Positive sentiment on the market, but is it justified? (Daily analysis 3.03.2020)

The market has high hopes connected with the teleconference of the G7 member states. Strong growths on the markets improve sentiment and also support the zloty. The EUR/PLN exchange rate is below 4.31. If it turns out that the optimism is slightly exaggerated, it may result in, among others, the weaker zloty.

Waiting for an interest rate cut in the USA

Positive sentiment dominates on the broader market this Tuesday. This is not linked to a halt in the coronavirus spread for the time being, but hopes for more stimulation from central banks and governments. Yesterday afternoon, a group of countries associated with the G7 published a statement about a meeting planned for this day at around 7:00 a.m. Washington time (in Poland it will be at 1:00 p.m.) on the coordinated action of governments and central banks in response to the economic threat posed by the coronavirus.

If we add to this the messages from the Federal Reserve and the European Central Bank stating that they will react accordingly to the developing situation, there is a clear decline in risk aversion. The announcement after the G7 conference call can probably still be expected today. Market expectations are now very high, as demonstrated by yesterday's 4-5% growth in the US market or today's 2-3% growth in the markets in Europe.

The absence of clear actions, and only assurance of coordinated cooperation in the event of a significant deterioration in the situation, can lead to a return to a higher level of risk aversion. The G7's actions may calm the financial market in the short term, but the impact of the fall in activity in the world's largest economies will start to appear in the macroeconomic data and the performance of companies in the following months. This should hamper a significant increase in optimism, at least in the first half of the year.

The US Treasury bond market continues to demand interest rate cuts from the Federal Reserve. The yields of the bonds maturing in two years, although they have moved away from yesterday's lows of about 0.7% (the lowest level since August 2016), still remain below the 1% boundary, today at midday it was around 0.86%. The Federal Reserve's monetary committee is scheduled to meet on March 18, although an earlier cut cannot be ruled out at an extraordinary meeting.

The market is currently pricing a cut of 50 basis points, which also puts supply pressure on the dollar. Today, however, there is a slight rebound from this strong fall in the dollar. The EUR/USD quotations fell to 1.11 around midday, and further depreciation of the dollar may be difficult to achieve for the market after an initial quick discount of a potential interest rate cut. A week and a half ago, we still observed levels below 1.08.

Zloty benefits today but can become a victim of the market disappointment

Improved market sentiment resulting in reduced risk aversion helped the zloty. The EUR/PLN exchange rate fell slightly below 4.31 at midday, i.e. to the lowest level since last Thursday, and the USD/PLN exchange rate was about 3.87, being close to the bottom line since February 6. However, the relatively good condition of the zloty is currently the result of increased market hopes for a coordinated fiscal and monetary policy, as well as the weaker dollar. However, this coordinated action may not happen as quickly or on such a scale as the market is currently pricing. The dollar can pare losses if sentiment deteriorates, and this could happen if weak macro data from major economies, including Europe, start to flow in the weeks and months ahead.

The probability of weakening of the zloty basket still remains relatively high (at least until mid-year). It should be remembered that neither the central banks nor the G7 group have a lot of macro data showing how much the coronavirus may affect economic growth. Therefore, they may be reluctant to take the drastic preventive measures that the market hopes for. The disappointment resulting from this may weaken the zloty somewhat in the short term.