Friday, March 13, 2020

Week Ahead: What Will the Fed Do Next?

NBHM Research Team

It was another dramatic week in the financial market. Global stocks, as measured by the MSCI World Index declined by 20% while the price of gold declined by more than 6%. Meanwhile, the price of crude oil dropped by more than 30% while the CBOE volatility index jumped by more than 90%. The reason is that market participants expect a recession this year as activities in most developed countries slow. A ten-minute speech by Donald Trump backfired after he cancelled European flights to the US. Other actions by the Federal Reserve and the European Central Bank (ECB) failed to convince the market.

Gold: Gold is often viewed as a safe-haven commodity. The conventional thinking is that its price will always rise when volatility increases. This did not happen this week as the price of gold had its worst week since 2013 while volatility rose to a multi-year high. The reason for this is that investors believe that central banks have started to sell some of their gold holdings to implement rescue measures. Another thought process is that there is simply minimal demand for physical gold. In the coming week, we will be paying attention to the Federal Reserve, which is expected to release its interest rates decision on Wednesday.

S&P500: The S&P500 declined by more than 17% this week as the rout in stocks escalated. The index fell into bear territory on Thursday, which happens when an index falls by 20% from its highest point. Most companies in the S&P500 have fallen by more than 20% this year. Apple and Microsoft, which helped the index notch a 30% gain last year have declined by 19% and 18% in the past five days alone. In the coming week, wild swings in the index will likely continue as participants start pricing-in a deeper recession. In the coming week, the February manufacturing and industrial production data from China will likely move the S&P500. Weaker numbers could take the index deeper into negative territory while better-than-expected numbers will likely take it higher.

US dollar: The US dollar index rose by about 1.5% this week as investors moved to the USD for safety. The Federal Reserve continued to insist it will support the market as much as possible. The bank implemented some actions to confirm this. On Thursday, the New York Fed injected $1.5 trillion into the financial market. This move was reminiscent of the quantitative easing when the Fed purchased trillions of dollars’ worth of assets. In the coming week, the Fed will meet for its monthly meeting and possibly cut interest rates for the second time in a month. Also, the US federal government could unveil a fiscal stimulus package to cushion American workers and companies.

Crude oil: The price of crude oil is between a rock and a hard place. On Monday, the price of Brent and WTI benchmarks fell by more than 30%. This happened after Russia rejected OPEC’s proposals to slash production to cushion the market. Russia is said to have been worried about the growing market share of American shale producers. In response, Saudi Arabia slashed oil prices by 10% and announced that it would increase production to 12.3 million barrels a day. Russia responded by saying that it too would increase daily production by 300k barrels. Therefore, the world will likely be flooded with crude oil. On the other hand, demand is expected to slow down because of the disease. In most developed countries, most people are staying indoors while many airlines have cancelled flights. Therefore, unless any major news arises, the price of crude oil could continue declining.

Euro: The euro declined slightly this week as traders worried about the impact of the coronavirus. Italy, which has been the hardest-hit country in the region, quarantined most of the country in an unprecedented move. Meanwhile, the region received bad news from the United States after Trump banned flights from the region. This will impact both American and European airlines, which carry more than 75 million every year. In response, ECB’s Christine Lagarde called for EU’s governments to implement wide fiscal stimulus, which will help cushion the economy. On her part, the ECB president left interest rates unchanged and announced several remedial measures. For example, the ECB will effectively pay banks to lend money to companies and customers. It will also increase the size of asset purchases to make capital cheaper. In the coming week, we will receive inflation and employment data from the region.

Japanese yen: The Japanese yen is often viewed as a safe haven currency because of the large holdings Japan has overseas. However, the currency did not perform well this week as it fell by more than 50 basis points against the US dollar. This is partly because the situation in Japan has continued to worsen. The number of infections has risen to more than 600, and the number of deaths has increased. Recent data showed that the country is currently in a recession that may be difficult to get out of. In the coming week, we will receive the interest rates decision from the BOJ, trade numbers, and industrial production numbers.

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