Markets Weekly podcast – 18 November 2024
18 Nov 2024
China’s ‘bazooka’ and currency special
30 September 2024
Join Bhaskar Gupta, our Head of FX Distribution UK, as he explores the outlook for currency markets over the short and medium term. Topics on the agenda include the weakening US dollar, the impact of key central bank decisions and potential risk factors for the remainder of the year.
Podcast host Julien Lafargue also examines economic stimulus measures in China, inflation in the major regions and interest rates in the eurozone.
You can also stream this podcast on the following channels:
Julien Lafargue (JL): Welcome to a new edition of Barclays Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and I will be your host today.
As usual, we’ll first go through last week’s events before moving on to our guest segment. We thought it would be good to have a bit of a deep dive on currency markets. So, later today I’m going to be joined by Bhaskar, who is the UK Head of FX Distribution here at Barclays Private Bank.
Now, before that, let’s look at last week’s events, and it was a fairly eventful week in particular in China. So, China came up with what one could consider being a ‘bazooka’ stimulus.
As we know, China has been trying to revive its economy for some time now, post the COVID-19 pandemic, but with little success. Up to now, most of the measures announced by the Chinese Government have been centred around the real estate sector, trying to put a floor below what has been a very challenging time for real estate and real estate investors in China.
Now, what the PBoC and the Chinese authorities did last week was to announce a fairly broad range of measures. Some have been confirmed, some have been rumoured in the press, but broadly speaking, we’re talking about not only a decreasing interest rate, as well as a lower down-payment ratio for second homes, we’re also talking about a cut in the reserve requirement ratio for banks.
So, all that is very positive from a liquidity and real estate market standpoint, but we’re also talking about ¥2 trillion, which is equivalent to $280 billion, issuance of special sovereign bonds, that will be used in two different ways. The first way will be to boost trading subsidies for consumer goods and large-scale business equipment, but also to provide a monthly allowance of about ¥800 per child to all households with two or more children.
Now, this might seem a big number, and in fact it is. If you think about ¥800, this is roughly $110, $115. The monthly salary, at least on average in China, is around ¥3,000. So, $115 is roughly equivalent to 25% of the average monthly salary, so a pretty big boost for those households who’ll benefit from it.
Of course, hard to know exactly how many households will actually benefit from it. As you may remember, before 2016, Chinese households could only have one child, and that maximum was lifted in 2021. It’s likely that not that many households will have two children, but, still, it’s quite a significant stimulus for those families.
And the other half of those ¥2 trillion will be used to potentially recapitalise banks, which, again, is a step in the right direction. We know how much banks have been hurt by the real estate crisis and they were potentially unwilling to lend money. Hopefully, this liquidity injection will boost credit consumption and credit availability in the country.
Now, it still needs to be seen if there is demand for this new-found credit. As you know, China has been going through what we call a balance sheet recession, where both corporate and households have been trying to reduce leverage, therefore, offering them more leverage is not necessarily a positive thing, or at least something that will necessarily move the needle.
But I think the big difference with this stimulus is because we’ve seen stimulus before from Chinese authorities. The big difference is what I mentioned around household and cash handouts to families. There’s also a discussion around cash handouts for the less privileged people in China. All that marks a significant shift in how the Chinese Government is addressing the issue by finally targeting consumption.
We are just going into the Golden Week in China. I guess those two things may be linked. The Chinese Government may want those households and people to spend money in this holiday period. And so, it will take some time to see if that has any effect but, clearly, from a market perspective, this announcement has taken a few people by surprise.
Clearly, the sentiment around China had been very, very negative for a while, and now that we’ve seen Chinese equities rebound extremely violently in the past week or so, and it looks like it’s continuing this Monday.
So, overall, a very significant development in China which, of course, has had implications for broader markets, with any company being somewhat exposed to China benefiting from this announcement, so thinking about the luxury space in particular in Europe, the mining metal companies, chemicals, capital goods, all have seen a very strong performance last week on the back of this announcement.
Now the other key news from last week was around inflation in both the US and the eurozone.
So, in the US, it was about the personal consumption expenditure, PCE, which is the US Federal Reserve’s preferred measure of inflation. Now, we know that this PCE can be extrapolated from the reading on the CPI and the PPI, which we already had, so not a huge surprise there. The number was pretty much in line with expectation.
The real surprise, when it comes to inflation, came from Europe. More specifically, from France and Spain, where we saw a very significant downside surprise to inflation expectations. Both countries now have a year-over-year headline inflation rate that is running below 2%, and quite significantly so.
As a result of that, the market has been pretty quick in changing its expectations for the ECB. At the beginning of last week, the market was pricing in about a 20% chance of a cut in the eurozone by the ECB in the October meeting. That probability has gone from 20% to 80%, as of today. So, the market now firmly believes the ECB will cut in October.
A few specific items have pushed down inflation in those two countries. Oil is a big component. But, even if you’re looking at core inflation, we’re still heading towards the ECB’s target. So, inflation is definitely not an issue anymore, and it looks like the real issue is becoming whether the eurozone can sustain any kind of strong economic momentum at this stage.
Now, that’s it for the main events of last week. We’ll discuss at the end what is coming up next. I’ve got a few items on the agenda, but I think now maybe is a good time to transition to Bhaskar, since we were talking inflation, and to talk about FX markets.
So, Bhaskar, welcome back to the podcast, always a real pleasure to have you. FX markets have been quite interesting, I’d say, over the last couple of months. So, maybe we can start by taking a step back, and maybe you can update us on what has been happening and how are the currencies moving these days?
Bhaskar Gupta (BG): Yeah, sure. Thank you, Julien, and it’s always a pleasure to be on this podcast. The FX markets have, indeed, been very interesting and active recently. We have seen the US dollar weaken over the last two months, and it has been a very steady and sustained move. All currencies have found a new level. So, in cable, we are now at 1.34, well above the 1.25 to 1.28 range that we saw in the summer.
And similarly, in euro/dollar, we are now trading at 1.12. Dollar/yen, the yen has strengthened as well, to levels close to 1.42, from 1.55, 1.60 back in the summer. So, this dollar weakening move has been very broad-based across all currencies, and with the US dollar index itself having come off 5% to 6% from its June peak.
So, what has been the driving force, if I may say, behind this? Well, it can solely be attributed to one thing, and that is the easing that’s priced in from the Fed. And there has been some unprecedented volatility in it. So, if we go back a few more months, the expected fed-rate-curve has swung from one extreme to another, you know, from six rate cuts to no cuts, to even a hike, and now we are back at six rate cuts.
And the fact that the Fed has not actually started the raising cycle last week, or the week before, that has priced in more rate cuts from then, which has resulted in a bit more of US dollar weakness.
JL: So, clearly, the Fed is the big driver here. So, what exactly is expected now when it comes to the Fed, and how does that play with expectations around other central banks? I guess the Bank of England and the ECB, we just mentioned, are also cutting rates, so on the other side that should weaken their currency too, right?
BG: Yes, that is correct, Julien. And, you know, after a two-year rate-hiking cycle, we are now in the cutting-cycle globally. So, while the Fed only took its first step in mid-September, the ECB was the first one to cut in June, and the Bank of England thereafter.
But, while all the three major central banks are cutting rates, it is the relative magnitude of cuts that becomes the decisive factor. So, if we look at the next six-odd months, you know, up until let’s say March next year, there’s a further about 140 basis points of cuts priced in from the Fed, vis-à-vis only about 90 basis points from the Bank of England and about 95 odd from the ECB.
So, in the FX world and in many other markets, it is the relative differential that matters, and this higher magnitude of cuts from the Fed has been instrumental in the dollar sell-off.
You know, while we are discussing central banks, I would also like to bring in the Bank of Japan. They had diverged with the other major central banks, you know, when the others were hiking, meaning the BoJ did not hike when other majors were hiking, and now they are again diverging, in the sense that while the others are cutting rates, the BoJ’s not now hiking rates.
So, obviously, it’s not intentional and each central bank is doing what is best for their economies, but this divergence has brought in significant volatility in dollar/yen. So, in the first period of divergence, we saw the yen weaken to beyond 1.60 to the dollar, and now, in the current period, we are seeing it strengthen to around levels of 1.42.
So, this pair, which is notorious for its volatility, has well and truly come back to life, and we did get a taste of it in the first week of August. If you remember, immediately after the first, after the BoJ hike, dollar/yen crashed from 1.55 to 1.42, and it sent ripples throughout the global financial markets.
JL: So, yes, it’s all relative, right? Now, a few, if it’s a few months, definitely a few years ago, everybody was talking about how the US dollar had to weaken. People were talking about the ‘de-dollarisation’ of the world, etc. So, what’s your view on the dollar? Do you think we could see further weakness, and maybe currency, which currency would you hold currently?
BG: Yeah, I mean for now the market is very intensely focused on the Fed’s impending, you know, easing cycle. But as the focus shifts back to let’s say the notably weak momentum in Europe and China, this dollar weakness should abate.
So, you know, also the bulk of the dollar weakness tends to occur ahead of a Fed easing cycle, and the current move that we’ve seen has been chunky, by historical standards. So, while we are at stage where, you know, bouts of further dollar weakness are likely, but they should not be very extreme. We think that a large part of this move is probably behind us.
So, overall, we now expect the dollar to recover modestly against some of the majors. So, say against the euro or Swiss, yen, those sort of currencies. But one currency that stands out is the pound sterling. So, we continue to see the pound as a likely outperformer.
Current UK economics suggests a slow, probably a relatively shallow, cutting cycle from the Bank of England, which will maintain the pound’s carry advantage. And the new UK Government’s intention, you know, to pursue even a closer EU/UK relationship is also good news for the sterling.
So, we do remain constructive on sterling against all currencies, and probably the biggest move that we can see is, would be in sterling versus the euro.
JL: Interesting. Who would have thought that there would be some optimism around the macroeconomic outlook for the UK?
Let’s discuss risk for a second. Obviously, you’ve just discussed your, I would say, base case scenario, but could you tell us what are the risks around those scenarios, and maybe how can investors just be invested today?
BG: Yeah, sure. So, while there’s never a dull moment in FX, the next few weeks and months are especially fraught with risk. Risk or opportunity, you know, it depends on how one perceives it. But before we discuss anything else, the US election is the biggest risk ahead, and we are now less than six weeks away from that. So, there will definitely be enhanced volatility around and after that event.
We also have the much-anticipated first full Budget from the new UK Government towards the end of October, and back in 2022 we saw what the result of ill-thought-out policies can be. So, that will be keenly watched.
Further, you know, the Fed, after having been solely focused on inflation for more than two years, they have now recently been talking about their dual mandate, which includes maximum employment as well. So, markets are more sensitive towards any US jobs numbers.
And then over the weekend, on Friday we also have this new prime ministerial candidate in Japan that could lean one way or the other when it comes to BoJ tightening. So, that will have a big impact, not just on dollar/yen, but also on the risk sentiment globally and all currency players as well.
So, while I might sound as it’s like it’s all bad, and landmines all around, but that’s not the case, you know, there are currencies where we see value. As we discussed, you know, we are constructive on sterling, and investors can look to benefit from buying any dips in sterling.
So, we also see value in being long dollar against some of the majors, like the Swiss franc, euro, that sort of thing. However, you know, this is a market, given the risks, where all investors need to stay alert and probably tweak their positions according to their appetite.
JL: I think being nimble is key in this market. That was extremely helpful. Thank you so much, Bhaskar. We’ll definitely get you back, potentially quite soon, simply because, as you were mentioning, the Fed and the dual mandate. Well, we’re going to get a good indication as to how the other side of the mandate is doing in terms of employment this week.
We’re going to get a lot of US labour market data but first, of course, we’re going to get the eurozone CPI, but as discussed, with those downside surprises in Spain as well as France, it looks like this number could only cement the current expectation for an ECB cut in October.
After that, a quick look at the rest of the week with the US manufacturing ISM for September on Tuesday. If you don’t have anything to do on Tuesday night, maybe you want to watch the vice-president debate, leading up to the US election.
We’re also going to get the ADP job report for September, that’s coming on Wednesday, followed by the US services ISM on Thursday. And we’re going to potentially finish the week with some fireworks with the US job report on Friday, which, again, will give us an indication as to how the US job market is doing and whether the market is right in thinking that the US will go through rather a soft landing more so than a hard landing.
So, plenty to debrief next week when we’re back but, in the meantime, as always, we wish you the very best for the trading week ahead.
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