Two potential FX breakouts, and a calming in global stocks
There is a sense of calm in financial markets today, after the mild sell-off on Tuesday on the back of fears about the spread of the coronavirus, which is reminiscent of fears about the SARS virus in 2003. Asian stocks had a strong performance, including more than 1% gains for the South Korean Kospi index, the Chinese stock index and a 0.7% gain for the Nikkei. US indices are poised to experience a mild recovery in the S&P 500 when it opens later today, and European stocks have had a small bounce, led by the FTSE 100. Although concerns about the virus remains, the market is optimistic that it can be contained and that health authorities will be able to halt its spread.
Why coronavirus fears could be overdone
Back in 2003, global stocks sold off on the back of fears about SARS, however, the sell-off was short-lived and after that US stocks soared. Thus, we expect any disruption to financial markets from the coronavirus to be limited. Chinese authorities have said that they are at the most critical stage of prevention and control of the coronavirus, and for now, as long as the disease doesn’t spread in large numbers from here, then we believe stock markets will be able to shrug off concerns about the coronavirus going forward. With US/Iran tensions noticeably quieter than they were in late December, and the truce between the US and China in the trade war, financial markets are able to put geopolitical concerns on the back burner for now and focus on the nuts and bolts that should move financial markets on a daily basis. Due to this, we believe that two FX pairs are worth watching: GBP/USD and USD/CAD.
Bank of Canada likely to break stalemate in USD/CAD
Looking at the latter first, USD/CAD is worth watching closely today. The Bank of Canada will announce its interest rate decision at 1500 GMT, where interest rates are expected to remain on hold at 1.75%. This is a big shift from the end of 2019 when the markets expected a rate cut from the BOC on the back of some disappointing economic data, most recently a downbeat report for manufacturing sales for November. The problem for the BOC, led by the hawkish Stephen Poloz, is inflation. The inflation rate is running above 2%, inflation for December, which is released later today, is expected to remain at 2.2%. Inflation was at 1.4% at the start of 2019, so this large increase in price pressure could force the hand of the BOC to keep rates on hold, even as the economy continues to look patchy.
While the actual interest rate decision from the BOC is unlikely to move markets, the more important aspect of this meeting will be Governor Poloz’s press conference at 1615 GMT. Will he concentrate on the dismal state of the Canadian economy, or will he instead talk up its chances on the back of the US/China phase one trade deal, which could pay dividends for Canada’s vast manufacturing and energy sectors? Will he sound worried about inflation? If he does sound confident about the economy and concerned about inflation, then we may see the market rush to price in interest rate increases later in 2020, which could see the CAD rise sharply. If he sounds concerned about the Canadian economy, then the CAD could fall as it increases the chances of a rate cut from the BOC. Thus, today’s decision from the BOC is a binary outcome for the CAD, in our view.
USD/CAD technical focus
From a technical perspective, USD/CAD is ripe for a breakout after sticking to a tight range of late between 1.3030- 1.3080. This incredibly tight range cannot last forever, and usually when ranges remain this tight for so long it can be a prelude to an explosive move in one direction or another. Thus, watch what Governor Poloz says, if he sounds hawkish then USD/CAD could head for a decline back towards 1.2960, the low from early January. Alternatively, if he sounds downbeat about Canada’s prospects then we could see a surge in USD/CAD back towards 1.3160.
What next for the pound
Elsewhere, the pound is also in focus today. It has broken above 1.3050 this morning and could attempt to retake yesterday’s high at 1.3080. 1.3100 has been a major level of resistance of late, and from a technical perspective, GBP/USD needs to rise above 1.3150, the 38.2% Fibonacci retracement of the December 13thhigh to the 23rdlow. UK borrowing figures released early on Wednesday, showed that public sector borrowing had risen sharply. Rather than worry about the impact to the UK’s public finances, the market could be looking at the boost to economic growth from loosening the fiscal purse strings and the help that this could give to the UK’s lacklustre economy over the coming months. This is one reason why the pound could be rising today. We believe that a decisive move back above 1.3150 could see a move back to 1.3260- the Dec 31sthigh. The UK is set to leave the EU on 31stJanuary, and even though some of the government’s legislation was defeated by the House of Lords on Tuesday, it is likely to be overturned once it returns to the House of Commons. While Brexit at the end of this month is now a certainty, and rhetoric from both sides about a trade deal now sounds more constructive, the FX market may focus on the UK’s economic data going forward. If there is a notable pick up in the UK’s economy, on the back of an increase in public sector spending, then GBP could return to its status as a top performer in the G10 FX space.
The Dax heads to dizzying new heights
Lastly, the Dax reached a record high earlier today, as global risk sentiment recovered. However, it has since given back some gains, after rising to 13633 it is now 50 points lower. If the US indices manage to make gains today, then we could see the DAX continue to rise in the short term, particularly if concerns about the coronavirus continue to calm down.