Tag Archives: Charles Porter

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Morning Brief – Cool, but how?

Cool, but how?

 

If you want the simplest of summaries to yesterday’s budget speech in South Africa then read no further than the title. Tito Mboweni mostly said the right things as he laid the budget before the nation yesterday. The one thing he missed out was how!? What the review promised was more parsimonious compensation for government workers. We learned how much the Treasury expected to save and therefore the support it would provide to efforts of fiscal sustainability. What was missing is how they’re going to achieve such cuts, limiting the positive impact the announcement had on the Rand yesterday.

 

As with any budget review the Minister opened by painting the scene. With broad strokes the image that emerged wasn’t pretty. The biggest deficit in 28 years was the conclusion. Not a good start!

 

A deficit of 6.8% is forecast for 2021 facilitated by shrinking economic output (GDP) meaning that any shortfall in spending is exaggerated in percentage terms versus the size of the economy. The 2021 forecast deficit is the largest hole in South Africa’s coffers since 1982/3 when the figure soared to 7.2%. European readers living under the harsh constraints of the ECB’s six-pack of fiscal rules legally limiting their budget deficits to 3% upon threat of Billions of Euro’s of fines must be surprised at South Africa’s forecast.

 

Kicking off with such dire news the Minister was on the back foot to placate markets who were chomping at the bit to sell the South African currency. And so the Treasury delivered:

 

To contain the budget deficit and move towards debt stabilization, the 2020 budget proposes a significant reduction in government expenditure growth, mainly as a result of lower growth in the public-service wage bill.

 

The long and short of it is nominal spending is forecast to be down 2.7% for this year and 3.3% for two years after that. The big question: will that outweigh the burden placed on the nation by the debt of Eskom. The big answer: NO! And the Rand’s price action yesterday reflected a discount in domestic assets still representing the headache that the state owned utility creates. With fear around the Coronavirus intensifying, Rand trading was overwhelmed in the latter half of Wednesday’s session by a broader emerging market sell-off. Whilst the pattern emerging in the global infection rate is motivating risk decisions, Trump’s admonitions regarding infection on the continent of North America jolted markets. The President offered an hour long press conference yesterday afternoon on the subject, appointing Vice President Mike Pence as the man in command of coordination.

 

Markets will now turn their focus to Moody’s for any indication on the path of South Africa’s sovereign debt rating. The rating decision will arrive in one months’ time and global risk factors as well as details on the implementation of Tito Mboweni’s cost-cutting plan will be pivotal to predicting the Rand’s movements.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Decoupling

Decoupling

 

Over the weekend (apparently), we learnt who the king and queen of Winter love island ‘19/‘20 would be. I can only tell you their names by googling it. So I won’t pretend to be a fountain of knowledge on the subject and allow you to make your own searches. One thing I can say is that a lot of these couples made and tested on the ITV hit show and others fail the test of time and decouple pretty fast. With the champions now proud collectors of their £50k prize money and soon to sign their Instagram product placement contracts, ‘tis the season to decouple!

 

As with most things, the currency market beat them to it. Severe economic and market conditions cause exaggerated movements. Those surviving with the trend tend to be struck from their supposed peers and find their own price path. Some of these are low profile like the de-grouping of South American currencies from their regional or emerging market trend. Others attract more capital and therefore more publicity. I would contend that the biggest decoupling of 2020 so far has been the price of Gold from the value of the Japanese Yen.

 

As I’ve written about before, the Japanese Yen is a classic safehaven and for a long time has been desired during times of trouble given its track record of relative fiscal profligacy and monetary consistency. As the price and traded volumes of Gold have hit 7-year and all-time records respectively, the value of the Yen has gone the other way, losing as much as 4 Yen versus the US Dollar this year alone. Maybe the Coronavirus is just too close to home for the Yen to be a safe haven? Well I would contend that’s not true: even during the China-US trade conflicts, the heavily exposed Japananese Yen outperformed on haven demand. Instead, the real risk is that Japan, the world’s third largest economy, is staring down the barrel of recession. While the Yen has struggled, other safehavens have pinched a defensive bid and those include the Dollar, Gold and the Swiss Franc, which reached 5-year highs versus its neighbour, the Euro.

 

As the decoupling stretched further yesterday the global stock market, the sum of the whole world’s publicly listed companies lost a trillion Dollars. A trillion! Beat that Paige and Finn. Ha! Yes, I succumbed to the temptation to google it… Anyway, yesterday’s sell off all stemmed from weekend headlines that the Coronavirus has reached Europe (and Africa) and from WHO admonitions that we could end up with a pandemic. Italy is now the Petri dish for Western capacities to control the Coronavirus – for markets thankfully the outbreak is in Northern Italy which boasts superior medical infrastructure. The Japanese Yen will continue to underperform as a safehaven so long as its economy is under threat. The very characteristics that make the Yen such a haven are threatened by recession and the Coronavirus because, as we’ve already seen from the central bank, monetary and fiscal expansion start to become necessary.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Cushty

Cushty

 

There have been times since he took over the FED presidency from Janet Yellen that Jay Powell’s job looked unenviable. October last year, for example, when the chairman had to calm a liquidity drought using severe repo operations, must’ve been a particularly stressful time for Mr Powell. The minutes released from the FOMC’s latest meeting, the document detailing the conversation that took place during the rate-setting body’s January sit-down, showed relative calm. The Committee saw lower systemic risk in markets as a result of trade which was a classic scape goat for economic vulnerability last year. The monetary authority’s mention of the Coronavirus (the first mention so far) was limited suggesting their position is that the virus does not carry similar risks to global trades as does White House foreign policy. Mind you, these minutes are from January’s meeting and the escalation in infections and subsequent deaths since this meeting could leave a surprise in their next minutes.

 

Sovereign yield in the States versus Germany is over 2% per annum. This differential has given impetus for the carry trade and bearish sentiment underpinning EURUSD. The business as usual message from the Federal Reserve last night has done nothing to upset that dynamic and could even be seen to strengthen the Dollar further as confidence around US yield supremacy was bolstered. There were no major shifts last night given the news was confirmatory not revolutionary but the support was just enough to push the Dollar index to its highest level since May 2017.

 

Futures markets priced in little change on the back of the minutes and still saw a 10% chance of a cut in interest rates at the March meeting and a 45% chance of a cut by the end of June. Upside risks to the index that would usher in further Dollar strength come from these expectations being priced out further and a data-led shift to hiking expectations within the Fed. But the Dollar buyers and Euro sellers might have one thing on their side that could present credible downside risks to the Dollar. Unfortunately, it might come in the form of a rather unpredictable individual with floppy hair.

 

It’s been a while since @realDonaldTrump attacked the Federal Reserve’s policy for the export-killing Dollar strength that it has created. Last time the President weighed into the currency market the reaction was limited. However, history does tell us that the Treasury can intervene in the FX market. Severe policy actions under the administrations of Clinton, H. W. Bush, Reagan, Carter and Ford saw billions of USD purchased per day by the Treasury in the market. Typically these have been interventions to prop up the Dollar but there have been similar episodes of strong Dollar selling to weaken an over stimulated greenback. It’s a long shot and following the worst start to EURUSD since 2015 and the put-to-call price being most in favour of the Dollar since September last year, the bearish EURUSD episode might not be over just yet.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Continental chaos

Continental chaos

 

This morning I bring you a story from Europe that should show you just how vulnerable the financial world has become and therefore just how unstable it could prove to be during in the coming year. It comes in the form of fixed income products in Europe that, let’s not forget, have an important impact upon the foreign exchange market.

 

What do you do when harbouring money in the German government for 10 years costs you more than 40 basis points? You quite rightly look for alternatives and, if they exist, you’ll make a rational decision to buy the alternative instead of the costly Bund. It’s not rocket science – if your favourite brand of shampoo let’s say becomes 10 or 20 times more expensive than its substitutes you’ll strongly consider switching. Trading and investment decisions are no different. The problem comes when the alternative shampoo you’ve purchased in a bright shiny bottle brandished with more superlatives than Donald Trump’s speech writer is actually full of poison. When everyone who used to love the same shampoo you used jumps ship to the new one the behaviour of the herd will mean that we all soon forget what lies within.

 

Queue Italy and Greece, two protagonists of the European Sovereign Debt crisis in 2010-2014. Loaning to the aforementioned governments was seen as one of the fastest ways to lose your money during this crisis. Expectations of default and economic fundamentals convinced investors that European fixed income products, in particular those of Italy and Greece would never be repaid. They were, ultimately, wrong in their conclusions.

 

The speech of Mario Draghi promising to do whatever it takes restored some order to the market with Greek debt coming down from its perch above 30% yield. Where investors weren’t mistaken was in their appraisal of the debt. Crucially, the structural problems that created this bondmageddon haven’t changed. The reason bonds rallied so far in the run up to this crisis was because investors believed that whatever they purchased was basically German debt with a different name on it. Why not, right? They’re in a monetary union with each other of course they’ll bail each other out. Wrong! The lack of risk sharing and fiscal Union meant that Germany, as it always promised would be the case, did not come to the guarantee of the Greeks and Italians when investors decided to close their purse strings.

 

So surely to get back down to the perilously low yields before this crisis something must’ve changed. Surely Eurozone states share risk better now and there is a guarantee to these bonds. Wrong! We had Draghi, we now have Lagarde that built up biblically large balance sheets at their central bank to sure up Eurozone debt and the wider economy but private markets still aren’t willing to take up the risk the central bank has racked up. The very actions undertaken by the European Central Bank are still facing legal action in German courts with no decision forthcoming for almost a decade. Even more concerning than that is the bonds themselves are running out!

 

Take Italy for example: last week it auctioned off €9bn 16-year duration debt. For this auction it received a record €50bn worth of bids. The yield on debt of this duration is below 1%, down from about 3% at the beginning of last year, baffling levels versus the +35% yield in 2012. When this event unfolded and peaked in 2012 the Euro sold off as far as 1.40 versus the US Dollar and peaked at 1.40 also versus the Pound a few years later. If the bubble dissipates which I’m sure it will eventually, the risk surrounding Eurozone assets including the Euro will be severe and cause a flight to real safety – queue safehaven demand including the US Dollar.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Eurovision

Eurovision

 

Resistance, support, reversal and jargon. Is pretty much what you’ll receive if you try and research the Euro’s sell-off since December 2019. If you try and read a forecast about what is going to happen to the Euro from here you’ll find even more nonsense. Here’s the truth of the matter:

 

The Euro yesterday evening hit its lowest value versus the US Dollar since 2017 and its weakest level versus the Swiss Franc since 2016. Although only a two (and a bit) and three (and a bit) year high respectively, the surge is important because the 2017 low on EURUSD is close to the all-time low and sufficiently weak to start discussions about parity: 1 Euro equals 1 USD and vice-versa. The immediate path of EURUSD should be uncertain. The reason is that the market has traded and turned at the price it is at today so many times that so many interests and expectations have built up around these levels. Accordingly, traded volumes should be elevated as market participants position themselves around what they think could be the next turning point.

 

There are three factors for the Euro’s weakness. The first two, economic in nature, are the Euro’s role in markets today and, secondly, the bloc’s economic fundamentals. With bafflingly low rates and thus yields the Euro has taken on the role of the funding currency. This means it’s the one you’re going to sell when you’re looking to buying something else to pick up a bit of real yield and interest. Sure, to take profit you’ll have to buy Euros back eventually but with futures markets telling us that interest rate expectations are still pointing towards a cut this year, it could be an incredibly long time until you have to buy them back.

 

Secondly, with industrial activity waning in Germany and the wider Eurozone, the threat of the coronavirus to global demand for Eurozone exports is undermining growth expectations further. Overnight the new cases of coronavirus have registered at 14,800 in a single day. It’s too early to tell whether the change in counting methodology is to blame or the reinvigoration of risk appetite yesterday driven by expectations of peak virus transmission were misplaced.

 

The final threat pushing the Euro lower is political. With the resignation of CDU leader Annegret Kramp-Karrenbauer announced this week, the successor to Chancellor Angela Merkel is now uncertain. In addition the development of the far-right in German politics is undermining the perception of German political economic stability.

 

To reflect Euro fragility, JP Morgan, RBC and Credit Agricole have immediately downgraded their forecasts for the Euro. The median forecast for 2020 year-end amongst analysts when last observed was 1.14, pie in the sky territory from where Europe opens trade this morning. The market will provide interesting enough conditions on its own at this all too familiar level but external stimulus will come from Germany tomorrow morning as we learn more about Q4 growth in the EU’s largest economy. The median forecast is for a 0.1% quarterly expansion. But approximately 30% of analysts surveyed predict a contraction for Q4. The release is scheduled for 7AM tomorrow morning. If the statistics realise a contraction then recession expectations will be back in full focus and the Euro will sink lower.

 

 

 

Discussion and Analysis by Charles Porter

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UK buildings

Morning Brief – Oh that’s where I left it!

Oh that’s where I left it!

 

It takes a big lens to capture a clear image of a piece of paper from tens of metres away. But in most of those circumstances what takes far more skill and consideration is the hand placement, angle and speed of travel to ensure the photographer achieves the seemingly accidental photograph. Journalists would be forgiven for thinking Sajid Javid, UK Chancellor and inhabitant of no. 11 Downing Street, had taken up moonwalking practicing his daring performance.

 

A briefing paper carried into no. 10, the Prime Minister’s residence, and captured in Downing Street purports to show the UK government’s stance on Financial Services in a post-transition trade deal. It’s no Canada style and is the antithesis of Johnson’s so-called ‘Australia-style’ – whatever that is – deal. Instead it shows that the government is aiming to create the first ‘permanent equivalence’ regime outside of the Union. Awesome. But what does that mean?

 

Nations outside the Union can have the right to operate within the Union’s boundary if they are deemed to have achieved equivalence. Equivalence means that the ‘3rd country’, the outside party, has legislation and regulation deemed to be equivalent to EU rules and therefore not undermine the integrity and competitiveness of the bloc. However, as we were reminded of with Switzerland last year, equivalence can be ripped away from 3rd countries like the UK with virtually no warning. In some circumstances financial services are afforded a grace period of 30 days to sort their affairs out – a woefully insufficient period of time if you’re a hefty financial services provider who’s just been told their European client and product bases are now off limits.

 

The financial services sector is not only responsible for 7% of value added in the UK each year and just shy of 4% of the UK’s labour force, it is also a source of comparative, and in some cases absolute, advantage for the nation. That means the UK is strongly advantaged by trade in that service at the very least, and at most has a world-leading provision and efficiency in the service. The deliberately accidental leak that financial services are receiving explicit attention within the negotiations should reassure markets slightly. The news has offered little confidence to Sterling traders this morning as the Pound trades in line with its average value yesterday, just shy of a 2.5 month low for the Pound versus the US Dollar.

 

The lack of optimism in this phase of negotiations reflects the reality that just because a deeper trade deal than Johnson and Javid have espoused in recent weeks might actually be on the cards, it doesn’t mean the UK will be able to prise the deal from the mouth of EU negotiators. For example, developments in the political landscape of Ireland, a nation that joined the-now European Union at the same time as the United Kingdom, might cast doubt on the willingness of the EU Council to grant the UK a generous post-transition deal.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Goodbye and good riddance!

Goodbye and good riddance!

 

If you hadn’t noticed, the United Kingdom has left the European Union. You could be forgiven for not having noticed because by design of the Withdrawal Agreement, nothing changes until the transition period is concluded. However, at the formal and legal level the departure has taken place: the UK’s flag has been ceremoniously removed from the European Council’s lobby; remainers have either found inner content, are now remourning or have become rejoiners. If nothing else yet Brexit has certainly developed the nation’s skill with the portmanteau… confined to the universe of ‘motel’ and ‘brunch’ we are no more! Although technically Grexit came first if you recall.

 

The final official words from the European Union to the UK as a member state might surprise you. Coming from the chair of an official meeting between member states a couple of days before the UK’s exit, the Croatian Ambassador (holding the 6-month rotating presidency) concluded the final engagement by fondly saying to the UK, ‘thank you, goodbye and good riddance’! The UK ambassador reportedly took the somewhat insulting conclusion of a 47 year long relationship in good spirits receiving reassurance the parting message was lost in translation and intended to mean good luck. Keep that excuse up your sleeve next time you’re caught whispering something under your breath perhaps!

 

Sterling tumbled to a six-week low versus the US Dollar yesterday as Johnson set out his position for trade deal negotiations. The Prime Minister called for a Canada-style trade deal to be constructed between the UK and the EU. The market was spooked by Johnson’s threat to walk away from negotiations if the EU insisted that the UK must be bound to the Union’s rules and concern built around what Johnson called an Australia-style trade deal. If you were wondering, Australia does not have a trade deal with the European Union. They have been in talks since May last year attempting to construct one and in the absence of progress on this endeavour they trade with each other based upon the 2008 EU-Australian Partnership Framework. This framework aims to boost trade by reducing technical barriers to trade but is fundamentally WTO trade with a touch of respect.

 

We should expect a tough line from Johnson at the start of negotiations in order to improve the prospect of the final trade deal. Nonetheless, the market braced yesterday and this morning by selling the Pound to react to unfolding events. Cable lost more than 2 cents yesterday from the price it opened at in Wellington, New Zealand to its close in London. The low we now sit on versus the Dollar is an important technical level. We have traded below this level at the end of November and subsequently touched this price floor four times in the two months of trading that followed. If this level is broken then ground opens up for the Pound to fall all the way to 1.20, the low reached in August 2019. Even if there is a retracement in the Pound in the short term, yesterday is a sign of the volatility to come during these negotiations.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Baaaaad news

Baaaaad news

 

If you’re planning on taking on the pub quiz any time soon it may be worth keeping this one in mind. Not the traditional victim of sheep observations, it is in fact Australia that is the world’s leading exporter of lamb and mutton. Towering above New Zealand and Wales, Australia in 2018 exported a whopping 2.6 billion US Dollars of lamb and mutton and accounted for 7% of agricultural production. Exports in agricultural produce have fallen in the last half century from just over 60% of total exports by value to marginally over 10%. However, having realised a fragile current account surplus of 7.85 billion AUD in Q3 2019 and deficits throughout 2016/17, the trade in lamb and mutton cannot be considered negligible to economic performance. With the wild fires destroying acre upon acre of arable land, concerns surrounding Australia’s agricultural exports are mounting.

 

The economic risks to Australia and thus the Australian Dollar sadly do not even end with the devastating wild fires. In the same time as Australia’s reliance upon agricultural exports has shrunk by 50%, so too has its exposure to Chinese importation swelled from 2% to 27% over the same period. The Coronavirus crisis in China has seen flights into the nation suspended from many countries and expectations of a slowdown in consumer spending and economic performance gather speed. Australia is therefore facing risks across the breadth of its exports rather than having to deal with the specific threat to agriculture.

 

As the health crisis has unfolded the prices of non-precious commodities has tumbled. Crude oil, a good barometer of economic expectations so long as conditions of supply can be assumed to be stable, has tumbled by as much as 10 US Dollars per barrel throughout the crisis so far. The same is true in metal and ore prices, the underlying commodities of which account for more than 50% of Australia’s total exports.

 

Aside from risks derived from the wildfires in Australia and the Coronavirus outbreak, economic fundamentals are also not on the side of the Aussie Dollar. Despite inflation picking up at the start of the year following its 2019 slump, the Reserve Bank of Australia is not looking raise rates any time soon and yesterday only signalled a delay to further monetary easing. Markets still price in a 20% chance of a 25 basis point cut at the Bank’s next meeting in February. The tripartite problems to the Aussie’s value show no sign of abating and it seems likely we get a re-test of December’s GBPAUD low. If this resistance is taken out in the coming weeks there is headroom towards GBPAUD 1:2. Against the US Dollar, the Australian Dollar could reasonably print at its worse value since 2009 within weeks.

 

The Bank of England will present its latest monetary policy decision today. The market still prices a 50% chance of a cut in futures markets as all eyes will be on Carney’s last Monetary Policy Committee meeting before the Governorship changes hands. The interest rate decision today comes the day before the UK leaves the European Union and embarks upon its transition period. The Withdrawal Bill has passed through the Lords paving the way for a smooth transition tomorrow but as focus turns to trade negotiations there will be episodes of extremely choppy trading in the months ahead.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – No small issue

No small issue

 

Buyers of Rand have enjoyed the sell-off in the South African currency so far this year. Sellers on the other hand have displayed concern throughout the market as the South African economy embarks upon quite the first quarter of the decade. This shift in sentiment has been responsible for the change in price so far this year with the Rand yesterday trading at the cheapest level so far this year against both the Pound and US Dollar yesterday afternoon. The problem you might rightly suspect begins with Eskom, but it doesn’t end with the state-owner utility company.

 

The sell-off in the Rand in the past week or so is most likely the effect of position adjustment as we move towards the draft Eskom solution this week, budget speech next month (26th February), and Moody’s credit rating in the first week of March. Last week we learned the likely cost of load shedding in 2019. Estimated by the Council for Scientific and Industrial research at as high as R118 billion last year, the lights were switched off for a cumulative planned 530 hours in 2019. If that figure is correct it means that the single issue created by the failure of the state utility and its management is alone responsible for a puncture approximately 2.5% of the size of the entire economy. The cost per capita of Eskom’s failings last year alone therefore is over two thousand Rand. And what did each citizen get for their R2,000 bill? Less than nothing! Growth forecasts for South Africa are weak and if load shedding were to take place at a rate akin to 2015 this year, they could well turn negative plunging the economy into its second recession since 2018.

 

In accordance with President Cyril Ramaphosa’s announcement last year, we had expected Eskom’s CEO Andre de Ruyter to announce his plan to split up the energy provider into three separate legal entities each responsible for generation, transmission and distribution respectively. On Sunday, he cautioned against rushing the division of responsibilities announcing his concern that a sudden separation could provoke lenders to constrain credit and cash even faster. The market sensed division between political and executive leadership in South Africa and, fearing another potential delay to the emergence of a holistic plan, sold the domestic currency.

 

Finance Minister Tito Mboweni will deliver his budget speech to the nation with the world watching in one months’ time. The cash allocated and commitments made to the provider responsible for 90% of South Africa’s energy provision will set the stage for Moody’s ratings agency to decide once again if domestic debt is worthy of an ‘investment grade’ stamp or should be classed rather fondly as ‘junk’.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Who are you?

Who are you?

 

0.7% in one day is a pretty decent rally for the Pound. Sterling currently sits at 2 week highs against the US Dollar and yesterday GBP reached 2020 highs against the Euro. But what brought us here might surprise you: Confederation of British Industry survey data! This piece of soft data is normally not considered a market moving piece of information. However, yesterday’s fragile market conditions and Sterling traders’ agitation ahead of next week’s Bank of England decision and formal exit from the Union allowed it to become salient information.

 

Headline data at the beginning of the year and rhetoric from the Bank pointed to the need for a cut in rates. Subsequently, soft data releases have shown evidence of a pick up in activity and confidence following December’s general election – a period not yet observed by more concrete headline economic data. The CBI data release was startling. It showed that overall business optimism had strengthened sharply to record a figure of 23 in the 3 months to January versus -44 the previous quarter.

 

A reading of 23 is the healthiest observation of business confidence that the CBI has recorded since April 2014 and analysis reveals that it is the sharpest quarterly gain for over 60 years. The composition of the data showed that optimism was broad based and shared by businesses affected by the exportation capacity of the UK. The CBI data is (at least) the 4th such indication of an observable economic boost granted by the 2019 general election and with the interest rate decision exactly 1 week away for the Bank of England, the data was enough to cast doubt over what was previously priced as a confident cut in rates. Money markets immediately moved to slash the discount priced into Gilt Futures to leave only a 50% probability priced in of a Jan 30th cut.

 

Today it is the turn of the European Central Bank to offer markets its latest interest rate decision. All three barometers of the price of Eurozone money (their interest rates) are expected to remain the same with no new commitments to outright monetary transactions Quantitative Easing. What President Lagarde is expected to do is offer more insight into the Bank’s Strategy Review. The Review could look into everything including the inflation target and monetary policy instruments. As with any systemic economic shakeup there is the potential for volatility. With the Euro at 2020 lows and political headlines in Italy dragging the single currency lower yesterday, Lagarde’s Review could even cause markets to re-view 2019 EURUSD lows.

 

 

 

Discussion and Analysis by Charles Porter

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