This past week, risk markets rallied as infection curves gave tentative signs of peaking and authorities continued to deliver unprecedented levels of fiscal and monetary support. Of particular note is that fiscal support has pivoted from measures to “keep the lights on” to ones designed to ensure sufficient demand once the lockdown has been lifted. The rally in risk assets suggests that, on balance, the markets seem to believe that the effectiveness of these policies will outweigh the remaining virus related uncertainties including extended lockdowns and worsening economic data.
However, it is important to remember that COVID-19 news remains mixed. While New York has shown a decrease in the growth rate of confirmed new cases and Italy has shown an outright fall in the number of daily new cases, other countries are seeing the emergence of new issues. In several parts of Asia, the focus has shifted to preventing a second wave of infections and the risk of asymptomatic spreaders. In South Korea, the number of cases rose again on the week, and Singapore has issued a warning on public gatherings after it had its highest increase in daily cases this past week.
In essence, uncertainty around the pandemic remains high which makes it difficult for governments to decide on policies moving forward and raises the risk of extended lockdowns. Germany, France and Italy have all pushed their initial lockdown deadlines further out into April and are likely to extend them again into May. In the US, the picture is similar. States accounting for over 90% of GDP currently have stay-at-home orders through the end of April for the early moving states and well into May for others.
The markets are a forward looking mechanism and faith in this rally stems from anticipation of a rebound in H2/2021. However the abruptness and depths of the current contraction is unprecedented. Historical evidence from past recoveries strongly suggest that most economies do not bounce back to their pre-crisis economic trend. Whether or not economies are able to recover this time around remains to be seen and supports monitoring incoming high frequency data series.
European Finance Ministers finally agreed to a fiscal response package that totals around 2.6% of GDP, which pales in magnitude compared to what other countries have done. Moreover, the issue of mutual debt still remains unresolved. Overall, the virus news remains mixed with some countries extending their lockdown but others making plans to reopen the economy. The ability for these countries to reopen their economy while keeping a second wave of infections from hitting bears watching as it better informs the ability for Western democracies to reopen than the Chinese example does. Longer term the outlook is for a weaker euro but the near term outlook is neutral.
GBPUSD has made a significant rebound from its lows and currently sits around a 1 month high. Part of this move is due to the magnitude of the initial drop and part of it is due to the UK’s strong response to the crisis. February’s GDP data failed to show a post-election bounce, raising question around the UK economy’s ability to rebound post lockdown. Additionally, COVID-19 and Brexit headwinds combined with the UK’s sizable current account deficit makes GBP vulnerable to a pullback in global flows. In total, it remains difficult to see the GBP move materially higher from here.
Markets have continued to stabilize as stimulus and virus data showing a light at the end of the tunnel has shifted the market narrative. Given this, the US has yet to reach peak infection and clarity around the ultimate economic impact remains elusive. Beyond the virus, 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. Expect yen to continue to be range bound.
Last week’s jobs report out of Canada reported that the economy lost ~1 million jobs, an amount equal to roughly 2.7% of the population. Relatively, Canada’s report is worse than last week’s US jobs report. Longer term, USDCAD still remains vulnerable. Canada’s 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.
AUDUSD was the top performing G10 currency this past week by a significant margin. Positive sentiment around the virus’s spread as well as a forceful stimulus response from the Australian government were key drivers of the move but a further climb appears difficult. While recessions are caused by shocks, they continue to persist even after the shock has dissipated. As such, expect headwinds to continue to weigh on domestic and 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%
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