Risk rout moderates as markets await the ECB (Daily analysis 29.10.2020)

Brent crude is almost 8% lower than last week. European equities experienced a three day long, huge sell-off. Germany’s blue-chip index DAX slumped over 8% this week to close on Wednesday at the lowest levels since May. Compared to that, the FX market shows a muted reaction to a repricing of economic growth expectations.

The EUR/USD exchange rate decline was stopped well above the 1.17 boundary. The common currency trades heavy but it remains within last week’s range. The sentiment is showing some signs of stabilization on Thursday morning. Equity index futures point to modest gains and the US dollar drops against the riskiest G-10 currencies including the GBP, the NOK and the AUD.

Germany and France reintroduce lockdowns

Germany will start a four-week partial lockdown on Monday. Lockdown in France begins on Friday, but the schools will remain open. The Eurozone’s two largest economies will close non-essential services, bars, restaurants to regain control over the rapid spread of COVID-19 infections. Before those announcements, investors had probably feared even harsher restrictions. The majority of businesses and schools will remain open, which shows the governments will do utmost to hurt the economic growth prospects as little as possible. The main event today is the ECB meeting, but markets will look into Germany CPI as well as US Q3 GDP data.

With COVID-19 infections on the rise and reintroduction of restrictions in Italy, Spain, France and Germany, the European Central Bank has little choice, but to prepare the markets for more stimulus. The case for more easing has undoubtedly strengthened lately. Nonetheless, the decision to extend and expand the Pandemic Emergency Purchase Programme (PEPP) is expected in December when the Governing Council is equipped with a new set of macroeconomic staff projections.

The ECB is ready for the second wave

The second wave of COVID-19 in Europe poses a downside threat to economic recovery and makes a double-dip recession a material risk. The reimposition of restrictions will hit the services sector hard. Making an exact assessment is not an easy task, especially that political events, namely the US presidential election and Brexit negotiations disturb the outlook as well.

The euro strength became less of a problem. The common currency has traded sideways since the previous meeting. The peripheral debt markets remain stable, which also makes the action less urgent. In the central scenario, the Governing Council highlights the persistence of easing, points towards expanding and extending PEPP to the end of the next year and stresses that other means remain in its toolbox. Surprise easing on today’s meeting or opening the door for a rate cut in December would depreciate the euro.