Cost of continuing bailout measures troubling traders

The Bank of England cut the base interest rate to 0.10% yesterday and announced its largest ever package of quantitative easing to drive long term rates lower.

At £200 billion the new purchases of Government bonds are the most dramatic intervention in decades and continues the baptism of fire being experienced by new Governor Andrew Bailey.

Several reasons are being considered for the dramatic recent collapse in the value of the pound which continued yesterday. It has now fallen for nine straight trading sessions although it is (so far) in positive territory overnight.

The open-ended commitments being made by Chancellor Rishi Sunak are the correct response to the Coronavirus outbreak, but economically the gamble being taken is possibly bigger than any previous response. There is likely to be still more announcements of stimulus and support for both the corporate world and individuals, particularly the self-employed.

Quantitative easing is becoming an accepted tool for global Central Banks. This is more than a little ironic given the horror with which it was greeted by economists at the time of the financial crisis in 2008.

With interest rates now at 0.1%, the lowest in history, the restarting of printing money, the monetary policy response is likely to be matched by further fiscal stimulus. It is rumoured that Sunak will announce a further massive stimulus package today which may include freezing of income tax payments and a National Insurance holiday.

Given the slightly misleading headline of Sunak’s previous package which appeared to mix up the difference between grant and loan, analysts will await the full details of any move before judging its effectiveness.

The pound reached a low yesterday of 1.1469 versus the dollar, closing at 1.1485, So far overnight, it has rallied a little to reach 1.1674 as market volatility continues.

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Dollar index buyers remain in control

The feeding frenzy being seen as every part of the market is trying to get hold of dollars to ensure continued liquidity has led to rumours of the return of direct joint intervention that was last seen before the financial crisis.

In an era of closer cooperation between Central banks, the Bank of Japan was often joined by the Federal Reserve in direct action in the market to either buy or sell JPY to stabilize its value.

Just how the cooperation will manifest itself remains to be seen despite a certain amount of relief from the opening of $450 billion in swap lines by the Fed yesterday.

If there is direct intervention by Central Banks it is likely to be mostly symbolic as it will be a huge risk to the stability of the system for Banks to undertake wholesale sales of dollars given the markets current state. Such moves were abandoned some while ago as individual Banks were left to intervene individually to (generally) weaken their currency. Since that was often not in the best interests of the market in general. it seldom worked given its overall power.

Norway yesterday became the first Central Bank to openly discuss intervention to prop up its currency. The Kroner has plunged by more than 30% as the Norwegian economy has had the additional issue of the plummeting oil price to contend with. Generally, commodity currencies like the AUD and NZD have suffered most during the recent maelstrom.

With the likelihood of a recession, however mild it may be, and an election in the offing, the Fed may go it alone, since it may not receive too much support given the America First mantra of the President.

The dollar index remains well above the 100-barrier reaching 102.84 yesterday and closing at 102.70. The index has also corrected a little overnight, but it is too early to label its recent rally as over.

ECB unveils massive QE programme

In keeping with its past actions and the present actions of several other Central Banks, the ECB has announced a massive programme of intervention in the markets to try to offset the effects of the Coronavirus outbreak.

The Eur750 billion programme of quantitative easing put in place to try to shield Eurozone economies will mark the outer limit of how far the Central Bank can take its support.

This represents 6% of the total Eurozone GDP but it is the ability to produce a joint fiscal plan which would not only support the QE but provide direct support to businesses and individuals that is needed. While QE will be a significant prop to the economy both individually and collectively, to the man in the street and small businesses, it cannot provide the practical level of support that is needed.

The announcement from the ECB is open ended but that is likely to mean it is temporary in nature, likely to be withdrawn as soon as the crisis is deemed to be at an end.

There are rumours that not all the ECB’s monetary policy committee were happy to agree to the package. The quite tight restrictions on what the Central Bank can buy as part of QE could limit its effectiveness.

Over the next few weeks/months Christine Lagarde, the ECB President, is likely to have to justify several issues, namely; a change to the securities than can be bought, will the Bank actively support the economies of Italy and Greece, seen as the most vulnerable? and will those actions be seen as supporting individual Governments which is illegal under EU regulations.

With the approach of the end of Q1, it is likely that the economy will have contracted already which means an almost certain technical recession as growth is unlikely to turn positive in Q2.

The euro reached a low of 1.0655 yesterday closing at 1.0692