Central Bank Watch: BOE, ECB, & Fed Rate Expectations; EUR, GBP, USD Positioning Update
Central Bank Watch Overview:
- As Eurozone economic data has continued to struggle, European Central Bank interest rate expectations have steadied in April 2021.
- It’s still the case that neither the Bank of England nor the Federal Reserve are expected to shift policy in 2020; the BOE is likelier than the Fed to move first on rates.
- Retail trader positioning suggests that the US Dollar has a mixed trading bias.
Bank of England Rate Cut Odds Hone in on August 2021
The self-imposed Brexit deadline of October 15 on behalf of UK Prime Minister Boris Johnson is quickly approaching, but rates markets don’t seem too concerned that the pace of news headlines has become more frenetic and discouraging. Asymmetric risk exists on the near-term horizon: volatility likely arrives in the unlikely situation that no deal is achieved; in turn, BOE rate cut odds are likely to either stay where they are or pull forward in the coming weeks, particularly as BOE policymakers discuss the prospect of negative interest rates more frequently and publicly.
Bank of England Interest Rate Expectations (OCTOBER 12, 2020) (Table 1)
It still holds that speculation surrounding negative interest rates remains premature at best, insofar as rates markets don’t foresee that kind of possibility from becoming reality until at least August 2021. An EU-UK trade agreement would further reduce the likelihood of a shift into negative interest rate territory by the BOE; the current course would likely stick for a few years, akin to the Federal Reserve.
IG Client Sentiment Index: GBP/USD Rate Forecast (OCTOBER 12, 2020) (Chart 1)
GBP/USD: Retail trader data shows 42.37% of traders are net-long with the ratio of traders short to long at 1.36 to 1. The number of traders net-long is 25.92% higher than yesterday and 2.13% higher from last week, while the number of traders net-short is 10.42% higher than yesterday and 4.21% higher 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 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 GBP/USD trading bias.
European Central Bank Rate Cut Holds for April 2021
Eurozone economic data continues to deteriorate, and the upcoming release of the Eurozone inflation report suggests that disinflation remains significant. To this end, the late-summer jump in European Central Bank interest rate expectations has held, insofar as an interest rate cut deeper into negative territory will arrive sooner in the first half of 2021, as was expected one month ago. Weak CPI readings coupled with a strong Euro relative to the ECB’s internal forecasts are increasing the odds of dovish jawboning in 2020, leading to a rate cut in the first half of 2021.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (OCTOBER 12, 2020) (TABLE 2)
According to Eurozone overnight index swaps, there is a 24% chance of a 10-bps interest rate cut by the end of 2020. Interest rate cut odds have been pulled forward in recent weeks; one month ago, there was just under a 15% chance of a 10-bps cut before the end of the year. April 2021 remains favored with an implied probability of 57%.
IG Client Sentiment Index: EUR/USD Rate Forecast (OCTOBER 12, 2020) (Chart 2)
EUR/USD: Retail trader data shows 36.08% of traders are net-long with the ratio of traders short to long at 1.77 to 1. The number of traders net-long is 24.36% higher than yesterday and 9.41% higher from last week, while the number of traders net-short is 1.73% higher than yesterday and 5.14% lower 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.
Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current EUR/USD price trend may soon reverse lower despite the fact traders remain net-short.
Federal Reserve Content with Standing Pat for Now
It still holds that little has changed with respect to the Federal Reserve, having enacted emergency interest rate cut measures and a slew of balance sheet-expanding operations. To this end, interest rate markets are still stuck in a state of suspended animation. Should the Fed change course, it will likely shift to via more QE, a repo facility, Municipal Liquidity Facility, etc.
FEDERAL RESERVE INTEREST RATE EXPECTATIONS (OCTOBER 12, 2020) (Table 3)
Seeing as how there’s been no indication thus far that the Fed will cut interest rates into negative territory,we’ve reached the lower bound for the time being. In the future, 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, especially now that the Fed has extended its promise to keep rates low through 2023.
IG Client Sentiment Index: USD/JPY Rate Forecast (October 12, 2020) (Chart 3)
USD/JPY: Retail trader data shows 55.41% of traders are net-long with the ratio of traders long to short at 1.24 to 1. The number of traders net-long is 8.09% higher than yesterday and 12.35% higher from last week, while the number of traders net-short is 0.29% higher than yesterday and 18.77% 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.
Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger USD/JPY-bearish contrarian trading bias.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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