Morning Commentary: The R Word

Foreign Exchange - Morning Commentary
The R Word
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The rapidly evolving COVID-19 crisis has triggered a wave of forecasting “waterfalling” with analysts issuing downward revision after downward revision.  These revisions have led to a growing narrative that COVID-19 will push the world into a recession.    

News headlines that are coming out in rapid succession show that what has happened in China is now happening around the world.  As we have touched on in past commentaries, the main economic drag is expected to be due to the partial shutdown in economic activity.  One of the clearest take-aways for recent events is that narrowly targeted strategies do not work and only broad-based economic shutdown measures (i.e. California’s state-wide lockdown) will help contain the virus. 

Put another way, measures similar to what had been imposed in China will be needed in the rest of the world.  However, given the differences in dynamics between China and Western democracies, the speed and scope of shutdowns in the Western world cannot match what happened in China.  As a result, it is likely that the disruptions will last longer in the Western world. 

What this means is the economic impact will likely follow the path of the virus and resulting quarantine measures.  China will feel the economic impact through a dramatic fall in Q1 GDP whereas Europe and the rest of Asia will see economic activity spread over Q1 and Q2.  Expect the US to feel the brunt of the pain in Q2 with double digit annualized QoQ contraction becoming the base case. 

However, it is important to remember that there is a high level of uncertainty around economic forecasts due to the nature of this crisis.  Therefore, it is critical to keep track of high frequency indicators such as traffic, school closures, and early labor market data such as initial jobless claims.  Of course, stimulus is important in determining how deep this recession goes and how long it lasts.  With no upper limit in place on the size of stimulus, timing is the remaining obstacle putting the ball firmly in Congress’s hands.  
  • Markets appear to be stabilizing, but this is most likely just a break as additional negative headlines are surely on the way.  Policy action has been swift and decisive but further action will be needed as there remains areas of the economy that have not benefited by the actions to date.  On a broader picture, this is a health crisis, not a financial one, so the financial tools being used have a limited ability to address the virus’ impact. 
  • The USD is weaker on the session, which isn’t a surprise given the huge run up on which it has been.  The pullback in the greenback has given some breathing room for some of the hardest hit currencies with the GBP rising as much as 3.4% and breaking an 8-session losing streak.  Other big winners include the AUD and CAD.
  • While the USD is down today, demand for the USD remains strong due to a rush into safe havens.  Recent headlines raise the possibility of coordinated intervention to help weaken the dollar, but we have some skepticism on this front.  Policymaker focus remains squarely on avoiding a recession leaving exchange rates as a secondary issue. 
  • The central bank of Denmark actually hiked rates by 15 bps in a move to support the krone.  Conversely, the Norwegian central bank delivered its second emergency cut, reducing rates by 75 bps to 0.25%, a record low.  Additionally, it is expected that the UK will announce additional stimulus measures today.   
  • Oil prices bounced sharply higher yesterday partially driven by reports that the US could step in to help resolve the Saudi-Russia oil conflict. 
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