Morning Commentary: Light at the End of a Long Tunnel

Foreign Exchange - Morning Commentary
Light at the End of a Long Tunnel 
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Risk markets rebounded sharply yesterday and continue to move higher today on the back of virus numbers signaling tentative progress in several key economies.  Fatalities in Spain and Italy have stabilized and should trend lower soon.  In New York, the virus fatality rate has been flat for two days and sits below the base case of most watched models.  Moreover, market volatility has pulled back from its very extreme levels just weeks ago.   

Clearly these developments are all positive, but everything needs to be taken in context.  FX volatility still sits above 10%, meaning uncertainty still remains high on a historical basis and continues to support defensive FX positioning, i.e. a stronger USD.  

From a technical basis, increased USD funding sources have helped to alleviate some of the funding demand that has pushed the dollar higher, but it is important to remember that funding pressures were not the main cause of the USD’s anticyclical bid.  Case in point, increased dollar liquidity does not alleviate balance sheet stress on international borrowers that have net USD liabilities which will lead to credit during recessionary periods.  

This is important because the recent run of positive headlines, while welcomed, is not enough to reverse the broad recessionary trend that dominates the market.  Yes, Italy reported its lowest level of new infections in 3 weeks but will still remain in lockdown even after the virus peak has passed.  Of course, other parts of Europe are still behind Italy on the infection curve, and the rate of infection in the US overall is still accelerating.  Even if a country is past the infection peak, a second wave of infections remain a risk.  

Because of this, it is prudent to remain defensive in the FX space even after the inflection curve begins to flatten amid unprecedented global policy support.  The speed of the pulldown in global growth has been unprecedented, but it still remains in its early stages.  With the extent of the downturn still unclear, it is difficult to calculate the ultimate economic damage.  Case in point, two weeks of initial jobless claims has delivered ~85% of the jobless claims from the 1980, 1990 and 2001 recessions but only ~33% of the losses in the 1981 and 2007 recessions. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Democrats continue to work on an additional round of stimulus reported to be at least $1 trillion and will include additional direct payments to individuals as well as funds to replenish programs established in previous support packages.  
  • Oil prices are up on the session as Saudi Arabia and Russia are reportedly closing in on a deal that could include a three month reduction starting in May.  Additionally, any production deal will likely have to include U.S. participation.  
  • U.K. PM Boris Johnson has been admitted into the ICU where he is receiving oxygen but not on a ventilator.  Foreign Secretary Dominic Raab will take over for the interim.  This adds further uncertainty to the U.K. picture as the country continues to fight the virus outbreak and continues to maintain that it has no desire to extend the Brexit transition period set to end this year.   
  • European Finance Ministers will hold a conference call today to discuss what, if any, actions will be taken to address the virus outbreak.  Of particular note is the call from some countries, and resistance from others, to mutualized debt in order to raise funds to finance measures to fight the virus’ impact.  Given the current landscape, a breakthrough today is unlikely.   
  • Japanese PM Abe has declared a state of emergency over seven prefectures that account for ~50% of total GDP.  
  • The Reserve Bank of Australia met last night and kept rates unchanged as expected; it had previously stepped up with decisive emergency steps.  The AUD is one of the G10’s top performing currencies as the bank also said it could taper bond purchases if market conditions continue to improve.  Data wise, Australia’s trade surplus narrowed to AUD4.4 billion with exports of goods and services dropping 5% MoM.  The sharp decline in exports was partially offset by an across the board decline in imports.  
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