One of the clearest public sector responses to the COVID-19 outbreak has been a rush to draw down as much precautionary cash as possible. This panic driven demand has put strains across a variety of markets including short term funding, US Treasuries and agency mortgage backed securities.
This is why central banks around the world have responded with a bazooka of measures designed to add liquidity to the marketplace. Some of the notable steps taken in the US include large scale asset purchases and access to the discount window. But what happens if these steps are not enough?
The COVID-19 crisis hits the livelihood of households and business. While some businesses have access to the banking system and capital markets, many businesses do not. For scope, labor market data shows that 25% of the workforce works for companies with 19 employees or less. These smaller companies are the ones that face the most difficulty during economic downturns.
Part of the answer to the shortcomings of monetary policy is to fill it with fiscal policy solutions. Direct payments, tax rebates or payroll tax deductions will provide relief for small businesses in ways to which current monetary policy measures are unable. One of the dangers here is the timing of things. Clearly, time is of the essence as liquidity conditions can deteriorate much faster than the government can legislate.
Government officials have been swift and decisive with their actions so far, but ultimately, more still needs to be done. The Fed does not have the authority to purchase corporate bonds, credit card receivables or bank loans. However, former Fed Chairs Yellen and Bernanke have suggested the Fed gain these authorities on an emergency basis. Alternatively, the banking sector could be used as a vehicle to aggregate these losses during the lockdown with the Federal government ultimately making the banking sector whole. Whether or not these measures are the correct ones, what is clear is that extraordinary times call for extraordinary measures.
With the Fed cutting to the zero lower bound and euro funded carry trades unwinding, EURUSD correlation to the equity markets have returned positive. Currently, Europe is one of the hardest hit areas by the virus. As such, expect EURUSD to remain pressured by economic and COVID-19 concerns.
Bias still remains bearish on the pound. Covid-19 fears continue to pressure global assets and the BoE’s emergency rate cuts have exacerbated the UK’s large current account deficit that is not compatible with its low yielding status. EU-UK trade talks have been suspended for now and an extension is likely, however the reality remains stark with both sides still far apart and the probability for a hard Brexit outcome not immaterial.
USDJPY has recovered a bit from its lows as the markets stabilized a bit at the end of last week. Given this, the expectation is for things to continue to get worse before they get better which will support safe haven demand. Keep an eye on Japanese investor demand for foreign risk assets, which has been a key factor dislocating USDJPY from levels implied by yield differentials. With Japanese long-term yields expected to persist below zero, investor outflows should continue and provide a counterweight to safe haven demand.
Falling oil prices as well as relatively more room to cut rates have been two key factors behind CAD weakness. Looking forward, these two issues should continue to put pressure on the loonie. With COVID-19 concerns continuing to roil markets, expect USDCAD higher on both USD safe haven demand and CAD weakness.
This past week brought headlines of China making purchases to keep its side of the Phase 1 deal with the US. Moreover, reports are emerging that economic activity is beginning to normalize in China. However, the virus continues to spread in other parts of Asia, Europe and North America meaning global growth remains in a precarious position. As such, expect further weakening in the near term. Longer term, the expectation that China will meet the Phase 1 currency clause, additional fiscal and monetary policy levers and head start on virus control argue for CNY outperformance.
This past week, the RBA took emergency steps to cut rates and launch its QE program as it joined the wave of central banks providing stimulus to the markets. As with other commodity currencies, expect COVID-19 headlines to drive price action as these headlines inform the extent to which global growth and commodity demand will fall.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
Expectations for rates to remain unchanged at 0.75%
Expectations for rates to remain unchanged at 0.10%
Expectations for rates to remain unchanged at 6.10%
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US Manufacturing and Services PMI
Expectations for a 45.0 and 44.0 print, respectively
US Durable Goods Orders
Expectations for a decline of -1.0%
US Initial Jobless Claims
Expectations for claims to spike up to 750K
EU Manufacturing and Services PMI
Expectations for a 40.0 and 39.8 print, respectively
German Manufacturing and Services PMI
Expectations for a 40.0 and 43.5 print, respectively
UK Manufacturing and Services PMI
Expectations for a 45.0 print for both data series
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