The Week Ahead: Before the Dust Settles

Foreign Exchange: The Week Ahead
Before the Dust Settles
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Risk sentiment absolutely plunged this past week with equity markets around the world selling off in a brutal fashion.  It is still too early to know the ultimate impact of the virus, but here is what we know right now. 

What is the state of the epidemic?

The good news is that things appear to be getting better in China.  Daily deaths and new cases continue to fall.  Given this, it is also important to keep an eye on real time sentiment measures such as when schools are reopened as a measure of how much progress the government thinks it is making. 

The bad news is that cases are popping up outside of China with Europe being hit hard.  In the US, the Center for Disease Control has disputed the claim from the White House that warm weather will slow the spread of the virus.

What are the macro level concerns?

When the virus first started spreading, the initial concern was on the manufacturing side.  Closed factories would disrupt the global supply chain as a lack of components from Chinese factories caused factories outside of China to also close due to a lack of raw materials. 

However, manufacturing has the advantage of “bounce back” factors.  Once firms ramp production back up, they should be able make up much of the lost productivity.  The issue gets trickier with services, the larger part of the economy.  If a consumer cancels a trip due to virus fears, it is unlikely they will fly twice as much once fears fade.  For scope, the United Nations estimates tourism to be over 10% of global GDP, making the potential impact very material.
 
What can central banks do?

Countries that have the most room to cut, such as the US and Canada, have seen markets aggressively price in monetary action despite the fact that monetary support might not address the cause of the issue.  For example, if a factory closed due to fear of contagion, lowering rates will not help it open any faster. 

But monetary policy can still play a positive role.  Easier monetary policy should put a floor under asset prices and help mitigate the negative impact of negative wealth effects.  Keep in mind that recessions often have a negative feedback loop.  Financial assets fall, then consumers pull back which hurts the real economy which in turn cause financial assets to fall further. 

What will the Fed do?

Likely the absolute level of equity markets, despite the recent plunge, doesn’t concern the Fed.  It is the speed of the move that is likely more of a concern.  Ideally, the Fed would like to wait to understand what the actual real economy impact of the virus will be.  However, with markets pricing in a 94% chance of a 50 bps cut for the March meeting, the Fed will most likely not want to disappoint the market if stocks continue to sell off sharply.        

FORECASTS

EUR

Last week, the euro had been one of the beneficiaries of the market’s risk off move.  Because the Fed has more room to cut rates than the ECB, the USD weakened as markets priced in more cuts on the USD side than euro side.  With things likely to get worse before they get better, expect further negative headlines on Covid-19 to continue out of Europe.  While the near term price action will be influenced by rate cut expectations, the benefit to the euro should be capped.  The European economy remains weak and highly exposed to weakening global growth.  As such, the medium term trend remains for EURUSD lower. 

GBP

Bias still remains bearish on the pound.  Covid-19 fears continue to pressure global assets and EU-UK trade tensions remain high.  If anything, the tone has soured further with negotiating positions confirming how far apart the two sides are.  Next week brings the start of negotiations so headline risk on the trade issue are front and center. 

JPY

Japan’s overseas portfolio investment flows remained strong for the week ending February 21, but this pace was moderate from the previous week.  This flow data will be a key measure to watch in light of the support it has provided USDJPY and the sharp risk asset selloff this past week.  Historical experience around VIX shocks is mixed, but outflows are likely to be relatively resilient.  Beyond flows factors, expect risk off/Covid-19 fears to continue to be a key driver.  The news trend currently slants negative which supports further safe haven demand. 

CAD

Canadian GDP beat expectations with consumption coming in strong.  Ultimately the data is backwards looking and the BoC will be looking at current risks at its meeting this week.  Any momentum in December is likely irrelevant due to Covid-19.  As a result, the GDP beat likely has minimal impact on the BoC.  With North American central banks (Fed/BoC) having more room to cut, the USD and CAD remain most vulnerable to pricing in Covid-19 risk. 

CNY

The coronavirus outbreak continues to dominate the headlines.  From China’s perspective, the rate of infection in the country appears to be slowing, but from the world’s perspective, cases outside the country are picking up.  Headlines around the rate of new infections as well as how soon the government re-opens factories will be important as it reflects how much progress the government believes it is making on the virus.  Absent any materially negative virus headlines, expect stability with the currency. 

AUD

Headlines last week around Covid-19 have taken a clear turn negative, especially outside of China.  As such, it is reasonable to expect markets to remain very concerned about global growth for some time.  This should cap any gains to commodity currencies.  Prior to the outbreak, the bushfire crisis and other factors were already pressuring the domestic economy.  Clearly things have gotten worse since then which does not bode well for the AUD and supports the view that the RBA will cut again in the near term. 

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

3/2 Australia Expectations for rates to remain at 0.75%
3/4 Canada Expectations for rates to be cut by 0.25% to 1.50%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

3/2 US Manufacturing PMI Expectations for a 50.8 print
3/2 ISM Manufacturing Index Expectations for a 50.5 print
3/6 US Non-farm Payroll Expectations for a 175K increase in jobs
3/6 Canadian Jobs Report Expectations for a 10K increase in jobs

Europe/Eurozone 

3/2 EZ Manufacturing PMI Expectations for a 49.1 print
3/3 EZ CPI MoM Expectations for a 0.2% increase
3/3 EZ Unemployment Rate Expectations for a 7.4% print
3/2 German Manufacturing PMI Expectations for a 47.8 print
3/5 German Factory Orders Expectations for a -5.4% decline
3/2 UK Manufacturing PMI Expectations for 51.9 print

Asia/Japan, and New Zealand 

3/2 Chinese Manufacturing PMI Expectations for a 46.0 print
3/3 Australian Q4 GDP Expectations for a 0.4% increase

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