FX Update: Widening coronavirus fallout sees muted FX impact

Trading interest

• Long USDCAD for 1.3500+, stops below 1.3220
• Buying long term (Nov 6 – days after election) EURUSD calls

The more full-bore risk off move is seeing FX playing more according to the old script as record lows in US 30-year benchmark and S&P futures off over 90 points as of this writing is seeing the USD, and even more so, the JPY trading as safe havens to start the week versus all other currencies, while the Euro is somewhere in between. The hardest hit currencies have been in EM, though still we are talking about mild moves in FX in general relative to traditional sensitivities. The Ruble is off a hefty 200+  basis points versus the USD from Friday’s close as I write but the traditionally more fragile South African rand is off less than 100 bps.

Looking at some of our risk indicators like corporate bond spreads and emerging market credit spreads, they have shown little cause for concern and the latter in particular remains incredibly tight relative to the recent pickup in EM FX volatility. These no longer appear to be good forward indicators of market risk as they were in the past – particularly ahead of the global financial crisis – when they were sending out loud divergence signals well ahead of the big market turn. In all, it leaves us with the feeling of flying a bit blind on the true level of market “potential energy” and risk relative to past market regimes..

To turn the tide here for markets, we need a turn in coronavirus news, one that has so far entirely failed to materialize and may be hard to achieve for a long time if the contagion spreads to countries less able to deal with the outbreak like the strange case of Iran. Until then, we will continue to watch for strain in credit markets from the the disruptions in supply chains and shutdown of activity. This is not a situation where traditional stimulus works very well. Small and medium sized actors in particular who are facing a funding squeeze – but for now, we will look for individual high profile stories and how the authorities and markets deal with these on concerns of a contagion risk (especially from sudden motivation to switch portfolio allocations, important because we suspect that passive portfolio flows into, for example, bond ETFs and funds, are behind the lack of pricing of risks thus far.)

A couple of things to round up from the end of last week and over the weekend. The flash US Feb. Markit PMI was very ugly at 49.7 vs. the prior 53+ reading – a dramatic heads up if there ever was one, though we will need more confirmation than this one data point. Also out on Friday, the Fed’s Lael Brainard delivered an address discussing the Fed’s “new tools” for a coming crisis: basically yield caps and encouraging strong fiscal stimulus (with the yield caps an implicit guarantee to monetize national deficits). This is an important signal – but not absorbed for the moment. Finally, over the weekend, Bernie Sanders won big in Nevada – getting 47% of the votes with 88% of districts reporting – far more than double the closest competitor Biden. Sanders is looking the runaway favourite to become the nominee. More on that later this week.

Chart: USDCAD
USDCAD has not sufficiently absorbed the risks to CAD from both a widening coronavirus contagion and a weakening US and Canadian economy (note Friday’s ). I am astounded that oil prices have held up as well as they have, but if oil plays catchup with the news, new low prices may lie ahead there and feed some catchup downside in CAD relative to some of its peers. With the G10’s highest policy rate, Canada has the most to cut and the economy features an overleveraged private sector relative to a US private sector that has, believe it or not, been deleveraging in aggregate since the financial crisis. Watching for the potential here that a new close above 1.3300+ highs of late leads to a significant extension higher still.