Markets Trade in ‘Risk Off’ Manner, BoE Downgrades Growth Projections

Markets traded in a risk-off mode yesterday, with risk-linked currencies and equities coming under selling pressure, and safe havens strengthening. The first hit came after the European Commission downgraded Eurozone’s growth projections, while the second was news that US President Trump and China’s Xi Jinping are unlikely to meet before March 1st. In the UK, the BoE kept interest rates on hold and downgraded its growth projections. The pound slid initially, but was quick to recover and trade even higher, perhaps as officials kept the prospect of hiking on the table, even in case of a no-deal Brexit.

Risk Assets Slide, Safe Havens Gain on Growth and Trade Concerns

The dollar continued to drift north against most of the other G10 currencies, for the sixth straight day. It gained the most against NOK, SEK, CAD, and AUD in that order, while it slightly underperformed against JPY and GBP. The greenback traded virtually unchanged against CHF and NZD.

The strengthening of the safe havens and the weakening of the commodity-linked currencies suggest a risk-off trading activity. The exception was NZD, which strengthened instead of weakening. Perhaps this was due to some short-covering following the steep slide on New Zealand’s jobs data during the Asian morning Thursday. In any case, the performance in the equity sphere confirms investors’ fragile morale. Major EU and US indices were a sea of red yesterday, with the negative sentiment rolling into Asia. Japan’s Nikkei fell 2.01%, while Hong Kong’s Hang Seng slid 0.16%. Remember that Chinese markets are closed this week in celebration of the Lunar New Year.

Risk sentiment took the first hit during the European morning after the European Commission downgraded notably Eurozone’s GDP projections for 2019 and 2020, noting that China’s economic slowdown and the uncertainty surrounding the US-China trade relationship are weighing on the near-term outlook. The euro also felt the heat of the news, as this may have prompted investors to add to bets that the ECB may not push the hiking button this year.

The second hit came during the US session. White House economic adviser Larry Kudlow said that there is still a “sizable distance” before a final trade deal with China can be sealed, while a report citing a senior administration official noted that US President Trump and his Chinese counterpart Xi Jinping are unlikely to meet before March 1st, which is the deadline set for the two nations to reach common ground. The report was confirmed by the President later in the day.

Following the positive remarks after the latest negotiations that Trump will meet with Xi to finalize a deal, as well as news that US Treasury Secretary Steven Mnuchin will travel to China next week for another round of talks, investors took the risk-on road on expectations that the two nations are closer to a final deal than ever. There were also reports suggesting that the two leaders will meet at the end of February in Vietnam. However, yesterday’s news hurt those expectations, with market participants abandoning riskier assets and seeking the shelter of safe-havens. Now, focus turns to next week’s round of talks. Once again, we don’t expect a final deal. We believe that if this happens, it will be at a meeting between Trump and Xi. We may get another set of “substantial progress” remarks, but the big question is whether markets will believe them again or shrug them off.

As if all this was not enough for the Aussie, which has been also suffering due to RBA Governor’s remarks with regards to a rate cut, it tumbled further overnight after the release of the RBA’s quarterly Statement on Monetary Policy, where the Bank slashed its GDP and inflation forecasts. In the report, it was also noted that financial market prices suggest that interest rates are likely to stay unchanged over the months ahead, with some expectation of a decrease by the end of this year.

DAX — Technical Outlook

The German-top-30-company index took a strong hit yesterday, breaking below its short-term upside support line drawn from the low of January 7th, which drove the price towards the psychological 11000 support zone, where it got held. Although this has turned the near-term outlook to the downside, given that the index already experienced a sharp drop, we may see a bit of correction to the upside before another leg of selling.

A small correction back up might test the 11045 resistance zone, or even slightly above that, the 11095 barrier, which if proven to be too difficult for the bulls to overcome, its break may drag the price back down towards the 11000 hurdle. A break of that hurdle could set the stage for a possible test of the 10945 support area, or even the 10850 level, marked by one of the good support areas seen on January 17th.

In order to start examining the upside again, we would need to see a push back above the previously-mentioned upside line. This way we may target the areas around which the index was seen yesterday, the first one being the 11245 obstacle. A break above that could set the stage for a further move higher towards the 11290 hurdle, marked by yesterday’s intraday swing high. If the recovery is strong and we see the price accelerating further, then DAX could even travel towards this week’s high, at 11390.

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BoE Stays on Hold, Downgrades Growth Forecasts

Yesterday, the big event for GBP-traders was the BoE policy decision, which was accompanied by the quarterly Inflation Report and a press conference by Governor Carney. As was widely anticipated, the Bank decided unanimously to keep policy unchanged, while in the accompanying statement officials reiterated that an ongoing tightening at a gradual pace and to a limited extent would be appropriate.

In line with our expectations, the Bank remained concerned with regards to Brexit, noting in the minutes that key parts of the process had remained unresolved and that uncertainty had intensified. They also maintained the view that whatever form Brexit takes, the monetary policy response could be in either direction. With regards to the Inflation Report, officials downgraded by a large margin their GDP forecast for 2019 and 2020, while they revised somewhat lower their CPI estimate for the end of this year.

Initially, the pound slid due to the Bank’s downgraded projections, but was quick to rebound and trade even higher during Governor Carney’s press conference. Although the Governor highlighted the uncertainty surrounding Brexit, noting that the probability for a no-deal outcome has increased recently, he also said that there is upside risk for the UK economy if a Brexit deal is agreed soon. Alongside the fact that the Bank kept the prospect of hiking on the table, even in case of a disorderly withdrawal, the aforementioned upside-risk remarks may have encouraged investors to buy some pounds.

The British currency could gain somewhat further on the view that, in case of an orderly Brexit, the BoE may proceed with raising rates sooner, at a time when other Banks are signaling patience or even discussing the likelihood of a rate cut. That said, we expect such gains to stay short-lived. With the clock ticking towards March 29th, the official Brexit divorce date, and still no concrete plans on how to avert a disorderly withdrawal, we find it hard to imagine yesterday’s recovery leading into a healthy uptrend. Until we have material evidence that a no-deal outcome could be averted, we see a decent likelihood for the pound to turn south again.

GBP/JPY — Technical Outlook

It all looked like it may be smooth sailing south for GBP/JPY in the first half of the European trading session yesterday, but all changed after BoE’s press conference, as the British pound got a boost and travelled higher. That said, the yen was the only currency that managed to hold the pound down, not allowing the British currency to get the upper hand. But today, the GBP/JPY-bulls might attempt to have another go at lifting the pair and pushing it towards the short-term downside line, taken from the high of January 25th. In our view, Brexit uncertainty could still weigh further on the pound, hence why the overall downside idea is still in play.

At the time of this analysis, GBP/JPY is balancing around the 142.10 level and slightly above the 200 EMA, which may be seen as a positive for now. If the pair makes another run higher and breaks above yesterday’s high, at 142.63, this could open the door to a possible re-test of the aforementioned short-term downside line, which if continues to hold the rate down may be a good sign for the bears to step in again and drive GBP/JPY back down. This is when we will aim for the same 142.63 hurdle, a break of which could set the stage for another test of the 142.10 level. If that zone fails to stop the selling activity, the slide may be extended towards yesterday’s low, at around 141.13.

Alternatively, a break of the previously-mentioned downside line and a push above the 144.17 obstacle could invite more buyers to the table and the rate might get lifted towards the 144.80 barrier, marked by the high of January 25th. If the buying activity doesn’t stop there, the pair could continue its path north, where the next potential resistance zone to watch out for could be at 145.90, marked by the high of November 28th.

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As for Today’s Events

The only data set worth mentioning is Canada’s employment report for January. The forecasts suggest that the unemployment rate ticked up to 5.7% from 5.6%, while the net change in employment is forecast to have slowed to 8.0k from 9.3k. When they last met, BoC policymakers kept the door open for further rate increases and noted that growth has been running close to its potential rate. However, last week, data showed that economic activity contracted in November, dragging the yoy rate down to +1.7% from +2.2%. Thus, coming on top of that release, a weak employment report may raise doubts as to whether the BoC could indeed maintain its upbeat view with regards to future rate increases.

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