Head of Macroeconomic Research
Summary: Risk aversion is not off the table in start to second quarter as coronavirus outbreak continues to destabilize financial markets and the economy. In today's edition, we look at our FX risk barometers to assess the level of risk in the market and we discuss what may be needed to spur risk appetite.
Our favorite FX risk indicator is based on the evolution of Asian currencies (excluding Japanese yen) versus the US dollar. From Q2 2019 till the end of 2019, we have seen a continued improvement of risk appetite in the FX space which has not happened since the end of 2017/early 2018 and was mostly driven by the prospect of US-China trade deal. Since the beginning of 2020, this trend has reversed due to the COVID-19 crisis and our barometer is flashing a warning signal again. In Q1 2020, it was running at minus 4.4% vs +2% in the previous quarter. This is the biggest drop since the Chinese yuan devaluation in 2015 and a more important quarterly decrease than in the Global Financial Crisis.
The coming months will certainly be even more challenging as investors will need to cope with a continued flow of bad statistics and as lockdown measures will remain in effect for a prolonged period of time (up to June in the United States according to some simulations). The best way to assess the level of risk in the forthcoming days and weeks is to observe AUDJPY – the ultimate barometer of risk on / risk off. Back in 2008 when Lehman wasn’t rescued, the AUDJPY cross collapsed from 105.00 to 55.00 in less than four months. The scale of the depreciation is far more limited now (minus 14% since January) but the cross is already back to GFC levels. After a short-lived bounce at the end of March, the cross has entered into a bearish trend again. The formation of an inverted head-and-shoulders pattern confirms that bears are still in control and that more losses are about to come in the medium term. It is probable the AUDJPY cross will go all the way down to 60. This is a clear signal that risk aversion will stay elevated for the time being.
For more charts, see our MacroChartmania.
Basically, a real improvement in risk appetite is unlikely until some of these combo materialize: RoW growth rate for COVID-19 cases slows, oil price rebounds or funding/liquidity stress significantly decreases (see our G7 Policy Tracker to follow the latest Fed’s monetary policy tweaks to facilitate access to USD funding).
Important note: The March Employment Report that is due today at 12:30 GMT is the most useless number released this week. Due to methodology (the Labor Department’s surveys took place during the week that contains the 12th day of the month), it is unlikely to show labor market disruption related to the COVID-19 outbreak. Investors will need to wait for the April Employment Report to be released on May 8 to assess the real impact.
2024: The wasted year
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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.
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.
