Said Madame Lagarde urgent action
Is needed if we’re to gain traction
In putting a lid
On spreading Covid
Or we’ll have an ‘08 contraction
No sooner were those words reported
Than Governor Carney supported
A 50bp cut
(More than scuttlebutt!)
Thus, hoping recession is thwarted
Another day and another raft of new and important news driving markets. So far this morning, the biggest news has been the BOE’s surprise emergency rate cut of 0.50%, taking the base rate back down to 0.25%, its all-time low first reached during the financial crisis. Governor Carney, in his last official act, as he steps down on Sunday, explained that the idea behind the early cut (after all, the BOE has its regularly scheduled meeting in two weeks) was to show coordination with the government which will be releasing its budget for the new fiscal year later today. In addition, he explained, and was seconded by incoming Governor Andrew Bailey, that the BOE still had plenty of tools available to ease policy further if necessary.
In addition to the rate cut, they also restarted a targeted lending scheme that is designed to support bank lending to SME’s. As I type, we have not yet heard the nature of the budget package, but expectations are for a significant increase in spending focused on the National Health Service and small businesses. The market response has been positive for equities (FTSE 100 +0.8%), although Gilt yields have edged higher by 5bps. In the FX market, the pound’s initial reaction on the rate cut was to fall sharply, more than a penny, but it has since recouped all of that and then some and is currently higher by 0.2%.
Turning to Europe, Madame Lagarde led a conference call of EU leaders this morning and explained that if they don’t respond quickly and aggressively, the situation could devolve into the same type of financial crisis that the 2008 mortgage and credit crisis engendered with an equally deep recession. At the same time, Italian PM Conte is trying to get the rest of the EU to allow him to break the spending limits in order to rescue his country. With the entire nation on lockdown, economic activity is
screeching grinding to a halt and the impact on individuals, who will not be able to get paid and therefore pay their bills, as well as small companies will be devastating. But remarkably, the EU has not yet endorsed the package, which is set to be as much as €25 billion. In the end, there is no question the package will be implemented even if the Germans are dragged along kicking and screaming. Italian stocks rallied on the announcement, +0.9%, while Italian BTP’s (their treasury bonds) rallied sharply with yields falling 16bps. The euro has also benefitted this morning, currently higher by 0.4%, although I think a lot of that is simply a rebound from yesterday’s sharp decline. After all, the single currency fell 1.5% yesterday.
Turning to the dollar itself, broadly speaking it is weaker overall, albeit not universally so. Versus its G10 counterparts, the dollar is on the back foot, which seems to reflect the fact that we are hearing of every other G10 country taking concrete action to fight Covid-19, while the US remains a little behind the curve. The $8 billion package passed last week is small beer in this economy, but the administration’s calls for a reduction in payroll taxes and federally supported sick leave pay has fallen on deaf ears in Congress. With Congress due to go on a one-week recess starting Thursday, it is hard to believe they will come up with something before they leave. This policy uncertainty is weighing on US assets with equity futures pointing lower as I type, on the order of 1.7%, and Treasuries rallying again with the 10-year yield falling by 10bps.
At this point, all eyes are on the Fed with market expectations still fully baked in for a 50bp rate cut one week from today. What is interesting is the number of pundits who are pointing to a speech given last summer by NY Fed President Williams, where he highlighted research showing that when policy space is limited (i.e. rates are already low), a central bank should be more aggressive to get an impact from their actions, rather than trying to hold onto what limited ammunition they have left. This has a number of economists around Wall Street calling for a 1.00% rate cut next week by the Fed, which would truly be a shock and awe move, at least initially. The problem for the Fed is that they don’t have the structure to create targeted lending facilities the way other central banks do, and they can only buy securities issued or guaranteed by the US government, so Treasuries and mortgages. While that law can be changed, it will not be done either quickly or without controversy. In other words, the Fed may find it has a more limited toolkit than they need in the short run. At this point, a 0.50% cut to Fed funds next week will not do very much, but more than that is likely to have a big market impact. In fact, I’m leaning toward the idea that they cut 1.00% next week to see if they can get a positive response and force the government to step up.
In the EMG bloc, only ZAR (-0.7%) and MXN (-0.65%) are under any real pressure this morning as both feel the weight of sinking commodity prices. While some others here are soft, the moves are modest (RUB -0.3%). On the positive side, INR is the leader, rising 0.7% in a catch-up move as the country was on holiday yesterday during the rally by other Asian currencies.
But as we look ahead to today, unless we get new news from the US administration, my sense is the dollar will remain under pressure overall. There is data upcoming as CPI will print at 8:30 (exp 2.2%, 2.3% core), but I don’t think anybody is paying attention. The market is still completely driven by comments and official actions, with longer term views sidelined.