Chief Macro Strategist
Summary: The corona virus outbreak continues to dominate market attention, though concerns are slow to be felt in currencies. Given the unknowns and where this situation can ultimately take us, the market looks complacent and we urge a very cautious stance and even purchase of protective hedges until this situation blows over.
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.
The G-10 rundown
USD – the US dollar trading as a safe haven here, second perhaps only to the JPY as long as risk-on, risk-off behavior extends here in the near term.
EUR – the weak German IFO expectations out this morning (92.9 vs. 94.8 expected and vs. 93.9 in December) certainly a disappointment relative to the massive surge in recent ZEW survey numbers, but more importantly, the risk of weak demand from China as it deals with its virus outbreak is a concern for the heavily export-dependent EU economy.
JPY – extremely orderly bid into the yen relative to past episodes of risk off behavior and the bounce-back overnight in USDJPY is a mirror image of the action in US treasury futures – as long as we remain in risk-on/risk-off mode, will likely see this correlation continue.
GBP – sterling looking reasonably stable and then some, given risk off concerns and the disappointment of the reaction to Friday’s solid UK PMI survey data – the Bank of England cut odds have dropped and it would make some sense for the BoE to wait and see here, though a bad further stumble in markets on the coronavirus this week could be a factor in the mix of the MPC’s decision.
CHF – absorbing a very modest safe haven bid, if any at all, and we wonder at some point whether the SNB’s foreign equity holdings could become a source of relative weakness to JPY in a big way on a larger risk-off move.
AUD – the Aussie getting about the worst of it within G10 FX from the coronavirus fallout and for good reason as it so heavily exposed to Chinese demand. The NAB surveys from Australia out tonight and CPI later this week.
CAD – risk off and tumbling oil prices are not the loonie’s best friend – surprised that USDCAD hasn’t traded even higher here after the recent Bank of Canada dovish tilt on top of that, not to mention another weak Retail Sales number on Friday.
NZD – kiwi absorbing less of the fallout from the corona virus than AUD and could point to new local lows here in AUDNZD, but failure in NZDUSD to new lows point to a further run lower as long as this risk off move extends.
SEK – krona generally does not like risk aversion, so we see EURSEK back toward the recent highs, but nothing breaking unless 9.60-65 comes under siege.
NOK – EURNOK clears 10.00 overnight on the fallout from the corona virus as oil prices are one of the most heavily impacted commodities for obvious reasons. Given EURNOK shorts a likely consensus trade, if the fallout extends – squeeze risk on an extension above 10.00.
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