ECB and US Q4 GDP in Focus

Forex

Economic

Summary:

Today's focus for European markets which are set to open slightly lower, is on the ECB and the press conference later with Christine Lagarde...

European markets saw a much more positive session yesterday, carrying over the momentum from a buoyant US market, but also getting a lift after China announced a 0.5% cut in the bank reserve requirement rate from 5th February.

US markets finished the day mixed with the Dow finishing lower for the 2nd day in succession, while the S&P500 and Nasdaq 100 once again set new record highs, as well as record closes, although closing off the highs of the day as yields edged into positive territory.

This divergence between the Dow and Russell 2000, both of which closed lower for the second day in succession, and the Nasdaq 100 and S&P500 might be a cause for concern, given how US market gains appear to be being driven by a small cohort of companies share prices.

Today's focus for European markets which are set to open slightly lower, is on the ECB and the press conference later with Christine Lagarde, where apart from questions on time lines about possible rate policy, Lagarde could face some questions a little closer to home amidst dissatisfaction over her leadership style from ECB staffers.

When looking at the economic performance of the euro area, we've seen little in the way of growth since Q3 of 2022, while inflation has also been slowing sharply. Yet for all this economic weakness, a fact which was borne out by yesterday's flash PMI numbers, especially in the services sector, the ECB has been insistent it is not close to considering a cut in rates, having hiked as recently as last September.

Only as recently as last week we heard from a few governing council members of their concerns about cutting too early, yet when looking at the data, and the fact that the German economy is on its knees, the ECB almost comes across as masochistic in its desire to combat the risks of a return of inflation.

In a way it's not hard to understand given that after November headline inflation slowed to 2.4%, it picked up again in December to 2.9%, while core prices slowed to 3.4%.

This rebound in headline inflation while no doubt driven by base effects will be used as evidence from the hawks on the governing council that rates need to stay high, however there is already evidence that the consensus on rates is splintering, and while no more rate hikes are expected the economic data increasingly supports the idea of a cut sooner rather than later.

Markets currently have the ECB cutting rates 4 times this year in increments of 25bps, starting in June, although given the data we could get one in April.

This contrasts with the market pricing up to 6 rate cuts from the Federal Reserve despite the US economy being magnitudes stronger than in Europe.

No changes are expected today with the main ECB refinancing rate currently at 4.5%, however Q4 GDP due next week, and January CPI due on 1st February calls for a March/April rate cut could start to get louder in the weeks ahead, especially since PPI has been in deflation for the last 6 months.

US bond markets appear to be starting to have second thoughts about the prospect of 6 rate cuts from the Federal Reserve this year, although there is still some insistence that a March cut remains a realistic possibility.

Today's US Q4 GDP numbers might bury the prospect of that idea once and for all if we get a reading anywhere close to 2%.

This seems rather counterintuitive when you think about it, the idea that the Fed would cut before the ECB when Europe is probably in recession and the US economy is growing at a reasonable rate, albeit at a slower pace than in Q3.

Expectations for Q4 are for the economy to have slowed to an annualised 1.9% to 2%, which would be either be the weakest quarter of 2023 or match it.

Nonetheless the resilience of the US consumer has been at the forefront of the rebound in US growth seen over the past 12 months, with a strong end to the year for consumer spending. This rather jars against the idea that US GDP growth might get revised lower in the coming weeks as some have been insisting. If you look at the December control group retail sales numbers, they finished the year strongly and these numbers get included as a part of overall GDP

Weekly jobless claims are also at multi-month lows of 187k, and while we could see a rise to 200k even here there is no evidence that the US economy is slowing in such a manner to suggest anything other than a modest slowdown as opposed to a sudden stop or hard landing.

The core PCE Q/Q price index is expected to slow from the 3.3% seen in Q3 to around 2%, which may not be enough to prompt a softening in yields unless we drop below 2%.

EUR/USD – pushed up to the 1.0930 area before retreating. While above the 200-day SMA at 1.0830, the bias remains for a move higher towards the main resistance up at 1.1000.

GBP/USD – pushed up towards 1.2775 yesterday with support at the 50-day SMA as well as the 1.2590 area needed to hold or risk a move lower towards the 200-day SMA at 1.2540. We need to get above 1.2800 to maintain upside momentum.

EUR/GBP – fell to 0.8535 before rebounding modestly. Also have support at the 0.8520 area, with resistance at the 0.8620/25 area and the highs last week.

USD/JPY – finding a few offers at the 148.80 area over the last 3days which could see a move back towards the 146.25 area. A fall through 146.00 could delay a move towards 150 and argue for a move towards 144.00.

To stay updated on all economic events of today, please check out our Economic calendar

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Damon

Economic

Central Bank

The Bank of Canada's unwinding of a pandemic-era stimulus policy could end sooner than expected after a shortage of cash in the financial system forced the central bank to use a key liquidity operation for the first time in four years.

CORRA, the rate at which banks lend funds to each other overnight, has traded above the BoC's 5% target for the overnight rate, or benchmark policy setting, since August of last year.

This month, after CORRA climbed as much as 6 basis points above target, the central bank acted, injecting C$5 billion ($3.7 billion) of liquidity into the market through its overnight repo operations.

Above-target CORRA is a sign that the BoC's quantitative tightening program (QT) is reducing liquidity, analysts say. The Canadian central bank launched QT in April 2022, aiming to reduce the size of its balance sheet after it purchased bonds in large scale to support the economy during the pandemic.

Ending the program, or reducing its pace, could lower borrowing costs and weigh on the Canadian dollar while also leaving less room for the BoC to grow its balance sheet in the future, analysts say.

Governor Tiff Macklem told reporters on Wednesday, after the BoC left rates on hold, that it's too soon to end QT but the central bank will be refining its view on the appropriate size of the balance sheet as the size approaches a previous estimate.

"It's important for the BoC to be able to steer markets toward their policy rate and their credibility is at stake in that regard given where CORRA sits," said Derek Holt, head of capital markets economics at Scotiabank.

"The cleaner solution is to address the root of the problem which is probably that QT is having adverse effects upon funding markets," Holt said.

Under QT, the BoC has been letting bonds roll off its balance sheet without replacement as they mature, with a resulting decline in settlement balances, or the reserves that were created to pay for the bonds.

Settlement balances have fallen to C$112 billion from a peak of C$390 billion in February 2021. Bank of Canada May End Quantitative Tightening Sooner After Money Market Strains_1

Bank of Canada May End Quantitative Tightening Sooner After Money Market Strains_1

The BoC has guided that QT will run until the end of 2024 or the first half of 2025 when settlement balances will have fallen to a steady-state level, which it estimates to be in a range of C$20 billion to C$60 billion, or roughly 1% to 2% of GDP.

Persistent upward pressure on repo rates could indicate that the steady-state estimate is too low, the central bank says.

"We are already seeing a rather persistent upward pressure on repo rates as reserves fall, and so that likely suggests the 'optimal' level (of reserves) is somewhat higher than initially believed," said Ian Pollick, global head FICC strategy at CIBC Capital Markets.

Pollick sees settlement balances stabilizing near C$80 billion, which could occur around the summer. At RBC Dominion Securities Inc, the estimate for the steady-state level is higher still at about C$100 billion. It expects QT to end by March.

U.S. dealers expect the Federal Reserve to end QT at a later date, in the fourth quarter, but central bank reserves are a much bigger share of the U.S. economy, at about 14% of GDP.

Not all analysts expect above-target CORRA to impact QT but they agree that ending the program could see the BoC begin buying bonds at a rapid clip, with tens of billions of dollars of bonds due to roll off the central bank's balance sheet in the next couple of years.

The BoC's next policy decision is on March 6.

"If they are not open to adjusting QT, then they should explain their plans for the repo book in a more transparent fashion," Holt said. "It's a long path ahead in terms of repo injections if they keep relying upon that tool until the next meeting or the one after that."

($1 = 1.3459 Canadian dollars)

Source: Reuters

To stay updated on all economic events of today, please check out our Economic calendar

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Thomas

Political

French farmers are blocking roads across the country to demand government action to address numerous grievances, as protests in the European Union's agricultural sector spread.

Here are some of the issues that have prompted the growing protest movement and how the government could respond.

Why are farmers protesting?

Farmers in France, the EU's biggest agricultural producer, say they are not being paid enough and choked by excessive regulation on environmental protection.

Some of their concerns, like competition from cheaper imports and environmental rules, are shared by producers in the rest of the EU, while others such as food price negotiations are more specific to France.

Costs

Financially, farmers argue that a push by the government and retailers to bring down food inflation has left many producers unable to cover high costs for energy, fertiliser and transport.

A government plan to phase out a tax break for farmers on diesel fuel, as part of a wider energy transition policy, has also been a flashpoint, in an echo of tensions in Germany.

Imports

Large imports from Ukraine, for which the EU has waived quotas and duties since Russia's invasion, and renewed negotiations to conclude a trade deal between the EU and South American bloc Mercosur, have fanned discontent about unfair competition in sugar, grain and meat.

Large imports are resented for pressuring European prices while not meeting environmental standards imposed on EU farmers.

Environment, Red Tape

On the environment, farmers take issue both with EU subsidy rules, such as an incoming requirement to leave 4% of farmland fallow, and what they see as France's overcomplicated implementation of EU policy, such as in restoring hedges and arable land as natural habitat.

Green policies are seen as contradicting goals to become more self-sufficient in production of food and other essential goods in the light of Russia's invasion of Ukraine.

Rows over irrigation projects, as water resources become a focus in climate debate, and criticism about animal welfare and pollution in agriculture have heightened feelings among an ageing French farmer population as being disregarded by society.

What measures could the government take?

The government, under pressure to defuse the crisis ahead of European elections in June and the annual Paris farm show next month, has postponed draft legislation on attracting more recruits to farming to add other measures.

The government has promised to simplify procedures for farmers. That could mean reduced waiting times for subsidy payments or farm project approvals, or easing paperwork and audits on environmental compliance.

The government could drop its plan to phase out the diesel tax break, though it has already softened the measure by staggering the move over several years and offering to re-invest the funds in farming.

Some changes would need EU approval, such as changing the rule on fallow land, and farmers warn any concessions may come too late for this year's production plans.

As in previous farming crises, the government could offer emergency aid. It has already pledged funds for wine producers hit by falling consumption and farmers affected by floods in the north and a cattle disease in the south, but may announce more money and quicker payouts.

Source: Reuters

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FastBull Featured

Remarks of Officials

Bank of Canada Governor Tiff Macklem spoke at a press conference after the policy meeting on January 24th with the following key points: Inflation is falling but remains too high and underlying inflationary pressures remain as high interest rates dampen demand. As supply and demand in the economy gradually return to balance, the discussion of future policy is shifting from whether it is sufficiently restrictive to how long the current restrictive stance needs to be maintained.

For its part, Canada's economy has been stagnant since mid-2023, and growth is likely to be projected near zero in the first quarter of this year. Besides, inflation is expected to ease further due to weak demand. However, there are still some sectors that continue to support inflation, such as housing inflation (close to 7%) and food inflation (around 5%). Services inflation excluding housing has improved but there are signs that price pressures remain. These drivers of inflation imply that the decline in inflation is likely to be gradual and uneven, and suggest that upside risks to inflation remain.

Moreover, the economy is expected to perform weakly in the first half of the year before starting to pick up in the middle of the year and is expected to grow to 0.8% in 2024 and 2.4% in 2025.

Meanwhile, inflation is expected to remain near 3% in the first half of the year and fall back to around 2.5% by the end of the year, returning to the 2% policy target by 2025.

Further rate hikes are possible as well, and he may raise rates if new circumstances lead to higher inflation. If economic developments are broadly in line with the forecasts released today, he expects future discussions to focus on the length of time to keep the policy rate at 5%.

It's worth noting that the Bank of Canada has abandoned its previous policy statement that it is "prepared to raise the policy rate further if necessary." However, Governor Macklem went on to say in his speech that he would not rule out the possibility of a further rate hike. Obviously, this is to prevent the market from acting in advance, after all, the 'examples' of the ECB and the Fed are in front of us.

Macklem Speech

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Westpac

Economic

Central Bank

In Australia, the latest NAB business survey delivered another sombre update on the state of the domestic economy at the turn of the year – the "December" survey was in the field January 3-15. In an environment characterised by high inflation, elevated interest rates and weak consumer spending, business conditions declined a further 2pts to +7 as trading conditions slipped below average. Forward orders point to persistent weakness having contracted in seven of the past eight months. Business confidence meanwhile continues to oscillate at well below-average levels, currently –1.

As discussed in our analysis of the NAB survey, last week's December labour force survey reported that businesses reduced hours worked by 1.3% in the second half of 2023, on par with Australia's GFC experience. Conditions as measured by the NAB survey are likely to result in a further decline in hours and a throttling back of business investment. These outcomes are consistent with Westpac's expectation that Australian GDP growth will remain below trend throughout 2024.

On a more positive note, the NAB survey reported a continued easing in cost and price pressures through the final months of the year. Final product price inflation is now tracking at a 0.9%qtr pace according to the survey, the softest pace since February 2021. In line with these developments and a benign read for Q4 inflation in New Zealand, Westpac confirmed its forecast for next week's Australian Q4 CPI at 0.8%qtr/4.3%yr for headline inflation and 0.9%qtr/4.4%yr for the trimmed mean.

Continued progress with inflation in 2024 and soft economic momentum should allow the RBA to commence rate cuts in Q3 2024, with 125bps of rate cuts from Q3 2024 to Q3 2025 to leave the cash rate at 3.10% by end-2025. A return to trend GDP growth in 2025 remains our baseline expectation.

Offshore, central banks remained cautious on near-term risks, but showed increasing confidence in achieving their medium-term objectives.

The Bank of Japan maintained its policy stance in January. Updates to GDP growth for fiscal 2023 and 2024 were minimal, FY2023's slight downward revision offset by a modest upgrade to FY2024. Forecasts for core inflation (less fresh food and energy) were broadly the same as October, the BoJ still anticipating this measure of inflation will moderate to 1.9%yr by 2025. The BoJ also continue to expect inflation expectations to drift up and prompt stronger growth in wages and consequently consumption into the medium term. Risks to this view are most prominent near term. Results from the spring wage negotiations will be available through March/April and the BoJ's take presented in the March statement.

The Bank of Canada kept rates steady at its January meeting despite December's upside inflation surprise. Shelter inflation remains high and is expected to show further persistence, keeping CPI above the 3%yr top of the target range during H1 2024. In the accompanying press statement, Governor Tiff Macklem did not ‘rule out' further policy rate increases, with inflation expectations and persistence in wage growth risks to their sanguine baseline view. However, in the absence of an unexpected resurgence in inflation, in coming months discussion will focus on how much longer rates need to remain on hold. The revised forecasts were supportive of moderate policy easing from mid-to-late 2024. GDP is expected to remain weak in 2024 then return near trend in 2025. Inflation meanwhile is seen back at 2.0%yr in 2025.

In Europe, the ECB's Bank Lending Survey showed that demand for loans continued to decline across both households and firms in Q4 2023, the consequence of high inflation and interest rates as well as a decline in fixed asset investment. Expectations for Q1 2024 were constructive, with net demand expected to increase in Q1 2024 for the first time since 2022. However, banks remain very cautious on the outlook, risk perceptions seeing credit conditions become more restrictive in the quarter, and a further tightening anticipated in Q1 2024. 2023's rate hikes and their consequences are clearly still transmitting through the economy.

Coming back to China. Overnight, the PBoC announced a 50bp cut to banks' Reserve Requirement Ratio, freeing up lending capacity. This follows reports of support for the equity market via buying by large government-linked entities. The intent behind these measures is principally to buoy, or at least hold up, sentiment across the economy while the benefits of rapid growth in high-tech manufacturing permeate and the cost of structural reform in the property sector is worked through. Authorities are likely to continue their targeted approach to supporting the economy through 2024, assuming 2023's gains in manufacturing, infrastructure and trade continue.

Still to come offshore are the European Central Bank's January meeting and, in the US, Q4 GDP and December PCE data, with the inflation print the market's primary focus.

To stay updated on all economic events of today, please check out our Economic calendar

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FXOpen

Forex

Tomorrow marks a poignant day for those observing the European economy as the European Central Bank is scheduled to hold its first monetary policy meeting of this year.

The European Union's central bank has continued to maintain a conservative approach in recent months, rather similar to that of the Bank of England and the Federal Reserve; however, perhaps it could be suggested that the European Central Bank has been a bit less aggressive with its interest rate rises than those of the United Kingdom and the United States over the past two years.

Tomorrow's meeting is being widely anticipated by financial markets participants as the first European Central Bank meeting in which a pause or potential reduction in interest rates could be announced, along with possible timescales relating to any such reduction if such a move is on the table.

Just one day before the meeting takes place, it is clear that some analysts within investment banks and fund managers are considering that the deposit rate will remain at 4.0% within European Union member states, and the general consensus among market participants to hint toward reductions of approximately 50 basis points in June and more than 125 base points during the course of the latter part of 2024.

In this regard, all ears will be focused on tomorrow's meeting.

In terms of currency price movements in the advent of this important economic policy-related event concerning the second most important major currency in the world, there has been a degree of volatility during the early hours of trading today.

It is not necessarily clear as to what has caused this. However, the US dollar's strong position in the light of the stellar performances of the stocks of some major publicly-listed companies included in prestigious indices is one factor alluding to the favourable position of the US economy overall despite the inflation, high interest rates and bank demises that have made high profile news over the past two years.

Therefore, a good US position rather than a weak European position may be a factor. However, there are some industrial concerns relating to potential supply chain issues due to the geopolitical situation in the Red Sea, which has caused many firms to cancel cargo ship operations transporting items through that major shipping route.Indicative pricing only EUR/USD Displays Volatility in Advent of First ECB Meeting of 2024_1

EUR/USD Displays Volatility in Advent of First ECB Meeting of 2024_1

Today, the EURUSD pair began the morning in the European session by trading around the mid-1.08 range, which is quite a difference from the 1.11 mark that the pair traded on December 28. Moving into 2024, the EURUSD has been experiencing an overall downward direction. Therefore, tomorrow's monetary policy meeting may provide further insight and clarity on the euro's medium-term position.

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FastBull Featured

Daily News

[Quick Facts]

1. Qatar postponed to Europe to transport LNG due to the Red Sea crisis.

2. UK PMI data suppress rate cut expectations.

3. German business activity deteriorated in January. Manufacturing, services are shrinking.

4. Bank of Canada: interest rates unchanged, inflation outlook remains a concern.

5. U.S. economic growth in January was strong, inflationary pressures fell sharply.

[News Details]

Qatar postpones LNG shipments to Europe due to Red Sea crisis

Qatar, one of the world's largest exporters of LNG, is delaying some shipments to Europe because the Red Sea crisis is forcing longer transportation times. According to traders, Qatar has notified some European buyers of shipment delays and rescheduling. Since Jan 15th, Qatar has detoured at least six European-bound shipments to the Cape of Good Hope in southern Africa instead of the shorter route via the Red Sea and the Suez Canal, ship-tracking data show. Detouring through Africa to Europe adds about two weeks to the schedule, limiting the amount of time available for subsequent shipments.

To date, the gas market has been largely insulated from the disruptions of the Red Sea situation. European gas futures are near six-month lows due to high inventories, strong renewable energy output, subdued industrial demand, and ample supplies of alternative LNG.

UK PMI Data Dampens Rate Cut Expectations

Released on Wednesday, the UK January composite PMI rose to 52.5, the highest in seven months. Besides, the service PMI accelerated again, and ascended to 53.8, an eight-month high, further showing signs of a moderate recovery in the weak economy. In addition, factories are currently being affected by the Red Sea situation, and the manufacturing sector continues to shrink. However, its magnitude has slowed down, and the manufacturing PMI grew from 46.2 to 47.3, the closest level to 50 since last April.

The situation presented by this data is not optimistic. Because of the Red Sea crisis, many cargo ships are detoured to the Cape of Good Hope, so supply delays are exacerbated. The longer the voyage time, the higher the cost of factories, which may result in a rebound in inflation for the manufacturing sector. Furthermore, the service sector price pressures are still high and ultimately may lead to a postponement in rate cuts by the Bank of England.

German Business Activity Deteriorated in January, with Manufacturing and Services Contracting

German PMI data released on Wednesday indicated that the composite PMI (47.1) hit a 3-month low, and the services PMI (47.6) hit a 5-month low, while manufacturing PMI (45.4) hit an 11-month high, all below the breakeven level.

Obviously, the German private sector conditions did not improve in 2024, but continue to slump. Business activity has declined in January for the seventh consecutive month, meaning that the signs of general weakness in demand still exist. In addition, inflationary pressures in the service sector remain high, with activity in the service sector not only declining for the fourth consecutive month, but also accelerating. Meanwhile, the manufacturing sector has also been affected by the Red Sea crisis, and although the degree of weakness has eased, it is still in recession for the nineteenth consecutive month. All indications are that German economic growth is weak.

Bank of Canada: Keep Interest Rates Unchanged, Still Concerned about the Inflation Outlook

On January 24th, the Bank of Canada announced to keep the benchmark interest rate unchanged at the current level of 5%. It is the four consecutive times in the policy meeting to keep interest rates unchanged since last July.

The Monetary Policy Report shows that the Canadian economy has been stagnant since mid-2023, and economic growth in the first quarter of 2024 could be close to zero.

The economy is expected to start growing in the middle of this year and is expected to grow by 0.8% in 2024 and by 2.4% in 2025. Inflation is expected to fall to 3% in the first half of this year, down from 3.4% at the end of last year, and then gradually slow down to return to the target of 2% by 2025.

It's worth noting that the Bank of Canada has given up its previous policy statement that it is "prepared to raise the policy rate further if necessary." However, McCollum said in a later briefing that the Bank of Canada did not rule out the possibility of further rate hikes.

McCollum said the discussion of monetary policy is shifting from whether the policy rate is sufficient to restore price stability to how long they need to maintain the current rate. If new circumstances lead to higher inflation, they may still need to raise rates. If economic developments are broadly in line with the forecasts we released today, he expected future discussions to focus on how long they will keep the policy rate at 5%.

Rising housing and food prices have kept inflation high, and wages are still growing between 4% and 5%. Further declines in inflation are likely to be gradual and uneven, and the Bank of Canada is concerned about the persistence of underlying inflation.

U.S. Economy Grows Significantly in January, and Inflationary Pressures Falls Sharply

From the PMI data, the U.S. economy starts in a satisfying direction in January with business growth accelerating markedly, while inflationary pressures cool sharply. Output of both goods and services has grown at the fastest pace since June last year, with improved demand conditions adding to the growth momentum. New order inflows have now picked up for three consecutive months, helping to boost business confidence for the year ahead to the most optimistic level since May 2022. Selling price inflation is below the pre-pandemic average as prices rose in January at the slowest pace since the outbreak embargo in early 2020. With supply delays intensifying and the labor market remaining tight, cost pressures will need to be watched closely in the months ahead, but for now, the survey sends a clear and welcome message that growth is resilient and inflation has weakened sharply.