- USD down against all majors as stock markets crack.
- Stock markets down across board on pandemic fears.
- After new cases grow faster outside China for 1st time.
- U.S. has first unexplained case, raising risk of outbreak.
- Companies cut revenue outlooks, markets price rate cuts.
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The Dollar and Pound were deep in the red Thursday as investors appeared to be pricing-in a global coronavirus crisis that's walloping stock markets and could prompt a further unwinding of earlier bullish bets on both currencies.
Investors and traders dumped the Dollar leading it to fall against all major rivals except the Pound, which has seen renewed threats of a 'no deal Brexit' feeding a correction that had already gotten underway in the prior session. Sterling now risks being weighed down by the Brexit 'risk premium' that haunted it up until the withdrawal agreement was struck in October 2010.
Dollar weakness comes after official disclosures revealed that new coronavirus cases were growing faster outside of China than inside, with numbers increasing in Europe, North America and Asia. This has hurt stock markets which had largely defied gravity in recent weeks even as commodity prices tumbled and the global growth outlook darkened.
"Expect more’: that’s the message from a growing number of governments about the outbreak of the coronavirus. This increases the odds of early containment, limiting the wide-scale spreading of the virus, but the downside of this approach is that it will impact the global economy as business and consumer spending slows," says Jeroen Blokland, a multi-asset portfolio manager at Robeco. "Looking at recent developments, however, we are further trimming the weight of equities, holding onto our underweight in high yield bonds and favoring US duration over Eurozone duration."
Major European benchmarks were more than 2% lower throughout much of the Thursday session while the S&P 500 was indicated more than 1% lower ahead of the North American cash open.
Bond yields were lower, oil prices were down 3% and gold was higher but the rub for the Dollar is the punishing losses for stocks with the S&P and Dow having fallen 8% over the last five days.
“As the US stock markets have dropped in the last few days, so has the US dollar,” says John Goldie, an FX dealer at Argentex. “While many banks and analysts are distracted by poor German data and “King” dollar’s yield benefit, advocating a weak euro and strong dollar accordingly, I think that this underestimates the impact of the coronavirus which, in the short term, will potentially see sustained selling of the dollar in the coming weeks and beyond.
The U.S. discovered its first unexplained case of the deadly viral pneumonia in California Wednesday, raising the spectre of an outbreak in the world's largest economy just as more companies had begun to warn of the adverse impact that overseas outbreaks are having on their performances. Vice President Mike Pence, now also coronavirus czar, will manage the response.
This already prompted heavy losses for once raucous stocks that had drawn flows into the Dollar from most corners of the world in recent months. The Dollar is still the best performing major currency of 2020 although bets on it may increasingly be liquidated if the equity market sell-off escalates.
“When the stock markets sell off, investors close positions which involves selling USD (weakening that currency) and buying back the funding currency. As well as the Swiss or Yen, it is also the single currency which has also become a funding currency of choice in the last couple of years. With negative interest rates there is little motivation to hold euros but when the stock market turns around and carry trades are liquidated, money flows back into the euro,” says Argentex’s Goldie. “For the short term I think the euro continues to gain - which means back above 1.10 on EURUSD.”
Investors had piled into the Dollar as well as U.S. stocks and bonds in recent months in anticipation that the world’s largest economy would continue to expand at a best-in-class pace, underpinning the greenback’s interest rate advantage against other currencies while enabling U.S. stocks to deliver superior returns to those of economies elsewhere that have continued to slow.
However, the once rip-roaring stock markets are a liability to the Dollar now the economic risks posed by coronavirus are increasing. Vast swathes of China’s economy appeared to be brought to a standstill by efforts to contain the virus and already Italy has been compelled to quarantine some towns and villages to prevent an already rapid spread of the disease.
“Travel shutdowns and lockdowns are proceeding apace. Notably, Israel has become the first country to officially recommend, not yet order, that ALL international travel be postponed unless absolutely essential,” says Michael Every, a strategist at Rabobank. “Is that an over-reaction? The WHO and EU would of course scream “Yes” and “Because markets”. But what is an individual holiday, shopping trip, or business meeting weighed up against the fat tail-risk of catching and spreading a virus that might decimate an economy and kill an untold number?”
Italy’s government announced a total of 528 confirmed cases Thursday, up from 400 Wednesday and zero last Thursday, although many of the new cases are still concentrated in the Lombardy and Veneto regions. And since Italy’s outbreak was confirmed other European Union countries including Austria, Spain, Croatia, Greece and Switzerland among others.
Both self-enforced and government imposed quarantines can leave companies without staff or customers while also disrupting supply chains, with each on their own are enough to have a significant impact on GDP which is defined as the sum total of all spending within an economy. And slower or contracting economic growth risks the same for corporate revenues and profits in affected markets, which would always be negative for stocks.
“Bearing in mind that the market is currently holding long USD positions, speculation of lower Fed interest rates has the capacity to take some steam out of its current buoyant tone. This may strengthen the safe haven status of the JPY and the CHF in the near-term. That said, the EUR remains an unattractive currency,” says Rabobank’s Every.
U.S. bond yields have fallen to record new lows this week as investors shifted from betting on only one interest rate cut coming from the Federal Reserve in 2020 to assuming that three are near a certainty. And three rate cuts would leave the Federal Funds rate at just 1%, on a par with the New Zealand cash rate and only 25 basis points above the British and Australian cash rates.
In other words, they’d all but wipe out the Dollar’s rate advantage over other currencies unless offset by rate cuts elsewhere. Rate cut bets are mounting as concerns about the outlook for growth in the U.S. are growing mid-way through a quarter that typically brings seasonal weakness. Official data confirmed a steady performance from the U.S. economy in the final quarter but the manufacturing sector was already weakening before the coronvirus.
"The industrial stagnation was well-established before the Covid-19 outbreak began, thanks mostly to the ongoing trade war. The virus epidemic can only make things worse, given the disruption to both final demand for manufactured goods and the global supply chain," says Ian Shepherdson, chief economist at Pantheon Macroeconomics. "The "slowdown" in growth which seems to be signalled by our GDP forecasts is a seasonal story, not a Covid-19 hit. That's likely coming in the second quarter."
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