How is the COVID-19 pandemic impacting the FX market?
Concerns regarding an acceleration in the spread of the virus have caused many of the world’s governments to put in place strict containment measures designed to allay its impact. Mainland Europe has been particularly hard hit and is now very much at the epicenter of the crisis.
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Concerns regarding an acceleration in the spread of the virus have caused many of the world’s governments to put in place strict containment measures designed to allay its impact. Mainland Europe has been particularly hard hit and is now very much at the epicenter of the crisis. Italy, Spain and France are now on lockdown, having all experienced a large spike in the number of confirmed cases in the past couple of weeks. Drastic measures designed to halt the rate of contagion, such as the closure of restaurants, cafes, hotels, schools and cinemas, have been implemented across much of Europe, with borders closed and the movement of people severely restricted. Sporting events have either been cancelled or postponed, with even small gatherings now banned in many countries.The rate of growth in the number of overall confirmed cases, and indeed deaths caused by the virus, has continued to increase at an accelerated rate outside of China. Over 720,000 cases of the virus have now been reported across the globe in almost 200 countries at the time of writing (up over 500k in just two weeks), leading to the deaths of approximately 34,000 people worldwide (up almost five-fold during the same period)*. Outside of China, the number of confirmed cases now stands at approximately 640,000, accounting for almost 90% of the overall global cases. The good news is that the virus now appears to be largely under control in China, with the number of new daily cases there effectively slowing to a halt, averaging around 40 in the past two weeks*.Figure 1: COVID-19 New Daily Confirmed Cases (23/01 - 29/03)
The US has leapfrogged China and is now the worst affected country in the world, having experienced a massive surge in the number of new daily cases in the past week. Mainland Europe has also been particularly hard-hit, most notably Italy, which has experienced more deaths due to the virus than any other country. Spain also appears to be on a similar trajectory, with Germany not far behind in terms of confirmed cases (Figure 2). For context, the number of active cases in Italy (i.e. the total number of cases minus those either fully recovered or deceased) now dwarfs the same number in China almost thirty-fold. In fact, the ratio of confirmed cases to deceased in Italy currently stands at approximately 9:1 versus 25:1 in China. This is likely due to two factors, the first being the still relatively lower levels of testing conducted in Italy compared to many other countries around the world, and Italy’s comparatively high median age (46.5 years versus 38.4 in China according to the Central Intelligence Agency). Figure 2: COVID-19 Confirmed Cases [Europe] (26/02 - 29/03)
In the FX market, the most popular trading strategy throughout much of the past few weeks has been for investors to buy the US dollar, particularly at the expense of emerging market currencies. The dollar has acted as the safe-haven currency of choice among traders during the crisis, as it has tended to do during times of intense market stress in the past. We outline below the three main reasons why we think the dollar has outperformed:1) It is the most liquid currency in the world.2) The US economy is less reliant on external demand than much of the developed world, particularly Europe.3) The spread of the virus has been relatively less aggressive in the US than in Europe and Asia throughout much of the outbreak, particularly as a percentage of the total populus. An increase in the rigorousness of testing in the US has, however, led to a sharp increase in the number of confirmed cases there, with the country having now overtaken China as the worst affected country in the world.In trade-weighted terms, the dollar appreciated by 8% in the ten days or so from 10th March, although it has since given back some of its gains. The main EUR/USD pair has suffered from a very volatile few weeks, initially rallying sharply before crashing to a near three-year low below the 1.07 level. Now that the Federal Reserve has cut interest rates all the way down to zero, the reason for investors to buy the euro in the expectation of a narrowing in US-Euro Area interest rate differentials is now gone. Among the other major currencies, the Norwegian krone and Australian and New Zealand dollars have been among the most exposed, as has sterling. The UK currency fell to its weakest position versus the US dollar since 1985 on 18th March (Figure 4). Measures of implied volatility in the pair have sky-rocketed and have exceeded levels witnessed following the Brexit vote in June 2016 during the current crisis - levels that were deemed as unlikely to be reached again in a generation. We attribute the extent of the sell-off to investors unwinding their long GBP positions put in place following the UK election in December, and the pound’s higher risk premium due to Brexit and the country’s large external deficit.Figure 4: GBP/USD (February ‘20 - March ‘20)In the emerging market universe, a host of currencies have fallen to multi-year lows. Among the worst affected have been the currencies of countries that are heavily dependent on the production of commodities, particularly given the sharp sell-off witnessed in oil (down 70% in around a month). The Russian ruble has been among the worst affected, shedding around 16% of its value against the dollar so far in March alone. Elsewhere, the Mexican peso and Colombian peso have also experienced dramatic losses, with the Brazilian real and South African rand not far behind and down in excess of 10% this month at the time of writing. Further losses from current levels for these high-risk currencies are possible, in our view, while the virus is yet to peak in the key economic areas around the world.Figure 5: FX Performance Tracker [select currencies vs. USD] (March 2020)
The US has leapfrogged China and is now the worst affected country in the world, having experienced a massive surge in the number of new daily cases in the past week. Mainland Europe has also been particularly hard-hit, most notably Italy, which has experienced more deaths due to the virus than any other country. Spain also appears to be on a similar trajectory, with Germany not far behind in terms of confirmed cases (Figure 2). For context, the number of active cases in Italy (i.e. the total number of cases minus those either fully recovered or deceased) now dwarfs the same number in China almost thirty-fold. In fact, the ratio of confirmed cases to deceased in Italy currently stands at approximately 9:1 versus 25:1 in China. This is likely due to two factors, the first being the still relatively lower levels of testing conducted in Italy compared to many other countries around the world, and Italy’s comparatively high median age (46.5 years versus 38.4 in China according to the Central Intelligence Agency). Figure 2: COVID-19 Confirmed Cases [Europe] (26/02 - 29/03)How are financial markets reacting to the crisis?
The reaction in the financial markets has been aggressive and violent and akin to the moves witnessed during the global financial crisis in 2008/09, if not sharper. Equity markets have borne the brunt of the sell-off as investors flee higher risk assets in favour of the safe-havens or, in many cases, exit the market altogether. US stock indices have stabilised, although are still down approximately 25% since mid-February at the time of writing, with equities in Europe lower by a similar amount. The FTSE 100 index, for instance, has tumbled to its lowest level since 2011, having shed one-third of its value in under three weeks (Figure 3). Large scale intervention on the part of central banks and governments has helped to some extent, although it has far from fully restored investors confidence.Figure 3: S&P 500 and Dow Jones Industrial Average Indices (March ‘19 - March ‘20)In the FX market, the most popular trading strategy throughout much of the past few weeks has been for investors to buy the US dollar, particularly at the expense of emerging market currencies. The dollar has acted as the safe-haven currency of choice among traders during the crisis, as it has tended to do during times of intense market stress in the past. We outline below the three main reasons why we think the dollar has outperformed:1) It is the most liquid currency in the world.2) The US economy is less reliant on external demand than much of the developed world, particularly Europe.3) The spread of the virus has been relatively less aggressive in the US than in Europe and Asia throughout much of the outbreak, particularly as a percentage of the total populus. An increase in the rigorousness of testing in the US has, however, led to a sharp increase in the number of confirmed cases there, with the country having now overtaken China as the worst affected country in the world.In trade-weighted terms, the dollar appreciated by 8% in the ten days or so from 10th March, although it has since given back some of its gains. The main EUR/USD pair has suffered from a very volatile few weeks, initially rallying sharply before crashing to a near three-year low below the 1.07 level. Now that the Federal Reserve has cut interest rates all the way down to zero, the reason for investors to buy the euro in the expectation of a narrowing in US-Euro Area interest rate differentials is now gone. Among the other major currencies, the Norwegian krone and Australian and New Zealand dollars have been among the most exposed, as has sterling. The UK currency fell to its weakest position versus the US dollar since 1985 on 18th March (Figure 4). Measures of implied volatility in the pair have sky-rocketed and have exceeded levels witnessed following the Brexit vote in June 2016 during the current crisis - levels that were deemed as unlikely to be reached again in a generation. We attribute the extent of the sell-off to investors unwinding their long GBP positions put in place following the UK election in December, and the pound’s higher risk premium due to Brexit and the country’s large external deficit.Figure 4: GBP/USD (February ‘20 - March ‘20)In the emerging market universe, a host of currencies have fallen to multi-year lows. Among the worst affected have been the currencies of countries that are heavily dependent on the production of commodities, particularly given the sharp sell-off witnessed in oil (down 70% in around a month). The Russian ruble has been among the worst affected, shedding around 16% of its value against the dollar so far in March alone. Elsewhere, the Mexican peso and Colombian peso have also experienced dramatic losses, with the Brazilian real and South African rand not far behind and down in excess of 10% this month at the time of writing. Further losses from current levels for these high-risk currencies are possible, in our view, while the virus is yet to peak in the key economic areas around the world.Figure 5: FX Performance Tracker [select currencies vs. USD] (March 2020)