New Year, Old Policies: Maintain the Path on Interest Rates - Central Bank Watch
Central Bank Watch Overview:
- As 2020 gets started and central bank rate decisions begin to come into focus in the second half of January, it’s clear that the new year won’t mean new monetary policies.
- The Federal Reserve is expected to stay on hold until September; the BOC, until October; and the ECB, through the entire year.
- Retail trader positioning suggests that more gains ahead for the US Dollar.
Recession? War? Central Banks Shrug
The end of 2019 brought forth a number of significant developments: the US-China trade war Phase 1 deal; the historic victory by UK Boris Johnson, clearing the way for Brexit; and a sharp escalation in geopolitical tensions between the US and Iran. Yet equity markets are continuing to trudge high, unmoored by the prospect that anything that the Trump administration is doing is much more than ‘theater.’
As 2020 gets started and central bank rate decisions begin to come into focus in the second half of January, it’s clear that the new year won’t mean new monetary policies. Indeed, G10 central banks appear to be ready to chart the same path that they followed as 2019 ended.
BOC Rate Cut Pricing Remains Depressed
BOC Governor Stephen Poloz started 2020 with a positive assessment on the global economy: “potential downside risks” to the global economy due to the US-china trade war have dissipated. In turn, the view that BOC policymakers are signaling stability on the policy front remains valid. After peaking in November 2019, when rates markets were pricing in a 25-bps rate cut from the BOC as early as April 2020, interest rate cut expectations have been steadily declining.
Bank of Canada Rate Expectations (JANUARY 13, 2020) (Table 1)
According to overnight index swaps, the chance of a BOC rate cut in 2020 has not changed much at the start of the new year. At the end of 2020, rates markets were discounting September 2020 as the most likely month for the next rate move (52% chance of a 25-bps rate cut). Now, overnight index swaps are suggesting that October 2020 will be the first meeting in 2020 to produce a rate move (65% chance).
IG Client Sentiment Index: USD/CAD Rate Forecast (January 13, 2020) (Chart 1)
USD/CAD: Retail trader data shows 57.73% of traders are net-long with the ratio of traders long to short at 1.37 to 1. The number of traders net-long is 13.81% higher than yesterday and 22.15% lower from last week, while the number of traders net-short is 14.01% higher than yesterday and 44.63% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/CAD prices may continue to fall.
Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current USD/CAD price trend may soon reverse higher despite the fact traders remain net-long.
ECB to Stand Pat for the Foreseeable Future
The ECB enters 2020 in a holding period. New ECB President Christine Lagarde will be using the early months of her tenure to find unanimity among policymakers after schism formed 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 (JANUARY 13, 2020) (TABLE 2)
According to Eurozone overnight index swaps, traders are convinced that the period of recalibration by new ECB President Lagarde will take a very long time: there is only a 9% chance of a rate move through December 2020. Barring a significant deterioration in economic activity, it appears that the ECB, under President Lagarde’s stewardship, will be rather quiet during 2020.
IG Client Sentiment Index: EUR/USD Rate Forecast (JANUARY 13, 2020) (Chart 2)
EUR/USD: Retail trader data shows 59.15% of traders are net-long with the ratio of traders long to short at 1.45 to 1. The number of traders net-long is 11.58% higher than yesterday and 38.99% higher from last week, while the number of traders net-short is 9.70% higher than yesterday and 14.06% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EUR/USD prices may continue to fall.
Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EUR/USD-bearish contrarian trading bias.
Fed Unlikely to Change Rates in First Half of 2020
The Federal Reserve’s had made evident that we are currently at a pause in its rate cut cycle. To this end, Fed Chair Jerome Powell has indicated that there is a near-zero chance of a rate hike anytime soon. Much like the BOC and the ECB, the Fed is in a wait-and-see period for monetary policy.
Federal Reserve Interest Rate Expectations (JANUARY 13, 2020) (Table 3)
According to Fed funds futures, market participants are not expecting any change in policy the next few months, taking cues from the Fed chair. There is a 91% chance of a hold at the January Fed meeting, and there is a 65% chance that interest rates do not change through July 2020. If the Federal Reserve moves on interest rates, then September 2020 is being pegged as the most likely month (54% chance).
IG Client Sentiment Index: USD/JPY Rate Forecast (JANUARY 13, 2020) (Chart 3)
USD/JPY: Retail trader data shows 39.63% of traders are net-long with the ratio of traders short to long at 1.52 to 1. The number of traders net-long is 14.38% higher than yesterday and 22.68% lower from last week, while the number of traders net-short is 3.48% lower than yesterday and 45.98% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/JPY prices may continue to rise.
Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed USD/JPY trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at email@example.com
Follow him on Twitter at @CVecchioFX
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