- Market sentiment has improved ahead of the weekend; the situation in funding markets continues to improve
- The dollar is giving up some its recent gains; Fed announced temporary dollar swap lines with nine additional central banks
- The surging dollar has led to some market chatter about possible coordinated FX intervention
- The jump in initial jobless claims to 281k yesterday was big, but we have a long way to go still
- Denmark hiked rates while Norway cut rates
- Oil prices have jumped after President Trump suggested he would work to broker a compromise in the Saudi-Russia oil war
- PBOC left its benchmark Loan Prime Rate (LPR) unchanged today, contrary to expectations for a cut
The dollar is broadly weaker against the majors as an eventful week wraps up. Nokkie and Aussie are outperforming, while euro and Swissie are underperforming. EM currencies are broadly firmer. KRW and CZK are outperforming, while INR and IDR are underperforming. MSCI Asia Pacific ex-Japan was up 5.1% on the day, with Japan closed for holiday. MSCI EM is down 5.3% so far today, with the Shanghai Composite rising 1.6%. Euro Stoxx 600 is up 3.8% near midday, while US futures are pointing to a higher open. 10-year UST yields are down 16 bp at 0.98%, while the 3-month to 10-year spread is down 17 bp to stand at +99 bp. Commodity prices are mostly higher, with Brent oil up 6.3%, copper down 3.6%, and gold up 2.5%.
Market sentiment has improved ahead of the weekend. However, this is nothing more than a breather as more bad news is coming down the pike. Policymakers have taken decisive actions but we are only now starting to get an idea of how deep the economic impact may get. We suspect that markets will be ripe for another large leg down when the economic data collapse despite official actions taken to date. As most recognize, this is a health crisis, not a financial one, and we have limited tools to truly shield the economy from the very real impact ahead.
The situation in funding markets continues to improve. Cross currency basis swaps have narrowed almost back to pre-virus levels for the euro and sterling, showing the effectiveness of the Fed’s swap lines. The yen’s measure is stable, but has yet to narrow as much. FRA-OIS spreads, a proxy for credit risk in the US financial system, remains very elevated but well off its recent high. Once again, we think this is a manageable problem and spreads will continue to narrow, even if gradually.
The dollar is giving up some its recent gains. We are not surprised to see some consolidation ahead of the weekend given the scale of this move. Underlying risks remain elevated and so we expect the dollar to resume strengthening next week. DXY broke above the March 2017 high near 102.26 yesterday and so the next target is the January 2017 high near 103.82. After that, we have to go back to 2002 to find the next targets.
The Fed announced temporary dollar swap lines with nine additional central banks yesterday. The new swap lines will be $60 bln each for the central banks of Australia, Brazil, South Korea, Mexico, Singapore, and Sweden, and $30 bln each for the central banks of Denmark, Norway, and New Zealand. The lines will remain in place for at least six months, and the expanded lines tell us that the dollar funding shortage is a truly global problem. We think that when push comes to shove, the Fed will eventually just provide an unlimited supply of dollars. That won’t cure what ails the markets but we think it will provide valuable life support until that cure is upon us.
The FX markets have become disorderly, to state the obvious. Thin liquidity coupled with a huge surge in dollar demand has led to incredible swings for virtually every currency. Major currencies are trading like EM currencies, while EM currencies are trading like Frontier currencies.
The surging dollar has led to some market chatter about possible coordinated FX intervention. Could it happen? We think it highly unlikely. Besides Norway, no other country has expressed much concern about a weak currency. To put it bluntly, policymakers are focused on preventing recession and exchange rates just aren’t a priority right now. It also helps to put things in historical perspective. During the 1980-1985 rally, DXY nearly doubled; during the most recent rally that began in early 2018, DXY has risen around 17%. This just doesn’t cry out for policy action.
President Trump is probably concerned with the strong dollar. Here too, the President has bigger fish to fry as the US struggles with recession in an election year. A weaker dollar really won’t do much when the global economy is basically shutting down. All in all, we simply do not envision any groundswell of support for coordinated action within the Developed Markets. Emerging Markets are a different matter, as the surging dollar significantly raises the costs of servicing external debt. We have seen many EM central banks intervene to help soften the blow.
As the world’s source of dollars, it’s really up to the US to address the issue of dollar shortages. The Fed is doing its part with its expanded swap lines, but the demand for dollars is simply a symptom of the world’s rush to safety. As long as the coronavirus remains the major driver of global financial markets, it seems futile for G-7 or G-20 policymakers to attempt a Plaza-style intervention.
The jump in initial jobless claims to 281k yesterday was big, but we have a long way to go still. During the financial crisis, claims moved from around 300k in September 2007 to a peak near 665k by March 2009, while the unemployment rate moved from 4.4% in May 2007 to a peak of 10% in October 2009. The good news is that the labor market recovered fairly quickly. The economic outlook is still rapidly evolving but we think markets need to prepare for moves of possibly greater magnitudes if the impact of the virus continues to spread in the US as many expect.
During the North American session, the US reports February existing home sales. A gain of 0.9% m/m is expected vs. -1.3% in January. Canada reports January retail sales, which are expected to rise 0.3% m/m after a flat reading in December.
The central bank of Denmark hiked rates by 15 bp to -0.60% yesterday to support the krone. Recall that Denmark’s FX regime keeps the krone within a narrow band against the euro, and it will continue to sell reserves to maintain stability. The bank also expanded its 3-month lending facility to improve funding.
On the other hand, Norges Banks cut rates by 75 bp to a record low 0.25%. This was the second emergency cut, following the 50 bp move last Friday. The bank said it was also “considering measures to ensure that the policy rate passes through to money market rates to money markets.” The krone is up nearly 1% against the euro today and over 3% since yesterday’s open, but this is largely due to the rebound in oil prices. Year to date, the currency has depreciated a whopping 17% against the euro.
Oil prices have jumped after President Trump suggested he would work to broker a compromise in the Saudi-Russia oil war “at the appropriate time.” The US shale industry is suffering greatly and so Trump is coming under pressure from the states where shale production is concentrated. The four biggest producing states are Texas, North Dakota, Colorado, and Wyoming, which he won in 2016 with the exception of Colorado. However, Trump pointed out that low prices are akin to a tax cut for US consumers. Such is the delicate balancing act he faces going into re-election mode.
PBOC left its benchmark Loan Prime Rate (LPR) unchanged today, contrary to expectations for a cut. The 1-year rate is at 4.05% and the 5-year at 4.75%. These are the reference rates for new loans (set by a panel of 18 banks), but it’s only one of many levers that Chinese officials rely upon. The PBOC injected some $14 bln via medium-term loans. They need to strike the delicate balance between keeping liquidity ample and supporting the economic stimulus, but without spurring speculative investment or worsening the country’s credit misallocation problem. That said, we suspect policymakers will err on the side of stimulus in this current environment.