The Week Ahead: The Novel Coronavirus: Something to Look Through or Look At?
The Novel Coronavirus Something to Look Through or Look At?
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Andrew Kositkun Foreign Exchange Head Trader
Over the next couple of weeks, the evolution of the coronavirus outbreak will likely be the main driver of the FX markets. So far, emerging markets have been the market's focus with the economies of countries most dependent on China's supply chain and tourism hit the hardest.
Looking at China, clearly Q1 growth will suffer but what happens after that will depend on the length and extent of the outbreak. Here is what we do know.
The new virus is more widespread and more easily transmittable with the number of reported cases in mainland China exceeding that from the 2003 SARS outbreak. So far the mortality rate has been lower than with past epidemics but epidemiologists have noted the considerable uncertainty around the virus as well as the potential for mutation.
One of the key issues in assessing the economic impact is the lack of historical comparisons. SARS is an often used comparison but the slowdown in growth due to a pullback in consumer spending could be less severe given the rise in e-commerce. The counter to this is the fact that consumption and services are now a larger part of growth than in 2003. Notably, the WHO declared an International Health Emergency but did not recommend trade or travel restrictions, signaling confidence in the Chinese government's ability to handle the virus.
Looking forward, mid-February appears to be a key timeframe to watch. The extended holiday (with further extensions in heavily hit areas possible) and delayed work returns should help contain transmission. Prof. Zhong Nanshan, China's most authoritative respiratory diseases expert, expects the outbreak to peak in the next week to 10 days or roughly 2 months after the first reported case. As such, keep an eye on reports new infections (with a specific focus outside of Wuhan/Hubei) to gauge the effectiveness of virus detection and quarantine efforts. If stabilization isn't achieved by mid-February, then the risk for the more severe downside cases rises. Moreover, month end becomes important as it is the end of the 14 day incubation period for those return from the Lunar New Year break.
Near term, the PBoC fixing on Monday, when China returns from the Lunar New Year break, will be important. Authorities will want to show that it has control of its currency which opens up the possibility for a stronger than expected fixing.
The euro remains a balance between unconvincing near term performance countered by longer term expectations for a convergence of growth between Europe and the US to eventually lead EURUSD higher. Data out this week did nothing to change this narrative so expect the euro to remain pressured by negative carry, unconvincing economic data and safe haven flows to the USD. However, the euro has increasingly been used as a funding currency. This leaves scope for the euro to strengthen as investors buy euros as they take off risk positions.
The UK has finally left the EU but nothing much has changed with the UK entering the transition period. Ultimately hard Brexit fears should reemerge as the trade deal deadline approaches but for now the markets appear to be more focused on fundamentals and global growth prospects. With questions around both of these variables, the bias is to fade the post BoE bounce.
A dovish hold from the Fed and growing concerns about the coronavirus have both worked to push USDJPY lower. Last week the World Health Organization (WHO) declared the outbreak an international health emergency. While the WHO's involvement has somewhat eased the market's concern, the expectation remains for the outbreak to continue to spread and safe haven demand to persist.
The Bank of Canada's dovish pivot has opened the door to a cut and put increased importance on incoming data. To this point, last week's GDP data technically beat expectations but doesn't change the overall picture. The employment report due out Friday of this week will the data highlight. With the coronavirus outbreak expected to get worse. Expect concerns on global growth to hit commodity currencies.
The coronavirus outbreak continues to dominate the headlines and should, unfortunately, continue to get worse. China returns from its extended lunar holiday this week but concerns over the economic impact persist. Using past outbreaks as a guideline, it will likely time before authorities are able to gain control. As such scope remains for the CNY to weaken although expect the PBoC to show an obvious strengthening bias with its fixing to stabilize market expectations.
The overall picture remains unchanged for the Aussie. The domestic economy remains challenged and the bushfire crisis as well as the coronavirus outbreak add additional headwinds. The RBA is scheduled to review the economy when it reconvenes in February, making upcoming data releases more important than usual. Absent a marked uptick in data, it remains a question of when, not if, the RBA cuts again. The bias remains for AUD lower.
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