How the rising European virus cases are impacting FX
Risk assets sold-off across the board on Tuesday, with risk appetite deteriorating as investors refocused their
attention on a number of downturn threats facing the global economy.
Much of the action in the FX market in the past couple of weeks or so has be driven largely by optimism
surrounding a Joe Biden election victory, and the large US fiscal stimulus package that his Presidency is
expected to bring. This has been put on the back burner so far this week, with the market now turning its
attention back to the sharp rise in COVID-19 cases across Europe. Caseloads have exploded in a number of
key economic areas within the common bloc, notably in France (nearly 27,000 cases on Saturday versus a 7.5k
peak in late-March), Spain (around 10,000 daily cases) and to a lesser extent Italy (6,000 daily cases).
Fresh restrictions have been imposed to limit social interactions, including hospitality closures and curfews. As
we have mentioned in this week’s episode of our FX Talk podcast, we find it difficult to see how the euro can
post any sustained gains in an environment where European infections are rising aggressively and authorities
are scrambling to put in place tighter lockdown restrictions that will almost inevitably weigh on growth. We
have mentioned on a number of occasions of late that a short-term retracement in the euro is on the cards, and
that appears to be what we’re seeing at the moment.
So far, these rising case loads have not been reflected in any hard indicators of European economic activity.
We have, however, begun to see a deterioration in soft sentiment indices, notably yesterday’s ZEW economic
sentiment index that crashed to 52.3 this month versus the 70.5 expected. This is a clear warning sign that
businesses in the bloc are growing increasingly concerned about the virus, which not only suggests weaker
growth ahead, but raises the possibility that the ECB may act by increasing its PEPP measures later this year.
Sterling crashes as UK virus restrictions tightened
The pound was not spared from the sell-off in risk assets yesterday and has actually been one of the worst
performers for the week, down almost 1.5% versus the broadly stronger US dollar.
The UK is itself struggling to contain the aggressive uptrend in new virus cases, notably in the north of
England. Britain’s three-tier lockdown system has been introduced as of today. While the vast majority of the
country is currently on the ‘medium’ risk level, where national restrictions apply, the fear is that more major
cities are on course to join the likes of Liverpool and Manchester in the higher alert categories within the next
few weeks. Under theses restrictions, social interaction is limited and many leisure and hospitality industries are
forced to close.
With COVID restrictions tightening and Brexit negotiations reaching a critical junction, the outlook for UK
growth is not a particularly encouraging one. Boris Johnson’s self-imposed deadline for a Brexit deal is this
Thursday’s EU summit, although this is almost certain to be delayed. Headlines out of both sides of discussions
suggest that there is a deal to be done, although until we get concrete news that a ‘no deal’ is avoided we
think that we are unlikely to see investors take any sizable long positions in sterling.