FX Update: Coronavirus dominates attention across markets

The corona virus outbreak and concerns about its further spread continue to dominate the market’s attention here, though we continue to see little transmission into FX, with AUDUSD not even managing a full percentage drop yet from the Friday close, and oil-price impacted NOK around 0.5% weaker versus the euro from the Friday close. Action in EM is similarly orderly, even if clearly displaying a consistent risk-off pattern. Some of the relative complacency, in our view, may be down to the world suddenly feeling awash with virus experts and market commentators confident that we can compare this outbreak with past episodes like SARS or other epidemic outbreaks, with the implicit assumption that this will quickly blow over and that this could represent an attractive buying opportunity. Whether that proves the case, we have no idea, but our first instinct is to recognize the potential that the situation gets far far worse and proves more disruptive than anyone imagines based on historic precedents, particularly given that the situation could not arrive at a worse time given market complacency. Long volatility hedges are still fairly modestly priced.

With this outbreak dominating market attention this week, other themes in the market may prove muted, especially the impact of the FOMC meeting this week and the Bank of England rate decision as well (more comment on that in GBP below). A huge flag on what shape Fed policy is likely to take from here popped up in the Wall Street Journal (paywall) over the weekend. Authored by Nick Timiraos, it argues that the Fed is pursuing an eventual yield-curve-control approach in the next recession, a setup that would allow vastly expanded fiscal deficits without any disorderly rise in yields. This steals a page from the Bank of Japan playbook and points to an ugly negative real yield risk if inflation is picking up at the same time. As the article indicates (and as we discussed as far back as our 2017 Outrageous Prediction: “Desperate Fed follows BoJ lead to fix 10-year Treasuries at 1.5%”. This eventually looks a USD-negative story, but is likely something to tuck away for future consideration rather than something that is likely to see the light of day in this week’s statement or Powell press conference.

Chart: AUDUSD
AUDUSD trading heavily as the coronavirus outbreak and shutdown of economic activity across portions of China are weighing on key commodity prices, including the Australia-critical iron ore. Technically, this latest move is looking like a more full scale breakdown that  could point to a full test of the cycle lows and then some, particularly if the current coronavirus effect accelerates in the near term.