As an asset class, FX has been relatively ignored by investors as low volatility has relegated FX hedging as a secondary consideration to underlying asset decisions. However, FX volatility has spiked with the collapse in US yields and thin liquidity helping to explain much of this.
Initially, the USD weakened sharply as markets priced in aggressive Fed rate cuts. This drop in US yields eliminated one of the dominant themes supporting the US dollar. Subsequently, the US dollar strengthened as illiquidity exacerbated USD demand driven partly by deleveraging. Several central banks have stepped up with measures to address USD liquidity, which has led to a pullback in volatility from extreme levels.
Aggressive policy responses have helped to stabilize market sentiment. Nevertheless, volatility still remains elevated as the uncertainty around the ultimate impact of COVID-19 remains unclear. This uncertainty is illustrated by the dichotomy in rising equity markets versus more bearish survey indicators. Additionally, what the markets choose to focus on also implies elevated volatility. Positive virus data is currently dominating the market’s focus, but the extent and depth of the negative economic impact remains unknown before we even touch on the possibility of a second wave of infections.
All this suggests that there will be low conviction as markets move forward. Economic data surprises have been skewed to the downside of bearish estimates. As such, valuation measure as an anchor for hedging decisions carry less value than it normally does as the safe haven aspect of the USD dominates other signals. This all supports elevated volatility and advocates for active rather than passive engagement on FX hedging.
Last week, risk markets switched back to risk on as the US announced plans to reopen the economy and positive headlines around a possible COVID-19 treatment drug emerged. Despite this, uncertainty remains high as lockdowns continue to be extended and second wave infections are emerging. The view still remains for EURUSD to move lower. On a broader level, the US economy ended 2019 in a stronger position than the European economy. Since then, the US has been more decisive with its monetary and fiscal response, suggesting a stronger/faster rebound post-lockdown relative to Europe that has been indecisive with fiscal support and underwhelming on actions taken.
Cable finished the week up, but the magnitude of its gains somewhat masks the volatility in price action. As a high beta currency, risk positive news provides a tailwind to GBPUSD so the Gilead news is a positive albeit with reservations around the efficacy and veracity of the trial. Ultimately, the near term view remains bearish. The UK government has stepped up with more stimulus, but the virus poses significant economic headwinds that are exacerbated by Brexit issues which should start to generate negative headlines again as talks restart with both sides still far apart.
Risk sentiment turned positive last week but a lot of positive news has already been priced into the markets. While some countries are planning to reopen, others are extending the lockdown, and overall, the bias is for data to continue to deteriorate and support defensive FX positioning and safe haven demand. To this point, Japan has expanded its state of emergency declaration to cover the entire country. Continue to monitor Japanese demand for foreign assets (bond and equities) as this has been a key factor muting appreciation moves during risk off episodes. Expect further range trading.
Last week, the BoC kept rates unchanged but did expand its QE program as economic conditions should continue to deteriorate. Illustrating this point is the continued fall in oil prices as the drop in demand continues to exceed the historic production cuts. Flow wise, there is decent two way flow with no skew as markets hold one of two views: 1) oil will continue to sell off or 2) oil will recover with risk and the CAD remains cheap on valuation. Expect the CAD to continue range trading between as a definitive answer is sought. On balance, expect the loonie to be biased towards depreciation in the coming weeks due to growth risks to the US and Canadian economies. CAD should also underperform other commodity currencies as CAD benefits less from a pickup in Chinese activity.
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. Specifically on Asia, a second wave of infections are becoming an increasing concern especially in Japan and Singapore with some countries running infection rates higher than when the first shutdown occurred. Continue to expect currency stability as this is what the PBoC aims to achieve.
Since the middle of March, the AUD has been the top performing G10 currency. This outperformance has been driven by support from commodity prices, a light touch approach to unconventional monetary policy and relative COVID-19 outperformance that raises the possibility for an earlier reopening of the economy. These factors should continue to provide support in the near term as it seems like the markets want to rally, however expect things to remain choppy with uncertainty still high.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
European Board Meeting
EU heads of states will meet to discuss unfinished business regarding the European Recovery Fund.
KEY MARKET MOVING ECONOMIC RELEASES
United States and Canada
US Existing Home Sales
Expectations for a 5.36 million print
US Initial Jobless Claims
Expectations for 4.5 million jobless claims
US Manufacturing and Service PMI
Expectations for a 38.0 and 30.0 print, respectively
Canadian Retail Sales MoM (Pre-COVID-19)
Expectations for a 0.5% increase
Canadian CPI YoY
Expectations for a 1.1% increase
EZ Consumer Confidence
Expectations for a -20.0 print
EZ Manufacturing and Services PMI
Expectations for a 38.0 and 23.5 print, respectively
UK Jobs Report (Pre-COVID-19)
Expectations for a 100K increase in jobs
UK Manufacturing and Services PMI
Expectations for a 42.0 and 29.0 print, respectively
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