Morning Commentary: Market Calm with a Side of Weakness

Foreign Exchange - Morning Commentary
Market Calm with a Side of Weakness
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
After the intense deleveraging experienced during March, FX markets have settled into a consolidative phase.  Despite this, the global economic backdrop remains stark with it tracking for the deepest recession since the Second World War.  Thankfully, there are some emerging signs of stabilization in data, and monetary and fiscal policy responses are still increasing.  Nevertheless, it is still prudent to remain defensive. 

A key reason for this is the lack of visibility around the timing and shape of the recovery.  Most economists expect a rebound in the second half of the year but that doesn’t mean we get back to where we were pre-COVID-19.  Data out of China supports this concern as PMIs and retail sales have rebounded but show continued weakness in consumption.  Adding to this rebound uncertainty is the risk of a second wave of infections that continues to weigh on sentiment and confidence. 

Last week also saw a ramp up in US-China tensions that has continued into this week.  The US administration has blamed China for the pandemic and took steps against China’s Huawei as well as accused China of spreading the virus.  Further adding to the strain is the likely scenario where China is unable to live up to the purchase agreement in the US-China Phase 1 deal. 

On a broader level, policy rates around the world remain near zero.  This leaves differentiation between currencies more contingent on factors such as central bank stimulus activism, government indebtedness and external vulnerabilities (reliance on foreign capital etc.) 

Against this backdrop, expect the FX market to be asymmetrical to risk with sell-offs sharper than rallies.  Liquidity also remains thin with market depth ~35% below pre-COVID-19 levels.  All this supports a defensive stand/further USD strength. 
  • Equity markets are up on vaccine hopes as an experimental vaccine from Moderna showed promising early signs. 
  • US-China tensions continue to be elevated with White House officials accusing China of sending airline passengers to spread the virus.  For China’s part, it has been relatively subdued in its response ahead of this weekend’s National People’s Congress.  It is likely that Beijing wants to avoid adverse market movements ahead of the meeting and is saving its real retaliation for afterwards.  Chinese President Xi addressed the WHO’s decision-making body today as international leaders call for an investigation into the source of the virus. 
  • Comments from BoE Chief Economist Andrew Haldane fed speculation about the possibility of negative rates in the UK.  Given the current state of the economy, it isn’t surprising that policy makers are considering all measures, even the extreme ones, so expressing the need to study negative rates shouldn’t be a surprise.  Given this, the bar for going negative remains high as BoE Governor Bailey’s push back on negative rates illustrates.
  • Oil prices continue to move higher with WTI trading around a two month high.  Market data shows Chinese oil demand is almost back to pre-COVID-19 levels.
  • Japan’s Q1 GDP came in better than expected with GDP contracting -3.4% against expectations for a -4.5% decline. The numbers showed broad based weakness offset by government consumption.  It should be noted that lockdowns were not in effect until April so Q1 relative strength should not be extrapolated out to Q2. 
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