It’s Central Banks Vs. Coronavirus

Daily FX Market Roundup 02.04.20

By Kathy Lien, Managing Director Of FX Strategy For BK Asset Management

Currencies and equities traded sharply higher today with the Dow soaring more than 400 points intraday. Based on this rally and the strong performance in USD/JPY, it would be easy to assume that coronavirus fears are easing and investors are moving on. However, we have not even seen the beginning of the impact of the virus on economic data and the only thing masking the pain is Chinese stimulus. On Monday, Chinese banks were urged to provide liquidity, the government sent out guidances to limit short selling, cut interest rates by 10bp and injected $175 billion into the banking system. Overnight, the central bank provided even more liquidity through reverse repos and confirmed that the “national team” of state-backed buyers is prepared to buy stocks if necessary. For now, all of these efforts combined with strong earnings reports from big U.S. names effectively stemmed the slide in currencies and equities.

The U.S. and Australian dollars were the best performers with USD/JPY experiencing its strongest one-day rally in 3 weeks. There’s a lot of overhead resistance between 109.50 and 109.70 but if stocks push higher, so will USD/JPY. The Australian dollar rallied on the back of the Reserve Bank’s rate decision and its gains helped to lift NZD. Euro and the Canadian dollars were the weakest performers. While EZ data has been mostly positive, the conflicting stances by the UK and EU on post-Brexit trade along with a close election in Ireland are beginning to weigh on the currency.

Its central banks versus the coronavirus and right now central banks are winning. Investors were also comforted by the Reserve Bank’s decision to keep interest rates unchanged. According to RBA Governor Lower, the virus “is having a significant effect on the Chinese economy at present. It is too early to determine how long-lasting the impact will be.” Based on these comments, the RBA feels that despite the spread of the virus and the potential economic impact, they don’t see an immediate need to ease. Although the market still expects a rate cut later this year, equities and currencies are rallying because investors think this wait-and-see attitude could be shared by other central banks. Another way to explain this is that while the market panicked at the start of the year, everyone but the PBoC has not and they want to see how deep the impact really is before reacting.

With that said, the virus’ economic toll will be significant. SARS cost the world $40 billion and between the lost travel revenue to the earnings dent for companies like SBUX, DIS, MCD and AAPL who have closed their stores and airliners who have canceled flights to China, the impact will be much bigger. So while central bankers are successfully propping up the markets right now, when the dust settles and the numbers are shared, risk aversion will return.

For the time being, incoming data like Monday’s better-than-expected ISM manufacturing report doesn’t truly reflect the impact of coronavirus. Tonight’s New Zealand labor-market report could beat as well with the Manpower index showing an improvement in labor-market conditions. Non-manufacturing ISM is also due from the U.S. and a mild improvement is anticipated. However, Eurozone retail sales is expected to weaken with spending falling sharply in Germany and France. The sharp drop in IVEY PMI last month foreshadows deterioration in Canada’s trade balance.

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