Post date: 09/03/2020 09:00
The coronavirus epidemic became a full-on market rout last week. Equity indices fell worldwide, and the emergency 50 bp cut by the Federal Reserve brought only temporary relief. But the most volatile moves were seen in rates, as markets quickly priced in further cuts in the Federal Reserve rate and brough the yield in US Treasuries down to record lows. The US dollar suffered as the interest rate differential with most G10 countries shrank massively, and European currencies in general where the biggest performers of the week, led by the common currency. Emerging market performance was quite mixed, with oil-dependent countries doing poorly on the back of a collapse in oil prices while Pacific Rim currencies rebounded.
Italy’s decision over the weekend to lock down its Northern provinces, including Milan, is a stark reminder that the crisis is not yet under control. Sunday night trading in Asian is indicative of further turmoil, as US stock market futures tank and safe havens like the Yen and, for now, the Euro rally in early Asian trading.
This week markets will remain squarely focused on the evolution of the coronavirus epidemic, paying particular attention to the number of daily new cases declared outside China. The ECB meeting on Thursday will be key in terms of gauging authorities reaction to the crisis.
Sterling moved up more or less in lockstep with the Euro last week, albeit lagging the common currency slightly. Domestic matters are now on the back burner, and economic data is largely being ignored as hopelessly outdated in the face of the epidemic. The raft of data out this week (GDP and manufacturing production) is likely to be ignored. We may, however, see some effect from the publication of the Spring budget, where risks are now weighed firmly towards a more stimulative fiscal stance.
The news that Italy is locking down its northern regions, about 16 million people in all, means that the escalating response to the crisis will almost certainly result in a recession in Europa, and likely in the EU as a whole. The question now becomes the ECB response. Whereas its ability to reduce rates is quite limited, we expect the focus of the meeting to be on ways banks can support corporates, in particular the more vulnerable SME sector. We also expect Germany to announce at the very least some loosening of its fiscal stance to counteract developing recession risks. As for the Euro, the current rally has been a historically fast one, and it is starting to reach our medium term appreciation targets, so we would not be surprised to see the common currency take a breather in the short term.
The dollar suffered against all G10 currencies save the Canadian dollar. After the Federal Reserve announced a surprise 50 bp cut and an easing bias, US rates crashed and the greenback lost most of its cushion of positive interest rates. The payroll report on Friday was very strong, but markets ignored it roundly as it does not reflect yet the coronavirus impact. The market is now pricing in that the Federal Reserve will bring rates down to zero, with 25 bp cuts at each of the March and April meetings, and effectively zero rates by the end of the year. We expect markets to ignore the economic data out this week, as they did with the payroll report last week. The exception could be consumer sentiment on Friday, which will give us the first read of the US consumer reaction to the crisis.