Currency volatility explodes on pandemic fears
The sharp worsening of the coronavirus pandemic, which has led to nationwide lockdowns in Italy and Spain, has shaken world ﬁnancial markets in the past week.
The initial reaction was to send the euro higher, as the US yield curve evaporated and markets priced in Federal Reserve cuts all the way to zero. However, the worsening news and sharp acceleration in the number of new conﬁrmed cases in the Euro Area soon led to a reversal. In the end, the dollar reasserted itself as the safe-haven currency of choice, rising against every other major currency in the world. The euro, Swiss franc and the yen held up relatively well, though the relatively modest weekly changes in these currencies against the dollar are not reﬂective of the week’s enormous volatility.
The focus this week will be on the extraordinary measures taken by governments and central banks to mitigate the blow to the world economy. The Federal Reserve has already cut interest rates to zero, lowering its fed funds rate by 100 basis points during an emergency meeting on Sunday. This, we believe, should be followed by all G10 central banks that still have positive rates. We also should see aggressive measures to support demand, employment, SMEs and household ﬁnances, particularly in the Eurozone that is bearing the brunt of the crisis right now. Economic data out this week will be hopelessly out-of-date and markets will likely ignore it.
The Bank of England cut rates by 50 basis points to 0.25% during an unscheduled meeting last week, while launching a series of initiatives to ease the credit ﬂow, particularly to SMEs.
Sterling took little notice, having a rough week against both the dollar and the euro amid the stampede away from risk assets (sterling fell over 6% against the dollar last week alone). We do, however, think that the signiﬁcant ﬁscal easing announced in the Budget is a signiﬁcant medium-term positive, and that the pound is currently severely undervalued after last week’s sharp falls. We attribute the move more to investors favouring the US dollar due to its safe-haven status and role as the world’s most liquid currency.
With Spain and Italy under lockdown, and France not far behind, a pall of uncertainty has descended over the Eurozone economy. The good news is that monetary and ﬁscal authorities are reacting quickly. The ECB corrected Lagarde’s miscommunication during the bank’s Thursday’s meeting and has made it clear that it will ensure Eurozone sovereign bonds remain stable. European governments are preparing ﬁscal stimulus and various forms of support for households and businesses to ride out the lockdowns and consequent fall in demand. Germany’s €500 billion pledge is particularly welcome here.
A combination of bank forbearance, extremely low rates and ﬁscal stimulus is a powerful antidote to the economic and ﬁnancial consequences of the pandemic. We are optimistic that the Eurozone economy can rebound quickly after the lockdowns end.
The dollar turned around mid-week and became the preferred currency for investors ﬂeeing risk. The perception that the US is not as affected as Europe by the pandemic likely played a role. However, the numbers there are also worsening rapidly, in spite of the very limited testing.
With the Fed taking aggressive measures, including emergency cuts in rates and additional QE, it will be critical to see if the dollar rally continues as and when the US takes stronger measures of the kind we are seeing in Europe. The issue for the Federal Reserve is that it now has very limited additional room for maneuver, particularly on interest rates that are now at the effective lower bound – where they were in the aftermath of the ﬁnancial crisis in ’08.
EUR/CHF traded close to, but below the 1.06 level throughout much of last week. The franc was one of the better-performing G10 currencies amid the ‘ﬂight to safety’, although still succumbed to the dollar’s strength. Looking at the weekly data on sight deposits, the Swiss National Bank seems to have again intervened in the market to stem the currency’s appreciation, even ramping up the pace of those interventions. Total sight deposits increased by 4.4 bln CHF compared to 2.8 and 3.5 bln respectively in the two weeks prior.
The SNB will meet later this week. Despite the as of yet relatively limited containment measures in place in Switzerland, the coronavirus outbreak only adds more downside risk to an already weak macroeconomic backdrop. The SNB will stress the above and may try to warn-off markets from buying-up the safe-haven franc. Policymakers are likely to suggest that the bank stands ready to support the economy and introduce measures aimed at alleviating the negative effects of the virus on Swiss businesses. There is, however, almost no room for rate cuts with the reference rate already at a record low -0.75%. We therefore don’t think that we’re going to see a cut from the SNB this week, although nothing at this stage can be entirely ruled out.
The Aussie dollar was battered again last week, far from spared from the rampant rally in the US dollar. The AUD/USD cross is now trading around the 0.62 mark, down a massive 7% in around a week.
Similarly to sterling, AUD has continued to suffer due to its characteristic as one of the higher risk currencies in the G10 and its exposure to the global economic cycle, particularly China. Exacerbating the move, investors are now braced for another RBA rate cut and the introduction of quantitative easing in the country this week. In a statement released on Monday, RBA governor Lowe stated that the bank ‘stands ready to purchase Australian government bonds in the secondary market to support the smooth functioning of that market’. This would be a signiﬁcant move from the bank, given it would mark the ﬁrst time that it has ever introduced QE.
We also think that an emergency rate cut from the RBA this week is possible, in line with a similar move from the RBNZ. Yet with this mostly priced in by the market we do not see a huge amount more downside in AUD in the immidiate-term and think that is in fact slightly undervalued at current levels.
The Federal Reserve was not the only major central bank to surprise the market with a preemptive rate cut in the past few days, with the Bank of Canada also lowering its main base by 50 basis points in an emergency move on Friday. The BoC’s main rate was slashed to 0.75%, the second rate cut already by the bank this month. In its statement the bank noted ‘it is clear that the spread of the coronavirus is having serious consequences for Canadian families, and for Canada’s economy’. Similarly to measures seen around the globe, ﬁnance minister Morneau also announced last week that the government would be making $10bn available to businesses to ease the economic impact.
The reaction in the Canadian dollar has been a violent one, with the USD/CAD cross now trading around the 1.39 level – a near 4% move since the beginning of the month alone. The problem for CAD is that unlike many of its major peers, which now includes the Federal Reserve, there is still more room for the BoC to lower rates in order to protect the economy. We think that the BoC will have no choice but to continue lowering rates towards zero in the coming weeks, highly likely before the next scheduled meeting in April. This may continue to weigh on the Canadian dollar in the short-term.