Will the Fed hold rates despite coronavirus fears?

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29 January 2020

thomasdodds

The US dollar was broadly stronger against its major peers on Wednesday morning as investors braced themselves for this evening’s Federal Reserve monetary policy announcement.

D
espite the emergence of China’s coronavirus, we think that the Fed are all but certain to keep interest rates unchanged this evening, with FX traders instead interested to hear their comments on the strength of the US economy. Since the December meeting, where the Fed’s dot plot showed policymakers expected rates to be kept unchanged throughout 2020, economic data out of the US economy has come in mostly in line with expectations. There has been a modest slowdown in job creation and wages, although not to the extent that would warrant additional cuts. Inflation has accelerated, although given the Fed’s comments regarding the need for a ‘persistent’ move higher in price growth, we also do not think there will be much appetite to hike.

The move higher in inflation and alleviation in trade tensions ensures that we think the Fed will maintain an upbeat tone during its communications today. As mentioned yesterday, however, the emergence of the coronavirus and its potential negative impact on the Chinese economy could impact the Fed’s outlook. As always, the Fed’s interest rate decision will be announced at 19:00 GMT (20:00 CET), with Chair Powell’s press conference to follow half an hour later.

Pound edges lower ahead of knife-edge BoE meeting

Ahead of tomorrow’s Bank of England meeting, the pound shed around half a percent of its value against the USD, with investors nervous that Mark Carney could deliver a rate cut in his final meeting as BoE governor.

The decision itself is on a knife-edge and pretty much the toughest to call during Carney’s reign at the helm of the central bank. Analysts are divided as to whether rates will be cut, while the market is placing a 50/50 chance either way. As we noted in our Bank of England preview report, Carney himself may hold the deciding vote, should Vlighe and Tenreyro follow suit with the two MPC members that are already in favour of lower rates.

In the event of a cut, which we believe would be a ‘one and done’, we actually think that the sell-off in the pound could be relatively mild. This cut, we believe, would be of a similar ‘insurance’ nature to that conducted by the Federal Reserve and certainly not part of a sustained easing cycle. Currency traders also appear to be taking the prospect of lower rates in their stride. Should policymakers again vote in favour of stable rates, our base case scenario, we think a move higher in sterling would ensue given the relatively high market pricing for a cut. With UK economic data expected to improve in the coming months, January may prove to be the last opportunity the bank has to deliver its ‘insurance cut’ before domestic macroeconomic fundamentals simply do not warrant lower rates.

Chinese yuan sell-off continues on virus fears

Ongoing concerns surrounding the aforementioned coronavirus continued to sap risk appetite in the financial markets yesterday.

The Japanese yen consolidated some of its gains, although remained well supported around the 109 mark, while the Chinese yuan sold-off again and is now back above the 6.90 level versus the dollar. The death toll has continued to rise, now north of 130 in China alone, with the UK Foreign Office advising against all but essential travel into the country.

There is a growing agreement among those in the know that the worst of the virus is yet to come, with it expected to reach its peak in around ten days. There could, therefore, be more room for gains in the safe-havens and a continued sell-off in risk assets in the short-term, although we think that this will prove temporary.