28-Apr-2020

1) Zero Interest Rates: Japan and the Policy Trap
2) The GBP/USD Pair Gained Some Follow-Through Traction
3) EUR/USD Rebounds, But No Strong Momentum Yet

1) Zero Interest Rates: Japan and the Policy Trap

The La Brea Tar Pits in Los Angeles are famous for interring thousands of ice age animals from huge mammoths, dire wolves and saber toothed tigers to tiny shrews and ancient insects. A peculiarity of the asphalt and sandy clay that trapped prey and predators alike was that many of the creatures were frozen intact, their skeletons perfectly preserved in the pose in which they died.

Central bankers are hardly an impartial natural phenomena but the image of the stolidly upright mega fauna of the Pleistocene sinking to their doom, is an apt one for the zero interest rate policies that are threatening to inflict the same taxidermy on developed industrial economies, petrifying their life while leaving the structure seemingly intact.

None of the three major central banks, the Bank of Japan, the European Central Bank and the Federal Reserve, that have used very low or negative rates to promote economic growth has had appreciable success with their monetary policy innovations yet they continue to turn to the rate tool in every threatening situation.

Japan is the first place for an interested central banker to look for the economic efficiency of very low interest rates. The Bank of Japan has been following what has been effectively a zero rate policy for more than two decades. In September 1995 the BOJ reduced the overnight call rate to 0.5%.  It has not been above that level in the following 25 years.

Japan has had an outright negative interest rate for four years. The overnight call rate was reduced from 0.1% to -0.1% in February 2016. It has not moved since.

But Japan is rarely mentioned in the west or by central bankers as an example for the simple reason that negative rates have been resounding failure for the world’s third largest economy in the years when it gave up second place to China.

Japan’s growth rate over the last twenty years has varied substantially.  Her four quarter average went from 3.2% in 2000 and 2004 to -8.4% in the financial crash.

Since the BOJ overnight call rate has been at 0.1% (December 2008-February 2016) and -0.1% (February 2016-present) the four quarter GDP average for Japan has moved from 5.5% in the third quarter of 2010 to -1% nine months later, then 3% and -0.25% in 2012, 3.15% a year later, followed by -0.775% in 2014, then 2.125% in 2015, 0.2% in 2016, 2.575% in 2017, -0.35% in 2018, and 1.75% and -0.625% last year.

Since 2000 there have been four recessions. Three quarters in 2001, four in 2008-2009, three in 2010-2011 and two in 2015.

What there has not been is any prolonged period of rising GDP or any discernible correlation between growth and interest rates.  The economy expands and contracts, slips in and out of recession and behaves as if interest rates and the cost of money have been removed from economic consideration.

2) The GBP/USD Pair Gained Some Follow-Through Traction

The UK Prime Minister Boris Johnson – having survived from coronavirus – returned to the office on Monday and boosted sentiment surrounding the British pound. The GBP/USD pair gained some follow-through traction for the fourth consecutive session and climbed to one-week tops. The uptick was further supported by some intraday US dollar selling bias, weighed down by the latest optimism over the gradual re-opening of the economies globally. The pair maintained its bid tone after UK PM Johnson said that the first phase of the virus outbreak might be peaking, albeit highlighted the risk of a second spike in infections.

Meanwhile, a strong pickup in the US Treasury bond yields and persistent worries over the economic fallout from the coronavirus pandemic extended some support to the greenback’s status as the global reserve currency. Adding to this, a fresh leg down in crude oil prices – amid concerns about oversupply and a lack of storage space – forced investors to remain cautious and helped limit any meaningful USD fall. This eventually kept a lid on any runaway rally for the major, which struggled to capitalize on its intraday positive move beyond mid-1.2400s and witnessed a modest pullback during the Asian session on Tuesday.

Despite a modest slide, the pair has managed to hold its neck above the 1.2400 mark. Hence, it will be prudent to wait for some strong follow-through selling before confirming that the recent recovery might have already run out of the steam and positioning for the resumption of the prior depreciating move. Against the backdrop of increasing prospects of an extended lockdown in the UK, resurfacing concerns about hard-Brexit might undermine the sterling and exert some downward pressure amid absent relevant market moving economic releases from the UK.

Later during the early North-American session, the release of the Conference Board’s Consumer Confidence Index might influence the USD price dynamics. Apart from this, fresh developments surrounding the coronavirus saga and Brexit-related headlines might further contribute towards producing some meaningful trading opportunities.

From a technical perspective, the pair started retreating from the 50% Fibonacci level of the 1.2648-1.2247 recent downfall. Above the mentioned hurdle, the pair is likely to aim towards reclaiming the key 1.2500 psychological mark, which marks an important confluence hurdle comprising of 61.8% Fibo. level and a near one-week-old ascending trend-line. Some follow-through buying might be seen as a fresh trigger for bullish traders and set the stage for a move towards the 1.2600 round-figure mark en-route monthly tops, around the 1.2645-50 regions.

On the flip side, the 1.2400 confluence region might continue to protect the immediate downside. The mentioned support comprises of 200-hour SMA and 38.2% Fibo. level, which if broken might accelerate the slide further towards the 1.2340-35 horizontal support. A sustained break below might now turn the pair vulnerable to head back towards challenging the 1.2300 round-figure mark. A subsequent fall below the 1.2280-75 area would pave the way for a further near-term depreciating move, possibly towards the 1.2200 mark. The pair might eventually drop to test monthly lows support, around the 1.2165 region.

3) EUR/USD Rebounds, But No Strong Momentum Yet

Yesterday, a positive risk sentiment triggered a modest USD correction, but the major cross rates still traded in well-known territory. The trade-weighted dollar (DXY) slipped temporarily below 100, but closed at 100.04. EUR/USD tested the 1.0860 area. Aside from USD softness the euro maybe profited from the mild assessment of S&P of the Italian credit rating and the subsequent intra-EMU spread narrowing. Even so, no key technical levels were broken (close at 1.0829). The yen didn’t weaken despite further BoJ easing. USD/JPY finished the day at 107.25.

This morning, Asian equites are supported by yesterday’s rise on WS, but US futures are losing some momentum. Oil resuming its downtrend is a lingering source of uncertainty. The TW dollar regains a few ticks (100.15). EUR/USD hovers in the 1.0820/25 area. The yen preservers most of yesterday’s gain (107.25). EUR/JPY still struggles not to fall below the 116 area. The Aussie dollar remains well bid (0.6450 area). A gradual easing of the lockdown and (hope on) fiscal stimulus apparently outweigh downside pressure in some commodity markets.

Today US consumer confidence (conf. board) and the Richmond Fed manufacturing index are expected to show unprecedented declines. We also keep a close eye at the (US) earnings season as several bellwethers will report earnings. We especially look out for their assessment on impact of the corona crisis. This might be important for the equity markets and for global sentiment. Over the previous days, markets held a rather positive bias. Will corporate earnings lead to some more caution? If so, the dollar might remain well bid even as we don’t expect a return to the peak levels of March (DXY 103). EUR/USD dropped temporarily below 1.0770, but it didn’t trigger further follow-through losses. We keep the view that the overall level of uncertainty remains too high for investors to already substantially reduce their USD buffers. EUR/USD consolidation in the 1.0730/1.10 range might be on the cards. For today, risk might be skewed to the downside.

Sterling trades with a slightly positive bias due to the global risk-on. EUR/GBP closed at 0.8712. Today, the CBI retail data will be published. Regarding the exit of the corona measures, the UK isn’t a frontrunner. This might cap further sterling gains, especially if global sentiment would turn more cautious. We see the 0.8680/0.87 area as important support.