FX Update: Would a Covid-19 vaccine bring USD weakness forward?
Head of FX Strategy, Saxo Bank Group
Summary: The news of a possibly effective Covid-19 vaccine jolted currencies in a sometimes confusing way, but beyond near term volatility, the rising promise of an effective Covid-19 vaccine might bring forward the longer term weakening of the US dollar.
Today’s FX Trading focus:
Are we on the cusp of an effective vaccine and what does that mean for the USD?
The Pfizer announcement of very good results for its Covid-19 vaccine candidate has provided a real jolt to markets and to FX. At first, the news was taken as universally positive, boosting equities and crushing the USD, as well as US treasuries, JPY, CHF and gold safe-havens even more aggressively. But since then, a curious diffusion of that move has unfolded, with the US dollar more mixed, while the JPY and CHF remain weak as US long treasury yields are up near the post-Covid-19 highs. Why is the vaccine hope not universally being celebrated along the lines of reflation and across-the-board strong risk appetite? (For the below thoughts, we assume that the promise from this Covid-19 is confirmed in the coming weeks and months.)
- A Covid-19 vaccine means less stimulus (especially of the “money for nothing” variety and uncertainty that the central bank support under risky assets will be as profound as it would otherwise be. Given that the expected US political gridlock after the election results was supposed to mean that the Fed would be hyperactive in providing endless liquidity and support, the sharply higher US rates at the long end of the curve and implications for less stimulus as the end of Covid-19 lockdowns and restrictions means that stimulus could be tapered very aggressively next year. Oh, the irony of good news being bad for markets.
- The above triggering an ugly market liquidity event, with the added uncertainty that Republicans are backing Trump’s effort to challenge the US election results, although I’m not surehow seriously the market is taking this particular risk – not yet, but stay tuned on that front.
- Note the difference depending on the geography. US stocks – and the big tech stocks most notably – are clearly different animals relative to European stocks, which are profoundly higher after the announcement and remain bid in today’s session, even as the Nasdaq big tech stocks stumbled badly again today after coming sharply off their highs yesterday. See our Peter Garnry for his thoughts on the equity market reaction to this bit of news.
But for the longer term, we continue to keep the focus lower on the US dollar, as I discuss below. First, a brief look at the USDJPY chart.
The yen was far and away the weakest currency yesterday, responding with a massive jolt to the downside just after its recent break higher versus the US dollar had likely triggered heavy new interest in long positioning. The reversal will likely stick as long as US long yields stick higher (see thoughts below on Fed yield curve control – higher US yield per se won’t necessarily support the US dollar versus the JPY if the Fed feels compelled to step in to keep them from going higher still due to inflationary pressures.) As with any knee-jerk reaction to news, this one requires taking with a grain of salt, and the subsequent price action here may not live up to the steepness of this bullish reversal. Against commodity currencies, however, the JPY could yet prove very weak if the reflationary narrative is boosted in coming weeks with higher commodity prices and the growing promise of a vaccine rollout.
Yesterday, I indicated a struggle with the weak USD narrative based on the US election result, but the news of a possible Covid-19 vaccine could dramatically ease and bring forward the path to a weaker US dollar for the following reasons:
- Pent-up US savings – The US private sector stockpiled a large portion of the incredible stimulus blitz – by some estimates, some $2 trillion. If a path is open to fully reverting to “normal” pre-Covid-19 behaviour, this consumption would help drive enormous external deficits as the US imports a high percentage of its consumption basket.
- US Treasury has significant funds at the ready for stimulus – the Treasury has piled up over $1.5 trillion as it raised more money than it needed during the panic phase of the pandemic last year. The release of these funds will improves USD liquidity further as some form of stimulus will have to be forthcoming under a Biden administration to avoid a cliff-edge on some of the CARES act after December 31 and to prevent business closures. Also, given that the Treasury already has a good deal of stimulus money at the ready, it will mean that reduced fiscal stimulus after this winter and possibly spring made possible by a Covid-19 vaccine would mean a reduced need for US Treasury issuance, likewise a boost to USD liquidity.
- Fed will still prove slow to respond to rising inflation: With its new flexible average inflation targeting (AIT) regime, the Fed has promised it will be very tardy to respond to inflation eroding the value of the US dollar. At the margin, here is the additional risk that the Fed moves against higher US yields if the treasury sell-off deepens, fearing that higher rates will slow the recovery in the US labor market. If the Fed threatens yield caps, or yield curve control (YCC), this would crystallize the USD bears’ strongest argument: the erosion of the USD value on negative real rates. (Yield curve manipulation can come in many forms, in a soft way via QE purchase weightings or more explicitly in new YCC guidance).
EURGBP has rushed lower despite no notable development on the Brexit negotiation front today as it seems the Covid-19 vaccine story is the chief driver here for an economy that has been devastated by the virus. The price action had been bottled up near the pivotal 0.9000 recently until today, when it rushed lower, as a Covid-19 vaccine hope would lift the very heavy clouds that have hung over the UK economy since this spring, also likely banishing any thoughts of a negative rate policy from the BoE.
The G-10 rundown, express edition
USD – discussed above, not convinced USD upside gets much traction even in short term unless market volatility goes truly ballistic. A clear path to a Covid-19 vaccine brings forward a weaker US dollar.
EUR – if the Pfizer and other drugs continue to bring promise, great news for EUR, although strength could be modest as pro-cyclical beta is lower than for commodity- and EM F.
JPY – the action is in cross-JPY (yen weakness) more than USDJPY as long as market celebrates an improved global growth outlook.
GBP – need that Brexit breakthrough headline – and if Covid-19 vaccine hopes are sustained, EURGBP could have room for 0.8600 in short order, while 1.3500 is the big focus for GBPUSD, freeing up possibly 1.400.
CHF – the Swiss franc punished as global yields spiked higher and safe haven gold out of favour. If we can get post-Covid-19, post-Brexit and a solid EU fiscal package, may be room for a larger adjustment higher in EURCHF. For now, the 1.0900 level is the next hurdle.
AUD – if risk sentiment continues higher, AUD is well positioned for a post-Covid-19 boom if that is where we are headed.
CAD – USDCAD is teasing the major 1.3000 chart point – a deepening hope for a global recovery would open the path lower (stronger for CAD).
NZD – RBNZ is up tonight – and an interesting one. Expect “funding for lending programme” on track, but on the guidance, some chance for a hawkish shift as Governor Orr and company might want to extend the potential horizon for bringing a negative policy rate – or introduce doubt that they will go negative at all, given that the next couple of months could see the deepening promise of a Covid-19 vaccine.
SEK – the weight of Covid-19 on Europe lifting would be a huge boon for SEK, hence EURSEK already teasing below 10.20 at times today and ready for a try toward 10.00 if sentiment backdrop remains positive.
NOK – the path is open to the 10.36 range low in EURNOK and possibly more if oil can break above 46/barrel and the hopeful backdrop is maintained. Epic chart line in USDNOK don around 8.75 (price currently at 9.00).
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