Investors expect the Federal Reserve to cut interest rates twice by September. Market sentiment is still negative, but the dollar is not appreciating, which protects the zloty against a more significant depreciation. The EUR/PLN exchange rate exceeds 4.31 PLN, rising to its highest level since December 2.
The market awaits two cuts in interest rates
The quotations on the foreign exchange market were quite calm on Wednesday. The EUR/USD exchange rate remained at the level from yesterday's closing, i.e. around 1.0880. The market was dominated by a negative sentiment caused by reports on the spread of coronavirus. Therefore, there is an increased demand for so-called safe havens, including the yen, the franc or gold.
The dollar, in turn, although also classified as a safe haven, is still relatively weakened due to persistently low levels of US Treasury bond yields. The yields maturing in 2-year bonds fell this morning to 1.1548%, the lowest level in three years. Yesterday, on the other hand, the yields of 10-year bonds fell to 1.3055 percent, i.e. to the lowest level in history. Today in the morning, along with strong drops on the equity markets, they fell again to about 1.31 percent, although just in the afternoon there was a return to about 1.38 percent. However, these are still levels close to historical lows. Deterioration of sentiment may lead to further declines.
How sharp the falls have been due to the deterioration in sentiment is perfectly clear when we look at profitability levels from a week ago. At that time, they reached even 1.58%. Such a strong fall in such a short period of time (including bonds maturing on other dates) contributed to a significant increase in market expectations for interest rate cuts in the USA. This may prevent the dollar from further rapid appreciation. Only a week ago, the market valued (based on Fed rate contracts) one cut until the September meeting, while today it is already valuing two. If the Federal Reserve (Fed) does not make at least one cut, the weakening of the dollar may turn around, and the US currency may appreciate again.
Except for the situation around the coronavirus, the Fed strongly signalled a freeze in interest rates. The issue that the central bank in the US must consider is whether the virus will have such a significant negative impact on the global economy in order to justify a rate cut. If the Fed decided on such a move, it would not end with one cut, but most likely with two (by a total of 50 basis points). As a reminder: the condition of the US economy did not justify three interest rate cuts, which were much more dictated by external factors, especially the trade war with China, concerns about the global economic slowdown and Brexit.
The coming weeks and months will show - in the form of macroeconomic data - whether the impact of the coronavirus is significant enough to justify a renewed interest rate cut. Until then, on the one hand, the low level of US Treasury bond yields will keep supply pressure on the dollar, and on the other hand, weak market sentiment should protect the dollar from depreciation. As a result, fluctuations may be limited until the impact of the coronavirus on the global economy is known.
Euro the most expensive since December 2
Lack of a strong appreciation of the dollar protects the zloty against a greater depreciation with a currently increased aversion to more risky assets. The zloty remains weakened along with other emerging currencies. The EUR/PLN exchange rate rose today to approx. 4.3155, the highest level since December 2. Although the USD/PLN exchange rate did not reach new highs, it moves just below 3.97, which means that we are still within the upper limit since October. Currently, there is no sign of dollar appreciation, but when the US currency starts to gain in value, the supply pressure on the zloty may increase.