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Chinese Relief Efforts Boost Sentiment 

An escalation in Chinese stimulus efforts is helping boost global asset prices this morning, driving equity indices, commodity prices, and risk-sensitive currencies higher ahead of the North American open. The greenback is weaker, Treasury yields are slipping, and oil prices are holding steady in still-oversupplied markets.

In an unexpected step, the People’s Bank of China announced it would lower the amount of reserves banks need to hold against their deposits for the third time in a year, potentially unlocking roughly 1 trillion yuan in new lending capacity. The move, which comes after a raft of securities purchases by China’s “national team” of state-owned enterprises and securities firms, was paired with a commitment to lowering interest rates for small and rural businesses.

Signalling effects could exceed any fundamental impact, with the government’s increasingly frantic moves to support financial markets helping set the stage for deeper structural changes. But borrowing capacity isn’t the primary constraint facing the Chinese economy – domestic and foreign demand is. We suspect that authorities remain committed to defusing the country’s “debt bomb,” with efforts to unwind vast exposures among property developers, corporations, and local governments meaning that a 2008-style stimulus effort simply isn’t coming.

The pound is trading on a dramatically-stronger footing after the latest purchasing manager survey showed services-sector activity rising to an eight-month high in January while factories turned in the best performance in nine months. The headline print rose to a seven-month peak, helping lift first-quarter gross domestic product expectations into positive territory and lowering the odds on an aggressive easing cycle from the Bank of England. Markets now expect policymakers to deliver less than 100 basis points in rate cuts this year, down from 130 a week ago, and 150 in December.

In contrast, European activity remains firmly in contractionary territory, keeping the common currency rangebound between the 200-day moving average near 1.0925 and the 50-day, at 1.0850. Both the manufacturing and services sectors are mired in a slowdown, with the euro-area composite index sitting at 47.9, slightly below market forecasts set at 48, and well below the 50 level that would signal expansion. Officials at the European Central Bank are expected to look through this weakness in tomorrow’s decision, punting a decision to cut rates out to the June meeting as they seek to avoid an inflationary policy misstep.

The Bank of Canada is widely expected to stay on hold for a fourth consecutive time today, with markets prepared to examine nuances in the statement, Monetary Policy Report, and press conference for guidance on next steps. Policymakers are facing a difficult communications challenge: they know that the economy is facing near-recessionary conditions, but also want to avoid repeating last year’s mistake – triggering a sharp rise in home prices and aggregate demand by encouraging a further easing in financial conditions – so are likely to maintain a hawkish bias throughout.

We‘re no longer seeing evidence of a big disconnect between markets and officials. With inflation, wage pressures, and consumer demand showing signs of accelerating into year end, market participants have pulled back on monetary easing bets since the December meeting. Overnight index swap-implied odds now favour a move in June, followed by at least two more before year end – a trajectory that, to us, looks relatively reasonable.

Implied change in Bank of Canada policy rate by meeting, %


Still Ahead

THURSDAY

No one expects the European Central Bank to adjust policy at this week’s meeting, but markets will nonetheless pay rapt attention to Christine Lagarde’s comments during the post-decision press conference. We think Chief Economist Philip Lane’s comments in last week’s Corriere della Sera interview are fairly representative of the underlying message she will want to deliver, with the first rate cut most likely to land in June – defying market conviction in a March rate cut. Euro area inflation could prove stickier than expected in coming months, but the economy has suffered a rapid deterioration in recent months, suggesting that current policy settings are too tight. (08:15 EDT)

The US economy probably decelerated in the fourth quarter of 2023, expanding a little less than 2 percent after growing 4.9 percent in the prior three-month period. Strong consumer spending likely offset inventory drawdowns and more cautious investment from businesses in the quarter, nudging the full-year growth rate close to the 2.8-percent mark. The handoff into the first quarter of this year looks quite uncertain, with many underlying fundamentals pointing to a softening in consumer demand, even as survey data and the housing market support the case for a rebound. (08:30 EDT)

FRIDAY

The Federal Reserve’s favourite inflation indicator – the core personal consumption expenditures index – is believed to have accelerated slightly on a month-over-month basis in December, up 0.2 percent from the prior month. Fed chair Jerome Powell’s favoured “supercore” measure – core services excluding rents – should come in under the 2-percent threshold on a three-month annualized basis, suggesting that the central bank has largely achieved its inflation mandate, and helping set the stage for an easing in policy settings in the coming months. Consumer spending, partly driven by rising incomes and falling energy prices, but also boosted by easing financial conditions, likely grew more quickly, with total outlays rising 0.5 percent on a month-over-month basis. (08:30 EDT)

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