Global Rate Cut Cycle Looks Finished for Now - Central Bank Watch
Central Bank Watch Overview:
- Most major central banks won’t meet again until mid-January or early-February. For those with meetings remaining in 2020, no rate moves are expected.
- As the US Dollar contends with Fed rate cut odds ebbing and flowing, other currencies like the Canadian Dollar and the Euro have been able to rally as their central banks stay quiet.
- Retail trader positioning suggests that more gains ahead for EUR/USD rates, while USD/CAD and USD/JPY rates could struggle.
Traders Can't Escape US-China Trade War Headlines
As the calendar winds down, the news wire is heating up. Conflicting signals on the US-China trade war in recent days have injected a decent amount of volatility back into financial market, leading to weakness across the board for the US Dollar at the start of December.
It is no longer the case that the US Dollar has shifting central bank rate pricing as a bullish catalyst. Other G10 currencies’ central banks have seen their interest rate cut odds pullback meaningfully at the same time. In light of this, pairs like EUR/USD, USD/CAD, and USD/JPY have seen meaningful shifts in positioning in recent days.
ECB Rate Cut Cycle on Pause as Lagarde Repositions
The European Central Bank is in a holding period. New ECB President Christine Lagarde is using the early months of her tenure to try and clear divisions among ECB Governing Council members. The schism exists as a result of former ECB President Mario Draghi ramming through his easing package at the September ECB meeting. As policymakers search for a new consensus, it seems likely that the ECB will remain on the sidelines through much of 2020.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (DECEMBER 5, 2019) (TABLE 1)
According to Eurozone overnight index swaps, traders are convinced that the period of recalibration by new ECB President Lagarde will take several months: there is only a 17% chance of a rate move through March 2020. Accordingly, there are still no rates moves discounted through October 2020; now, there is a 44% chance of 10-bps rate cut in October 2020 as well as a 7% chance of a 10-bps rate hike.
IG Client Sentiment Index: EUR/USD Rate Forecast (DECEMBER 5, 2019) (Chart 1)
EUR/USD: Retail trader data shows 44.4% of traders are net-long with the ratio of traders short to long at 1.25 to 1. The percentage of traders net-long is now its lowest since Nov 01 when EUR/USD traded near 1.11648. The number of traders net-long is 7.3% lower than yesterday and 31.2% lower from last week, while the number of traders net-short is 15.8% higher than yesterday and 31.6% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD rates may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EUR/USD-bullish contrarian trading bias.
If the BOJ Cuts Rates, It Won’t be for a While
The Bank of Japan was considered to be on the verge of cutting rates just weeks ago, but that decision appears to be nixed for the time being. With fiscal policymakers approving a $122 billion stimulus package today to help support sagging Japanese growth, it appears that the BOJ will save its bullets for another battle. Both BOJ Governor Haruko Kuroda and member Yutaka Harada have said in recent days that the current BOJ is sufficient at present time.
Bank of Japan Interest Rate Expectations (DECEMBER 5, 2019) (Table 2)
According to Japan overnight index swaps, there is a 78% chance that the BOJ keeps its main rate on hold at -0.10% at its final meeting of the year; one-month ago, there was a 62% chance of no change in rates; and six-months ago, there was a 56% chance of no change in rates. Rates markets are rather docile for the foreseeable future; if there is going to be a rate move by the BOJ, markets are discounting July 2020 as the most likely period (50% implied probability).
IG Client Sentiment Index: USD/JPY Rate Forecast (DECEMBER 5, 2019) (Chart 2)
USDJPY: Retail trader data shows 51.9% of traders are net-long with the ratio of traders long to short at 1.08 to 1. The number of traders net-long is 1.9% lower than yesterday and 15.2% higher from last week, while the number of traders net-short is 8.5% higher than yesterday and 24.3% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USDJPY prices may continue to fall. Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed USDJPY trading bias.
BOC Rate Cut Pricing Eliminated Again
With the view that the global economy is weathering the US-China trade war, BOC policymakers appear to be pushing back on the market’s perspective that more easing is coming shortly. Prior to the October BOC meeting, there were no interest rate moves discounted over the following 12-months. At their peak in November, rates markets were pricing in a 25-bps rate cut from the BOC as early as April 2020.
Bank of Canada Rate Expectations (DECEMBER 5, 2019) (Table 3)
According to Canada overnight index swaps, the chance of a BOC rate cut in early-2020 has fallen further in the wake of the December BOC meeting. Immediately afterwards, there was a 52% chance of a 25-bps rate cut at the October 2020 BOC meeting, a dramatic collapse from the week prior, when April 2020 was the favored timing for the next rate cut. Now, there are no rate moves discounted through October 2020.
IG Client Sentiment Index: USD/CAD Rate Forecast (DECEMBER 5, 2019) (Chart 3)
USDCAD: Retail trader data shows 46.7% of traders are net-long with the ratio of traders short to long at 1.14 to 1. In fact, traders have remained net-short since Nov 08 when USDCAD traded near 1.31538; price has moved 0.1% higher since then. The number of traders net-long is 57.8% higher than yesterday and 32.7% higher from last week, while the number of traders net-short is 37.2% lower than yesterday and 35.4% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USDCAD prices may continue to rise. Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current USDCAD price trend may soon reverse lower despite the fact traders remain net-short.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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