After decades of economic growth, Australia is set to enter its first recession in 29 years. In reality, this economic crisis has been an accumulated one. Over the past several months, Australia has gone through a drought, brushfires and now the COVID-19 shutdown.
Thankfully for Australia, its long expansion allows the country more policy flexibility to respond than most countries. In total, Australia has delivered direct support measures totaling 11% of GDP. The relief package includes wage support that will cover ~6 million workers (out of a 13 million workforce) for six months at ~70% of average earnings. Moreover, if you include monetary measures from the RBA, the total government support increases to 16% of GDP and leads the pack relative to what other countries have spent.
With the government having stepped up with strong fiscal and monetary measures, the expectation is for the RBA to hold rates steady at next week’s meeting and refrain from making material adjustments to its unconventional policy package as broader market conditions have started to normalize and RBA board minutes indicated “no appetite for negative interest rates.”
However, over a longer window, further steps/adjustments to policy will be needed. The spread of the virus has shown no signs of slowing. Clearly, those countries facing upward sloping infection curves will not perform economically. Even China, which has started normalizing activity, will take time to return to normal as external demand shocks from its trading partners will be significant and protracted. Once the RBA has to make adjustments, expect more explicit guidance on targets further out on the yield curve and measures to strengthen forward guidance to be two levers likely to be pulled.
Last week, the US jobs report and European PMIs gave a glimpse into the negative economic impact of the virus outbreak with the impact only expected to get worse. On the week, EURUSD fell by ~3.0% and there really isn’t a compelling reason to fade the move. Europe continues to struggle to find a strong/unified fiscal response and remains hard hit by the virus. While the US is also being hit by the virus, the US economy was stronger going into the outbreak and benefits from strong monetary and fiscal responses.
GBPUSD has made one of the biggest moves up from its lows within the G10 space. While part of this move is due to the magnitude of the initial drop, a weaker GBP remains a reasonable reaction to unique headwinds created by the combination of COVID-19 and Brexit headwinds as well as the UK’s sizable current account deficit that makes it vulnerable to a pullback in global flows.
While markets stabilized last week, especially compared to recent history, material headwinds remain. The US has yet to reach peak infection and clarity around the ultimate economic impact remains elusive. As such, safe haven demand is expected to remain persistent. 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.
Oil appears to be the asset class currently being targeted by policy makers. As such, petrocurrencies should receive a boost should next week’s OPEC+ meeting deliver the cuts expected. However, the CAD still remains vulnerable. Its basic balance remains one of the worst in the world and exposes the CAD to reversals in capital flow. Even with the uptick in energy prices, Canada remains one of the highest cost producers, leaving production shutdown risk alive. With virus driven growth and unemployment headwinds, the bias is for a weaker CAD.
Reports continue to point to a normalization of economic activity in China. However, the virus continues to spread in other parts of Asia, Europe and North America and will lead to a demand shock for China, muting the pace of China’s recovery. Near term, expect currency stability as this is what the PBoC aims to achieve. Longer term, additional fiscal and monetary policy levers and a head start on virus control argue for CNY outperformance.
Although the Australian government has stepped up massive amounts of fiscal and monetary stimulus, the virus outbreak remains a global concern. The RBA is expected to remain on hold this week but further action will be needed. The virus has shown little signs of slowing down and should continue to drag on global growth, including China due to demand shocks. Continue to 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 interest rates to remain at 0.25%
Expectations for interest rates to remain at 0.75%
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