Kathy Lien is Managing Director of FX Strategy for BK Asset Management
January has proven to be a crushing month for risk. Currencies and equities sold off hard as trade war fears gave way to concerns of a global coronavirus pandemic. China, the world’s manufacturing floor is basically shut down and countries across the globe are closing down borders to prevent the virus from spreading. Even if China manages to get the virus under control and cases peak, it will be sometime before business returns to normal. The coronavirus could become the death knell for growth this year, especially in the Asia Pacific region. The world has become reliant on China for sourcing and demand which is a big reason why we do not believe that Monday’s recovery in risk and relief rally in currencies is durable.
Between coronavirus and the wildfires, it is not a question of IF but a question of when the Reserve Bank of Australia will lower interest rates. The RBA rate decision is one of the most important event risks this week because the decision to keep rates unchanged was likely a close call and the Reserve Bank’s take on the coronavirus impact could be an early reflection of how other central bankers feel. The market had priced in only an 18% chance of a rate cut this month and based on the table below, the arguments can be made for steady rates.
Since their last meeting in December, retail sales and consumer confidence improved, the unemployment rate fell, inflation increased, and the housing market showed further signs of stabilization. Unfortunately the trade surplus shrank, business confidence fell and most importantly, all three PMI reports dropped sharply, signaling broad based weakness in the economy. The PMIs are generally the most current pieces of data and provide the most accurate reflection of economic activity. These reports tell us that while Australia’s economy stabilized towards the end of the year, it slowed again into 2020. Chinese data was stronger than expected but those numbers are not only distorting but will worsen significantly over the past month. Between coronavirus and the ongoing wildfires (state of emergency was declared in Canberra this weekend), Australia’s economy should be hit hard this year. We see at minimum one if not two rounds of easing if the government wants to avoid recession.
There were only 2 realistic scenarios for the RBA today – a dovish hold or proactive cut. Almost everyone seemed to believe it would be a dovish hold, which was the case. We expect an initial rally in AUD that should be sold.
Aside from the monetary policy announcements, PMIs, retail sales, trade and other market moving releases are also due from Australia. Chinese trade data will have widespread impact on the market. Labor market reports are also due from New Zealand, the U.S. and Canada.
ECB President Lagarde will be speaking, so all in will be another busy week for currencies. Today, fourth quarter employment numbers are expected from New Zealand and despite a broader slowdown in the global economy, Q4 numbers could be better. The euro is holding above 1.10 well thanks to upward revisions to PMI.