The week ahead, three market events that you need to know about

There is plenty for traders to sink their teeth into this week, as geopolitical concerns mixed with critical central bank decisions and a flurry of economic data will, no doubt, make life interesting. It is also worth noting that measures of volatility have picked up recently. The Vix index, which is considered Wall Street’s fear gauge, jumped to its highest level of 2020 so far last week, so will volatility remain elevated, and what will this mean for price action? Below we take a look at four themes that could determine price action. 

1, Is the UK’s economy on the mend? 

There is growing optimism that the UK’s economy is enjoying a “Boris Bounce”, with some key economic signals suggesting that the UK economic malaise could come to an end at some point this year. The thumping win for Boris Johnson’s Conservatives in last year’s general election, and the dreadful performance for Corbyn’s anti-business Labour Party, no doubt helped the PMI figures to pick up sharply for January, with the service sector PMI rising to 52.4 from 49.3 in December. The service sector is the most important sector of the UK economy, by far, so it is easy to see why the tone has changed when economists are talking about Britain’s economy. However, before we get too carried away, it is worth remembering that retail sales haven’t risen since July last year, wage growth looks to be slowing and inflation is well below the Bank of England’s target rate at 1.3%.  However, car sales are on the up and house prices also jumped after the election. It’s confusing times for the UK economy, so the market is looking to the Bank of England to make an assessment on the state of the UK’s economy for it, when it releases its latest Inflation Report and interest rate decision this coming Thursday lunchtime. 

Before last week’s PMI data, the market had expected a rate cut from the BOE, as four of the nine members suggested that ongoing economic weakness deserved a monetary policy boost. However, could they be swayed by the Boris effect? The options market, which can be used to calculate the probability of changes to interest rates, has shifted in recent days, with the prospect of a cut now down to 50%. Thus, uncertainty about this week’s move from the BOE is the most important driver for sterling, in our view. 

While anyone trading the pound this week should try to keep themselves up to date with what the latest odds are on a rate change from the BOE, we’ll give you our humble opinion. We believe that the Bank will hold fire for a few reasons: 1, the economic data has picked up and this could be enough to feed inflation down the line, 2, interest rates are only at 0.75%, will a 0.25% cut really boost the economy? We think not, also the BOE may want to give itself room to cut rates if the economy has another dip the closer we get to the trade deal deadline with the EU at the end of this year. 3, The new governor, Andrew Bailey, will take over from Mark Carney on 16thMarch, shouldn’t Carney leave it to his successor to take a major decision on rates, especially when rates are this low? This is why, on balance, we believe that the MPC will leave rates on hold on Thursday and why we may see the pound rally into the end of the week. However, we caveat this by saying that Mark Carney may try to push through a rate cut at this meeting as his swansong – to show that his last few meetings, and last Inflation Report, still matter. 

We shall have to wait for Thursday to find out. Interestingly, GBP/USD fell after Friday’s good PMI data, it had been as high at $1.3150 before it fell back to $1.3060, it has also opened the week on a downbeat note. Part of the pound’s weak performance is due to fears about the Coronavirus driving people into the yen, the CHF and the dollar, which are considered safe havens. However, if Coronavirus fears die down next week, and the BOE keep rates on hold, as we expect, then we may see GBP stage a recovery back towards $1.3150 and then towards the $1.3275 highs from the Dec 31st. 

2, How the market deals with Coronavirus fears 

The weekend papers were in full-blown panic mode about the Coronavirus, even though the death toll remains fairly low at 56 people so far. The latest headlines suggest that coronavirus is infectious in its incubation period, before symptoms show, which makes it harder to contain, and several Chinese cities have imposed significant travel restrictions. The sale of all wildlife in China has also been banned, which highlights how serious the Chinese authorities are taking the threat of the virus, and unless a cure can be found, or a vaccine is deemed effective, then we expect nerves to remain high. USD/JPY is the key FX pair to watch, as the yen tends to rally on the back of geopolitical concerns. USD/JPY fell 100 points last week, from 110.20 to 109.20, and we could see sharper falls if this crisis escalates further, or if there are significant outbreaks in the US or Europe, as that would confirm everyone’s fears: that the Coronavirus had gone global. 

Overall, fear levels are quite high, so we could see an initial spike in the Vix index at the start of this week, which may also weigh on risky assets such as US stocks and oil. Asian stocks are also in the firing line, the Hang Seng has fallen nearly 4% in a week, while China’s main stock index is down nearly 3.5%. Airline shares and luxury goods makers are also seeing a negative effect from the Coronavirus, with IAG down 6% on Friday, while Burberry and LVMH were down some 4%. This trend could continue until the outlook about the spread of the virus and its ferocity become clear. So far, the coronavirus does not seem to be as deadly as the SARS virus in 2003, however it remains early days. Unless there is reason for hope that this virus can be contained, then we expect current trends to continue. 

3, What next for the Fed 

The first Federal Reserve meeting of 2020 will take place this Wednesday. It is unlikely to be too market-moving, as the market is pretty convinced that the Fed will remain on hold, and stick to its current message that rates won’t be cut unless the economy steeply underperforms, and it won’t raise rates until inflation is well above the 2% threshold. Overall, we believe that safe haven demand and the market impact from the Coronavirus will be a bigger driver of the dollar for the first half of this week. However, all of that will change on Thursday when the US Q4 GDP figure is released. It is expected to show that the US economy continued to grow at a 2.1% annualised rate. Any weakness in the numbers could see the dollar slump, while a positive surprise could push USD higher, particularly against the yen and the euro. European Q4 GDP figures are also released at the end of next week, with France and Spain expected to show a slight moderation in their figures for Q4, which could weigh on the euro. And, how could we not mention that Friday 31stJanuary is the UK’s Brexit deadline day, we will have more to say about that when we release our next report after the BOE meeting on Thursday. Until then, good luck with your trading!