Saturday, January 28, 2023

Panic Selling Accelerates, Will ECB React?


Currencies and equities traded sharply lower on Wednesday, as the tumbled more than 900 points. At the start of the week, we warned that panic selling can lead to multi-day declines in the market, especially after such strong gains in stocks. When you combine that with major events, “de-risking” can cause sharp and aggressive sell-offs in currencies and stocks. Another U.S. stimulus package is dead. The Senate pushed through Judge Amy Coney Barrett’s confirmation and adjourned for recess until Nov. 9, almost a week after the election. The odds of a stimulus deal before the election was slim to begin with, but the resilience in stocks over the past few weeks was a sign that investors held out hope. Unfortunately, now that reality has set in, the smartest move is to cut positions and reduce exposure. There’s no question that more stimulus is in the pipeline for Americans, but next week’s U.S. Presidential election and the fresh lockdowns across Europe are major distractions. Although risk aversion drove to one-month lows, at the end of the day, the is a safe-haven currency that traded higher against all other currencies.


On Thursday, the dollar will take its cue from U.S. third-quarter and risk appetite. A sharp snapback in growth is expected for Q3 after the steep contraction in the second quarter. The only question is how much of an improvement there will be and whether it matters to investors. Unlike other countries that face a dark winter, the U.S. government has largely ignored the record-breaking new virus cases. A few states have taken matters into their own hands, but unless more states impose wider restrictions, investors see the recovery in Q3 extending into Q4. So if GDP growth beats expectations tomorrow, the dollar will extend its gains against the euro, aussie and other high-beta currencies.


Meanwhile, the pressure is on the European Central Bank to act. It is widely expected to leave monetary policy unchanged on Thursday, but there’s a small chance that it could surprise with new policy action. Europe’s COVID-19 outbreak has gotten out of control. At first, governments were reluctant to return to full lockdowns, but they are quickly realizing that there’s no other choice.


Today, Germany announced a partial one-month lockdown that requires restaurants and bars to close. France announced a nationwide lockdown until Dec. 1. In both cases, schools will remain open, but in France, everyone is ordered to stay at home except for essential reasons, and non-essential shops will be closed for two weeks, after which a decision will be made on whether they can reopen. In Germany, retail shops can remain open for the time being. With smaller nations taking similar steps, there’s no doubt that the Eurozone economy is destined for contraction in the fourth quarter. 


Economists expect the to lower economic projections and central bank President Christine Lagarde to set the stage for December easing. However, between negative price pressures and the very real possibility of a double-dip recession, the ECB could decide that acting early is the right move. If that’s true, we’ll see a sharp sell-off in . Either way, the ECB won’t have anything positive to say for the euro. It is preparing to ease at a time when the Federal Reserve is comfortable with its steady stance, which is a key reason why we think should be trading closer to 1.16 than 1.18. 


shot higher after the Bank of Canada left unchanged. Although it now expects a smaller contraction in 2020, the BoC lowered next year’s growth outlook and pledged to continue buying bonds. It said Canada’s economy is transitioning to a more moderate recuperation phase, but saw growth in the U.S. and Europe slowing considerably. Australian inflation data was stronger than expected, but as risk currencies, and succumbed to broad-based selling. 

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