USD Gets Slammed, Is the Bull-run Over?
USD gets slammed, is the bull-run over?
Let’s have a quick recap of how USD has performed this year.
Up until the end of last week, USD was on an absolute bull run.
In January, the Chinese economy was paralysed by the Covid-19 outbreak. As such, all economies seen as exposed to the economic disruption in China saw their currencies sell-off.
Asian EMFX, AUD and NZD were all battered. The US was seen as less exposed to Chinese economic weakness, thus USD kept going higher.
Adding further support for USD (at the expense of EUR and JPY) was a string of data that suggested that the US economy had performed slightly better than expected in January, whilst both the Eurozone and Japanese economies had performed worse than expected at the end of 2019.
But since the end of last week, things have changed.
Triggering the initial pullback in USD last Friday was a combination of bad US February PMI data and strong Eurozone February PMI data, which served to undermine the argument that the Eurozone is more exposed to coronavirus-linked Chinese economic weakness than the US.
However, wrangling over who is more or less exposed to Chinese economic weakness seems irrelevant now, since the international spread of Covid-19 picked up pace over the weekend.
Unfortunately, Europe, the Middle East, South Korea and Japan all appear to be nursing their own self-sustaining outbreaks. US confirmed cases seem certain to drastically rise soon. Could huge economic disruption like we have seen in China be coming to Europe, Japan and even the US? Unfortunately, this seems likely.
Global Covid-19 is not good news for USD
As I discussed in a recent blog post, coronavirus going global makes it much more likely that central banks like the Fed, ECB and BoJ will have to ease policy in order to support their economies.
But the Fed has WAY more room to ease policy either the ECB or BoJ (Fed funds rate is at 1.5%-1.75%, ECB and BoJ rates are both negative and both are already doing QE).
As a result, we have only seen a modest rise in the market’s expectations for easing from the ECB and BoJ, but a HUGE rise in expectations for rate cuts by the Fed.
Indeed, money market now expect the Fed to ease policy by 75bps by the end of the year and price a cut with near certainty by the April meeting.
All of this is bad news for USD.
Why EUR might be an outperformer
The aforementioned lack of ammunition left at the ECB to further ease policy to counter a downturn should prove supportive of EUR.
Another point worth mentioning is that in times of “panic” (as we may be starting to see in the market as this coronavirus outbreak becomes more serious) EUR tends to be supported given its status as a funding currency. Basically, we might see EUR act with slight safe-haven properties, as we have previously seen in USD.
What that means is; given that the EUR has a negative yield, borrowing in EUR (selling EUR) to lend in another higher-yielding currency (buying EMFX, for example) is attractive, as you can make “risk-free” money. However, when times go bad (as they look to be right now), people often close these positions, leading to flows back to EUR.
Obviously, market narratives can quickly shift. One week of good US data/bad European data and everything could change, for example.
That is why keeping on top of these key themes driving markets is SO important to your long-term trading success.
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