Volatility is at crisis levels to start the week. Oil was down over 30% at one point in overnight trade on a rapidly developing oil price war, but has trimmed losses towards -23%. 10-yr US yields crashed to a low of 0.35%, and several currencies, notably CAD and JPY in developed market currencies, experienced 2-4% fluctuations. Emerging market FX is a mess with USD climbing over 6% and 8% versus MXN and RUB, respectively. The FTSE 100 is off by over 7%, while S&P 500 futures are trading limit down at -5%.
Last week, numerous efforts were made by central banks and governments to combat a strong downturn in the global economy due to the coronavirus. It remains highly questionable as to what extent and when those efforts will have a meaningful impact on a global economy coming to a grinding halt on supply chain disruptions.
Dialling back to the big-picture and assessing the broader risks, prior to the coronavirus the global economy was already vulnerable, highly levered, and with central banks running low on ammo. We consider the possibility that the coronavirus, even in the outcome that fears are overblown, may still be a rock thrown on a pile of sand waiting to collapse. At the very least, uncertainty will remain quite high in the months ahead, keeping financial market volatility elevated for the foreseeable future.
The USD is on its heels. Fed funds were cut by 50-bps last week, and as of Friday the probability for another 50-bps cut at the March 18 Fed meeting rose to 62%. Look for that to keep climbing. The bond market is pricing in pretty much the worst of the worst right now, with 10-yr yields hitting an overnight low of 0.35%. The rate of decline has been one of the sharpest in history, a rebound may be near. On Friday, Non-farm payrolls showed further job growth in February with an NFP reading of +273k versus the Bloomberg consensus estimate of +175k. A non-event in light of current events. The March figures will certainly be of interest, though, as we get a first look at the impacts on hiring in the wake of the coronavirus hitting the States.
If the dollar is on its back-foot, then the euro is off and running. It’s been a good while since we have seen this kind of price action in EUR/USD, thus far having rocketed nearly 6% off the February low and the a 20-year line of support. The 1.1239-line we noted last week was broken on Friday, increasing the bias towards the 1.17/20-area. The euro has thus far gone from a near three-year low to a one-year high in just over two weeks on a changing rate environment and carry-trade unwind. On Thursday, the ECB meets – but what impact, if any, will this meeting have?
Cable is springing to life off the 1.27s, an area of support we have been watching carefully. The sharp move last week above 1.30 could be the beginning of a much larger run. Last week trade talks formally kicked off in Brussels. This will be a winding road with the two sides having “serious divergences”, to quote Barnier. GBP/EUR found support at the 200-day moving average last week, but it is difficult to gauge the cross-rate right now. The level we are focused on is the top of the multi-year range at 1.2081. If this threshold is hurdled then we anticipate the backdrop has firmed materially in favour of higher sterling versus the euro. Expectations of breaking the range right now, though, are tempered.
Yen strength persists on further unrest in financial markets. Risk trends will continue to be the dominant theme for the Japanese yen for a while to come. USD/JPY crashed through strong support over 104.50 in overnight trade, next up could be a major test of the psychological level at 100. Keep any eye on developments as US stocks open today, the environment is conducive for even bigger decline.
The Australian dollar rebounded sharply off its lows along with other G10 currencies versus the US dollar, but overnight it had flash-crash market conditions with AUD/USD declining nearly 5% before rebounding sharply to down under 1% at the time of this writing. Last week the RBA cut 25-bps, clocking a new record low for the Australian benchmark at 0.50%. How much longer will it be before they are at the zero-bound?
The BoC cut rates by 50-bps the day after the Fed did so, and on that we saw some short-term gyrations with a zero net-effect. The weekend oil shock is the catalyst now, with USD/CAD up over 2% at one-point Sunday night. The long-view is that the 2016 high at 1.4689 is a potential target we feel the market should be prepared for. CAD (oil producer) was hit hardest against JPY (oil consumer) since the week opened, down 6% at one point.
Emerging market currencies continue to be in trouble. It’s the one bright spot for the dollar, if you can call it that. Even before the coronavirus hit, it looked likely that emerging market currencies were on the brink of further devaluation. The ZAR just recently fell to 3-year lows, BRL continues to flame out to new record lows. MXN and RUB are getting hammered on oil, and look next up in joining the category of EMFX reaching towards record lows.
USD vs EMFX Basket (Weekly)
In summary, financial market volatility is at crisis levels. JPY and CAD are in focus with risk trends and oil making massive moves. GBP is gaining ground against USD, but expectations are tempered for a clear direction versus EUR. Oil and US yields crashed, stocks could join them. We remain firm on our stance that FX hedging policies should reflect the rising levels of risk.