FX The “Oasis of Relative Calm” in Markets as Analysts Ponder Next Moves

A series of coordinated central bank actions around the world has failed to stave off another collapse in equity markets with volatility spiking once again and several indices down more than 5% on the day. The Federal Reserve cut rates by 100bp on Sunday and promised further QE initiatives, it also suggested in its forward guidance that the QE programme may be ramped up again. Elsewhere, there were policy easing moves from central banks in New Zealand, Hong Kong and Japan and a group of major central banks agreed to enhance dollar liquidity in global markets.

While equity markets reversed a large chunk of the gains made on Friday, dealers report FX markets working without issues in Asian and European hours, with one observing that the market is an “oasis of calm” amid the mayhem in other markets. FX markets are busy, but not to the degree witness last Monday when several LPs and multi-dealer platforms hit record volumes.

This is not the case elsewhere, as Ralf Preusser, global head of Rates research at Bank of America Merrill Lynch notes today, “COVID-19 is exposing flaws in the post-crisis market structure, with severe dislocations across rate markets. Trading without a functioning risk-free anchor and without a liquid hedge will be challenging.”

Generally speaking, analysts are unsurprised at the markets’ reaction. Writing in a note to clients before the Fed’s announcement, while predicting the 100bp rate cut (and subsequent sell off), Standard Chartered Bank’s head of global G10 FX research Steven Englander said, “If rate cuts on their own were going to work, we would have seen evidence of this already given how far rates have moved…Activity may fall sharply in coming months and there is not much demand policy can do prevent this. Monetary and fiscal policy will likely aim at helping viable companies get the credit support so that activity can bounce back once the disease abates.”

Meanwhile Oanda senior market analsyst, Edward Moya, notes that the Fed’s action has pushed the focus back onto the government as a fiscal response is “critical and needed soon”. He adds, “The Fed is now all-in on currency wars and their actions should help keep the dollar vulnerable as they finally erased their interest rate differential advantage.”

Analysts at In Touch Capital Markets agree on the likelihood of dollar weakness, writing today, “[price action] looks consistent with investors placing a much higher likelihood on potential for success in combating liquidity/functional strains in markets than the likelihood that action will cushion the economic blow. This makes a degree of sense, since the template for ensuring money markets don’t freeze is known following the GFC and central banks were ultimately successful in that episode. They appear to have learned their lesson from the crisis, but it is less clear that the same can be said of fiscal policymakers.

“As such, this could foretell an extension of USD weakness moving forward,” they add. “Weakness may be concentrated against non-USD safe-havens should sentiment fail to improve. Improved sentiment looks unlikely until there is greater certainty on the public health crisis itself in the way of ‘flattening in the curve’ of new infections or even the perception that sufficient public health measures are being put into place, with those seen in China, Singapore and Taiwan viewed as best practices.”

Looking at the sell off, Standard Chartered’s Englander sees the violent price action as a combination of four factors. The coronavirus is clearly spreading in the US and Europe, and more dramatic containment measures may well be implemented,” he writes. “This points to a much weaker Q2 and raises question marks for Q3 if the economic impact cannot be mitigated. The Fed measures make it easy for depository institutions to access very cheap credit, but it is unclear how much this credit easing will extend to corporates and households.

“Borrowing needs may be primarily for long-term credit on very easy repayment terms, not short-term credit, whose servicing may become onerous if rates back up,” Englander observes. “Fed Chair Powell, in his press conference, basically said that it is up to Congress to use fiscal policy to help the economy deal with the storm, and that there is little confidence among investors in Congress’ ability to move quickly. The economic costs rise sharply if a short-term disease shock becomes a solvency shock to the private sector.”

The need for a greater fiscal response is agreed amongst analysts, Kit Juckes, global head of FX strategy at Societe Generale, looking at the horrible data releases from China overnight, writes, “The measures introduced to stop the spread of the virus in China may have led to a sharper slowdown in activity than will be the case elsewhere but it’s clear that the measures central banks have taken, and whatever they do next, cannot prevent a major economic hit being felt globally.

“Making sure that money can still move around the economy, and the financial system doesn’t make a bad situation worse, is all they can do. Fiscal policy needs to alleviate the demand hit to businesses and employees.”

Colin Lambert

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