fed President Patrick Harker, arguably one of the more centrist FOMC members. Yesterday’s comments from the bevy of doves who were on the tape were just as expected. Things are fine, but more accommodation is available and if inflation were to rise, they would be comfortable with letting it run hot for a while before acting.
And that’s really all there is. I see no reason for the dollar to change its current trajectory, which is modestly lower this morning. And since we already know what Powell is going to say, unless some Senator pins him down on something, I suspect we will see yet another day of limited movement overall.