The week ahead: Coronavirus fears continue to drive investors

8 Mar 2020 05:12 PM

It’s been a truly chaotic fortnight in financial markets, with the number coronavirus cases and fatalities accelerating outside of China, prompting authorities around the world to raise their game.

Last week the tempo was set by the Federal reserve by cutting interest rates by 0.5% outside of a scheduled meeting bringing investors’ attention. Several more cut rates around the world with pledges from the IMF and the World Bank to stop a full-blown meltdown.  Next week the main event will be the European Central Bank (ECB) policy meeting, where markets are pricing in a 90% probability for a rate cut even though economists forecast no action. The ECB may opt for a targeted lending action instead of the rate cut to shield their economy from the virus fall out.

Also, another raft of economic data coming up; UK Spring Budget, US inflation numbers and consumer confidence data. Other important events to be fallowed by UK monthly GDP, Eurozone and Japan final Q4 GDP figures. In the Asian pacific, China`s consumer and producer inflation and Australian business and consumer moral.

All told, Markets will continue to dance to the tune of the COVID-19 news. Authorities will have to do much more in the coming weeks. Already, another 0.5% rate cut is priced in from the Fed and much more is expected from governments around the world.

Targeted Action for the ECB meeting on Thursday.

Thursday’s ECB meeting will be the first real test of newly appointed President Christine Lagarde. After the Fed, Canadian, and Australian central banks all did rate cuts last week to negate the negative effects of the coronavirus on their economies, it’s now the turn of European policymakers to decide whether to follow suit. The ECB will conclude its meeting on Thursday and while markets are convinced rates will be cut by 10 basis points to -0.6%, many economists disagree.

Markets are priced for 0.01% cut to the -0.5% deposit rate. European interest rates are deep in negative territory already, meaning that the ECB only has a couple more ‘rate bullets’ left, and it might prefer to save them for a crisis where monetary policy can actually help. As such, there may be emphasis upon further efforts to harness the positives of negative rates and mitigate the negatives on the banking system including potential adjustments to the tiering program.

Another issue on how the divided some ECB officials are. many policymakers represented by large economies such as Germany and France believe that the current monetary policy is already extremely accommodative, as c any more stimulus would do next to nothing to boost the struggling economy. Therefore, cutting rates further may be a bridge too far.

Instead of cutting rates, the ECB could announce on providing liquidity for business affected by the virus in order to help their supply lines cut and their cash flows dry up, by giving them low cost loans. This could be the best available strategy, seeing that the Bank is on low policy ammunition and highly divided. It won’t really boost market confidence, but it does put a bandage on the wound.

UK Government Budget on Wednesday; How will it affect the pound?

The new UK Chancellor will bring down his government’s first post-election budget on Wednesday at about 12:30pm London time. With the UK economy slowing down and the virus threatening to reduce growth even further, investors will analyze how expansionary this budget is.

A National Infrastructure Strategy has been further delayed and will not be included but significant investment announcements are anticipated. This will include a big boost to public spending and might see the pound gain, by raising expectation that the Bank of England may not have to cut rates aggressively to the stimulate the economy. This budget probably will include potential corporate tax cuts and reducing tax breaks for the wealthy to fund a surge in government spending and the overall mixture of measures will inform estimates of the fiscal impulse to growth.

The Cable (GBP/USD) has rebounded in the last three sessions reaching the $1.3040. this reflects more dollar weakness than the sterling strength. In the short term, this upswing may continue. Not due to the budget only, but also because of the BoE is unlikely to cut rates as aggressive as people would think. A 0.25% rate cut at the end of March meeting is now fully priced in by almost 60%, and markets are also pricing in a more than 40% probability for a larger, 0.5% cut. This is supported by the BoE Governor baily by stating that the bank should wait for more information and data that reflects the economic impacts of the coronavirus before making any decisions to cut the rates.

It could be true that the bank might cut the rate at the end of March regardless, the governor comments suggest the Bank won’t deliver an extreme dovish expectation. which argues for more gains for the Pound against the US dollar. On the economic data front, key releases are monthly GDP figures, manufacturing production, construction output and foreign trade.

United States CPI will be the main release on Wednesday, but is it a game changer for the Fed?

While financial market developments tracking COVID-19 will dominate, US CPI will also be worth a peek. the main release will be the CPI for February, due on Wednesday. Yet, with the Fed so focused on the virus, economic data might not matter much for the dollar’s near-term path. The Fed is not reacting to any real weakness in the US economy. Rather, it’s trying to shield the economy from the future virus impact.

A deceleration in headline inflation during February to 2.2% y/y will be mostly driven by lower energy products price inflation. A shift in year-ago base effects should mostly cancel out one another’s influences upon yearly headline inflation while leaving seasonally adjusted CPI flat. Core CPI is expected to remain unchanged at 2.3% y/y. Producer prices will also be updated on Thursday.

The US Markets already pricing a cut at the next meeting that is expected to be greater than 0.5%  but less than 0.75% and pricing a return toward the lower bound by the July meeting, the Fed might view itself as best advised to remain in observer mode barring a severe shock to the financial system. Its time may be better spent thinking about other less conventional tools that it could employ given that Washington’s politicians generally puts the full responsibility upon the Fed to respond.

The collapse in the Treasury long bond yield, if persistent, poses escalating funding challenges for intermediaries with longer-tracked liabilities like pensions and life cost. At a time of downward pressure on broad corporate earnings, the potential for pension top-ups to address underfunding magnifies the risk.

Rate cuts drive refinancing’s already did put money into strained cash flows. They also cheapen the rollover cost of corporate credit when earnings are being hit. It is too high of a burden upon one set of tools to expect it to address all facts of a highly uncertain shock, but the Fed has no choice but to use the tools at its disposal not least because US fiscal and regulatory policy probably won’t act in this election year.

Moreover, the release of the Michigan’s consumer sentiment reading on Friday for March may provide the first indication of how consumer confidence is holding up in the face of the shocks. A weaker reading is expected notwithstanding some positive effects upon household cash flows from refinancing activity and lower energy costs.

Therefore, markets are now pricing in another 0.5% rate cut at the Fed’s March meeting, and it’s doubtful that even stellar data between now and then would be enough to change that.

After a dreadful weak will Oil prices may drop sharply due to expectations of higher production

Oil prices fell during trading last Friday, to record the largest daily decline in more than 11 years ago, and we did not witness the sharp decline that occurred in Brent oil contracts since December 2008, to lose 9.4% over the course of one session and end trading at levels around $ 45.27 Per barrel. US West Texas Intermediate fell almost 10.1%, ending the session at $ 41.28, and this drop Is considered the worst price performance of West Texas Intermediate since November 2014.

The drop came after an already dreadful week after OPEC+ failed to come to an agreement on both an extension and an increase. The current cuts expire at the end of March, after which there will be no more restrictions. I doubt this is the end of the discussion, with Saudi Arabia in particular keen to prevent prices falling too far.

It is expected that Chinese demand for oil decreased by 25% during the month of February. the global oil consumption according to official sources could decrease by 3%. However, these expectations came before the spread of the Coronavirus around the world.

Continued decline in demand expectations, oil prices witnessed a sharp decline, which necessitated the meeting of OPEC +, which failed to reach an agreement to reduce production, and Russia has refused the agreement and indicated that it will return to natural production after the end of this month.

A shock in the supply, this is what the financial markets are preparing for with the opening of trading this week, especially with news that added concern about the abundance of American production, as Baker Hughes data released last week indicated the increase in the number of oil rigs for the fourth week in 5 weeks, bringing the number of rigs to 682 Digger, the highest level since last December.

All circumstances indicate the possibility of a declining opening of oil prices, as the abundance of supply, along with the expected weakness in demand, may push oil prices down and a strong drop in prices should not be ruled out, if Russia and Saudi Arabia are directed to raise production and reduce crude prices, and continue to increase production American.

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