23 January 2020: Manufacturing Rally cuts rate fears

Manufacturing Rally cuts rate fears

23rd January: Highlights

  • Sterling rallies as rate cut fears considered speculative
  • Dollar in limbo as traders await FOMC
  • Loan demand falls as ECB prepares to consider how to stimulate the economy further

Chances of a rate cut fall from 70% to 50%

A theme that was seen in the dollar recently has spilled over into the UK market as a bout of short-termism has set in.

In truth, the chances of a rate cut at next week’s MPC meeting haven’t changed overall in the past ten days, but the chances of a cut based upon every piece of data have started at 50%, risen through the sixties reaching 70% earlier this week and now we are back to 50%.

The comments made by four members of the MPC Mark Carney, Gertjan Vlieghe, Silvana Tenreyro and Michael Saunders won’t be swayed by individual data sets or a months combined data. They consider trends in the economy and comply with the Government’s demands for steady growth and controlled (not necessarily low) inflation.

The common theme running through this “gang of four’s” comments is that they will consider a cut if the outlook for the economy fails to improve.

So, in line with the money market, the chances of a cut at next week’s meeting remain at 50/50. Of course, there are five other members of the MPC. I imagine there must be at least one hawk amongst the remaining members. Unless there is a significantly poor activity report of both manufacturing and services released tomorrow, there is a reasonable possibility that they will keep their “powder dry.

The CBI’s industrial Trends survey which was released yesterday, show a marked improvement over December which added to speculation over the MPC’s actions and pushed Sterling higher

Yesterday, the pound fluctuated but ended higher against both the dollar and single currency. Versus the dollar it traded between 1.3035 and 1.3154, eventually settling at 1.3135. Against the euro it reached a high of 1.1871, closing at 1.1842

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But, as ever, the devil is in the detail

Next week the Federal Reserve’s rate setting committee will meet to determine short-term interest rates. The first meeting of the year will set the tone for the Fed’s actions during the year.

Jerome Powell, the Chairman of the Federal Reserve and his colleagues face a relatively easy decision over interest rates at the meeting. There is little doubt, given the advance guidance provided by Powell that rates will remain unchanged and monetary policy will be decided by a “watching brief”

Powell has had a rough ride since he entered the world of finance economics and banking which is alien to his background in law.

His boss, The President has been openly critical of some of his actions and the relationship with the financial markets started off on the wrong foot.

It took Powell some time to master just how much information he should provide the markets in advance. Too much and he runs the risk of becoming irrelevant, too little and traders will start to speculate, interpreting the Bank’s intentions, sometimes wrongly.

While he is unlikely to ever have the market “eating out of his hand” like some previous Fed Chair’s, Powell has at least earned the respect of the market by his stoic attitude to criticism and his determination to make the Fed’s decision-making more of a team effort.

The dollar remains in a transition phase as the market appears to want to believe that that growth will remain on course despite the issues with other major economies but cannot quite believe that the U.S. is “bucking the trend so conclusively.

The outbreak of a new seemingly deadly virus in China will add to the issues facing the global economy with estimates putting the damage at between 0.1% and 0.25% to global growth depending on the length and severity of the outbreak.

Yesterday, the dollar index traded between 97.69 and 97.44 on a quiet day. With the ECB, Bank of England and Fed meetings all about to take place, traders await more concrete news before committing to fresh positions. The dollar index closed at 97.51.

Signs of a stabilizing economy may be overdone

It is interesting to note that while the ECB is prepared to accept investment confidence readings as a sign of an imminent improvement in the Eurozone economy, the market is unwilling to accept the pronouncements from the Central Bank regarding the same issue.

The ECB firmly believes that it is a case of when not if the economy improves while the financial markets appear to believe the exact opposite.

A report delivered yesterday showed that demand for bank finance fell for the first time in six years in 2019.It may be that the development of new forms of finance have driven pure lending lower, but this seems to be restricted to the Eurozone.

The survey of 144 banks across the entire region showed that demand was lowest in Spain with France also facing a similar although smaller drop. Lending in Italy was flat from 2018 as the Italian Government stands on the brink of flouting budget rules and the growth and stability pact by increasing public spending to provide stimulus to its economy.

The Italian Government’s actions are being closely watched in Frankfurt by both the ECB and Bundesbank. It is possible that if the ECB is unable to create a situation where the EU Commission is able to loosen the purse strings of budget regulation, countries may start to “go it alone” without considering the potential harm to the region both politically and financially.

Today’s ECB meeting will, again, be more interesting for the press conference than the rate decision itself. No matter what Christine Lagarde and her colleagues decide, it will be her references to future developments that the market will most want to hear.

Yesterday, the euro was marginally stronger in light trading. It reached a high of 1.1099, closing at 1.1093.

Have a great day!
About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”