Head of FX Strategy
Summary: The sell-off yesterday across all risk assets was the tardy response to the severity of the unfolding coronavirus crisis. The question for FX traders is whether the transmission into FX, outside of individual, less-liquid EM currencies, will remain so remarkably muted. The status of the recent USDJPY rally deserves extra focus.
Trading interest
The broader market is finally beginning to take the coronavirus outbreak more seriously, as yesterday’s brutal sell-off in equities, one of the largest in years, depending on the geography, washed over markets in the wake of stories showing widening contagion of the virus in Japan, South Korea and Italy. The most concerning stories I came across this morning were the FT story on the outbreak in Japan, recent statements from the Imperial College of London (actually available as far back as Friday in their official report on the risk that some two-thirds of virus cases are undetected, and Iran’s unfolding outbreak.
As we discussed in today’s Market Call podcast, the “Turnaround Tuesday” narrative and buy-the-dip mentality were in full swing this morning after yesterday’s carnage, but we remain far from sanguine on the risk of further fallout. The difficulty for the FX trader is that the feed-through into FX has been so muted, save for individual EM cases – note the ruble yesterday, in particular. Below we look at USDJPY and whether the pair reverses hard back through 110.00, as a volatile JPY to this old trader feels like a prerequisite for FX to play a bit more catchup with the volatility impacting other asset classes.
Interesting to watch the Hungarian forint (HUF) over today’s Hungarian Central Bank meeting, as the bank has promised a policy review with the results set for discussion in March. Meanwhile, the bank has been tightening liquidity, evident in a sharp rise in HUF 2-year swap rates have spiked from below 50 basis points to north of 100 basis points over the last week in the wake of the January CPI release showing a 4.7% rise in prices. HUF only posted a modest consolidation on the tightening liquidity and it is clear that the central bank will need to make like the Czech central bank in responding to incredibly negative real rates with a rate hike regime or risk aggravated currency weakness.
Chart: USDJPY
We continue to watch USDJPY with interest if this sell-off in risky assets continues after last week’s spike higher may prove in hindsight to have been an aberration linked to the “unstoppable” rise in US tech stocks to new all time highs despite signs of concern elsewhere – a story that by yesterday’s market closed has reversed rather hard, to say the least, along with the USDJPY price action, though the reversal there has not yet taken out the important 110.00 area – need a close below there to signal that this chart is turning more forcefully lower.
Today’s G-10 rundown
USD – the US dollar looks inert – a safe haven from the riskier currencies, but potentially weak against the JPY and even the euro in the event the sell-off deepens. Long US treasury yields collapsing eroding the real interest rate advantage of the USD rather quickly here.
EUR – the euro picking up resilience in risk off conditions and despite locus of new coronavirus outbreak in Italy suggests the single currency could find support here on unwinding of carry trades. Still, some wood to chop to dig EURUSD out of the ditch (yes – mixing metaphors!).
JPY – the market is beginning to price in Bank of Japan rate cuts on the latest action and we suspect it is only a question of time until the Summer Olympics are canceled or delayed a year or similar. The December 2020 EuroYen STIR futures are pricing in 4.5 bps of easing.
GBP – the market unwilling to take a position on sterling here with distractions elsewhere and as we await signals on the UK budget next month.
CHF – EURCHF rejected the new lo for the cycle yesterday – is the 1.0600 level the SNB’s latest line in the sand?
AUD – somehow, iron ore prices are near the top of the range for the last year and offering a fundamental support, though shipments must have slowed sharply – meanwhile, private sector credit growth has been on a slide since earl 2016 and Australia is looking at a recession this year versus RBA hopes for 2% or higher growth….
CAD – looking for USDCAD to play a bit of upside catchup on further negative US data points and weaker Canadian oil prices. The BoC’s Lane is out speaking later today.
NZD – the RBNZ will need to cut rates and has at least 50 bps to cut before having to wrestle with talk of zero bound.
SEK – the SEK hanging in there rather well relative to the backdrop of weak risk appetite – key for SEK hopefuls is that price action remains south of 10.60-65
NOK – there is no lid for EURNOK if get another wave of price action like yesterday, or worse.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
