Central Bank Watch: BOE, ECB & Fed Rate Expectations; EUR/USD, GBP/USD, USD/JPY Positioning Update
Central Bank Watch Overview:
- The European Central Bank is already operating in negative interest rate territory, will either the Bank of England or the Federal Reserve join? While the BOE is exploring this possibility, it still seems unlikely for the Fed.
- Despite Brexit, the BOE is likely to keep rates where they currently sit. Meanwhile, amid sustained control over the coronavirus pandemic, the ECB will keep rates low to nurture the recovery. Elsewhere, the Fed has little choice but to stand pat thanks to the ongoing COVID-19 outbreak.
- Retail trader positioning suggests that the commodity currencies are on mostly neutral footing.
Bank of England to Keep Rates Low Through June 2021
Even though the June 30 deadline has passed, there is nothing stopping the EU and the UK from negotiating for a new extension or even reaching a full agreement. The context in which this is occurring – against the backdrop of the coronavirus pandemic – means that even a late request for an extension to the transition period or full agreement is likely to be granted. Contextually, this allows traders to ignore the threat of a hard Brexit in the near-term.
To be clear, a hard Brexit would be bad for the British Pound. If the EU and the UK are unable to reach an agreement before the end of 2020, then we are looking at a situation where the UK will lose all of its access to its privileges and it will be treated as if it were subject to WTO rules. The UK would have to pay substantial taxes, higher tariff rates and the cost of goods coming into the UK would increase significantly – all of which would hurt British businesses and households, especially during a fragile recovery.
Bank of England Interest Rate Expectations (AUGUST 17, 2020) (Table 1)
For now, with Brexit looming, and the UK economy outperforming its peers (via PMI figures), traders are not expecting the BOE to move on interest rates any time soon. Conversation around negative interest rates remains premature at best, insofar as rates markets don’t foresee that kind of possibility from truly emerging until August 2021. An EU-UK trade agreement would further reduce the likelihood of a shift into negative interest rate territory by the BOE.
IG Client Sentiment Index: GBP/USD Rate Forecast (AUGUST 17, 2020) (Chart 1)
GBP/USD: Retail trader data shows 33.85% of traders are net-long with the ratio of traders short to long at 1.95 to 1. The number of traders net-long is 1.85% higher than yesterday and 0.21% lower from last week, while the number of traders net-short is 4.87% higher than yesterday and 3.43% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests GBP/USD prices may continue to rise.
Positioning is more net-short than yesterday but less net-short from last week. The combination of current sentiment and recent changes gives us a further mixed GBP/USD trading bias.
European Central Bank Content for Now
The ECB has avoided doing “whatever it takes” to save the Euro, in part thanks to fiscal authorities finally getting their act together and announcing concrete steps towards fiscal union. Paradoxically, the ECB’s unwillingness to ‘go there’ put real pressure on government leaders, no longer afforded another kick of the can down the road. To this end, the ECB is on hold in order to keep fiscal authorities heading in the proper direction.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (AUGUST 17, 2020) (TABLE 2)
According to Eurozone overnight index swaps, there is only a 17% chance of a 10-bps interest rate cut by the end of 2020. If the ECB is doing to act, markets don’t see such action well into the future, where the June 2021 odds are currently pricing in a 54% chance of a rate move. The ECB will be keeping its head down and let government leaders take action as long as it possibly can.
IG Client Sentiment Index: EUR/USD Rate Forecast (AUGUST 17, 2020) (Chart 2)
EUR/USD: Retail trader data shows 34.22% of traders are net-long with the ratio of traders short to long at 1.92 to 1. The number of traders net-long is 4.11% lower than yesterday and 8.47% higher from last week, while the number of traders net-short is 10.48% higher than yesterday and 5.07% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.
Positioning is more net-short than yesterday but less net-short from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.
Federal Reserve Maintaining Low Rates, Not Negative Rates
Nothing has changed with respect to the Federal Reserve, having enacted emergency interest rate cut measures.Rate markets are more or less stuck in a state of suspended animation. If the Fed is going to do anything from here on out, it’s going to come via more QE, a repo facility, etc. The latest extraordinary effort, the Municipal Liquidity Facility, is an example of this effort.
FEDERAL RESERVE INTEREST RATE EXPECTATIONS (AUGUST 17, 2020) (Table 3)
There’s been no indication that the Fed plans on moving rates into negative territory, and as a result, we’ve reached the lower bound for the time being. If yield curve control is implemented, we would expect a similar outcome to what is being experienced by the Reserve Bank of Australia main rate expectations curve in context of the RBA’s promise to keep rates at 0.25% for the next three years (e.g. yield curve control): any suggestions by rates markets that a rate hike is coming anytime soon is a pricing quirk to be ignored; interest rates are not going anywhere higher, at least through January 2022.
IG Client Sentiment Index: USD/JPY Rate Forecast (August 17, 2020) (Chart 3)
USD/JPY: Retail trader data shows 57.88% 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 12.55% lower than yesterday and 7.66% lower from last week, while the number of traders net-short is 12.43% higher than yesterday and 25.10% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests USD/JPY 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 USD/JPY trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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