Europe ahead of interest rate cuts (Daily analysis 4.03.2020)

A 50-basis-point rate cut is not enough for the market. Another similar cut is currently being priced in two weeks' time. The difference between US and German profitability is the lowest since 2016. The zloty is strengthening against the euro, but the further growth path is uncertain.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

• 2:15 p.m.: Change in employment in the non-farm sector in the USA in February according to ADP (estimates: +170k).

US bond yields are dropping

Currently, the market's attention is still put on yesterday's event. The Federal Reserve cut interest rates by 50 basis points yesterday before its meeting on March 17-18. This is the first such move by the Fed since the financial crisis just over a decade ago. The move is likely to trigger a reaction from other central banks. The European Central Bank (ECB) will almost certainly do the same. Recent reports indicate that its head Christine Lagarde may be willing to grant short-term loans.

The 50 bps interest rate cut was priced by the market, but nevertheless triggered a further downward trend in the US Treasury bond yields. The cost of 10-year debt fell below 1%, to around 0.9043% yesterday afternoon, and today it oscillated around 0.95%. These are the lowest levels in history, and the current decreases may be even deeper. After a 50-basis-point cut, the market is valuing (on the basis of Fed rate futures contracts) another analogous cut already during the upcoming Monetary Committee meeting.

An important aspect of the observed decline in US Treasury bond yields is that the pace is faster than for their European counterparts. The spread between the 2- and 10-year cost of US and German debt has narrowed to the lowest level since 2016 (October and July respectively). In the same period, the EUR/USD quotations moved within a similar range as we observe today (around 1.1140 at midday).

The Fed has still room for further interest rate cuts as one of the few central banks of the largest economies. Further cuts could weaken the dollar somewhat. On the other hand, however, it is likely that the monetary stimulation will be observed in the case of the other central banks, and in the following months, the uncertainty as to the impact of the coronavirus on the economy will not pass. As a result, the dollar seems to have limited scope for further losses, especially as the US economy is still in good condition (especially in relation to other developed economies).

Although central bank activities are now the main element around which market participants' attention is focused, by midday some macroeconomic data from the eurozone came. The final PMI data of the services sector in the eurozone in February turned out to be slightly lower than the preliminary ones (52.6 vs 52.8 points). This was mainly due to the ultimately lower activity in German services (52.5 vs 53.3 points). Retail sales data in January in both Germany and the eurozone turned out to be slightly better than expectations (0.3 and 0.6 percentage points above year-on-year expectations respectively). The data for December were also revised upward. However, their impact on quotations is minimal. The following months will be important for the market, but the data from the beginning of the year may provide a reference point. Even before the coronavirus epidemic appeared, the state of European economies, especially industry, was widely expected to improve. Data from recent months indicate that the economies were in a relatively good place at the beginning of the year.

Will the Polish MPC copy the Federal Reserve moves?

The Federal Reserve's emergency rate cut has strengthened some of the emerging currencies, including the zloty. The EUR/PLN exchange rate fell below 4.30 yesterday, while today it exceeded 4.29 in the morning. The USD/PLN quotations, after falling to approx. 3.8360, i.e. the lowest level in over a month, stabilised in the range of 3.85-3.86. In the context of interest rate changes, the Polish Monetary Policy Council and, perceived as a supporter of a mild monetary policy, its chairman, Adam Glapinski, have strong arguments for interest rate cuts.

Even before the first reports about the coronavirus appeared, the most probable next MPC move in either direction (except for the base scenario no change) was an interest rate cut. Strong rate cuts in the USA and most likely the upcoming stimulation from the ECB may also prompt the MPC to cut rates in the near future, although not as radical (as the Fed), due to relatively high inflation levels. This could weaken the zloty in the coming months. This trend could be reinforced by the likely return of weaker sentiment in the markets and the potential recovery of the dollar.