Forex Review - Coronavirus and the monetary status quo

01/31/2020 | 08:28am

Against the backdrop of the inaction of several major central banks in January, the risk to the world economy from the appearance of the Coronavirus in China has revived risk aversion and is once again increasing the value of safe havens on foreign exchange. The US Dollar, the Yen and the Swiss Franc are in the lead.

Already at least 170 deaths and 7,700 reported cases. This is more than the severe acute respiratory syndrome (SARS) of the years 2002/2003. These figures could even be below the reality and minimize the scale of the pneumonia epidemic linked to a new form of Coronavirus, of which the city of Wuhan is the epicenter. Tens of millions of people are already under quarantine in the region and international health authorities have been mobilized. Several airlines have suspended flights to mainland China and WHO has declared an international emergency. According to the Financial Times, Chinese officials fear a shock to the manufacturing sector, and more generally to first-quarter growth as the Asian giant celebrates its New Year this week.

In Australia, after trade tensions and fires, the outbreak in neighboring China is now seriously threatening growth on the island-continent. In the meantime, the employment figures, particularly scrutinized by the central bank (RBA), are reassuring: 29k new hires in December (against 10k expected) and an unemployment rate that is falling against all expectations to 5.1% (-0.1%).

In Europe, the ECB has just announced a logical status quo after the package of measures launched in September. Christine Lagarde was once again optimistic, mentioning a stabilization of inflation and "less pronounced" economic risks after the Sino-US trade agreement. She also considered "positive" the progress of equivalent discussions between Europe and the United States. Indeed, Paris and Washington have just agreed on a truce in the context of the disagreement on the digital tax. Emmanuel Macron has agreed to extend the discussions until the end of 2020 in order to avoid reprisals on French exports. However, the central bank's boss has failed to reassure forex traders as the institution seems to lack ideas on how to change its strategy.

In the UK, with growth at half-mast and low inflation on the one hand, a strong labor market and booming business confidence on the other, investors were awaiting the Bank of England's decision with some impatience. In the end, the UK's money managers did not change their position from their last meeting, according to Chairman Mark Carney. Two of the nine members of the Committee are still advocating a rate cut, while the majority prefers to delay. On the eve of Brexit, the BoE is basing its decision on an upturn in activity since the beginning of the year as well as on the decline in uncertainty linked to the divorce between London and Brussels.

On the other side of the Atlantic, the Bank of Canada has not lowered its key rate since July 2015, while raising it by a quarter of a point five times since then. The monetary authority is now paving the way with its rhetoric. The BoC thus deplores an "unexpected" weakness in consumption and investment. One or more rate cuts could therefore support a persistent slowdown in 2020, which does not bode well for the Loonie.

In the United States, despite new pressure from Donald Trump, the Fed did not budge at its last meeting. Such a decision was largely anticipated by the markets as US consumer confidence has recorded a high since last August. In a press conference, Jerome Powell also welcomed the agreement between Beijing and Washington but described the Coronavirus as a "very serious problem". In the aftermath, Uncle Sam revealed a growth rate of +2.3% in 2019, the lowest score since 2016 due to trade tensions.

Finally, in Japan, the central bank did not change its monetary policy either, but it nevertheless revised its growth forecasts upwards while slightly lowering its inflation projections. As a safe haven, the yen is benefiting greatly from the Coronavirus' fears about global growth. However, the potential exposure of the Japanese peninsula to the epidemic is linked to its geographical proximity, which favors tourism and retail trade.

Over the next few days, Forex traders will be focusing on European inflation on Friday, US ISM Manufacturing and Services indicators on Monday and Wednesday respectively, and most importantly, the RBA's monetary policy decision on Monday night and Tuesday. The consensus is for a quarter-point drop to 0.50%, although the risk of a less accommodative tone than expected, or even of a status quo, does exist, since this would be consistent with the strength of the job market while compensating for the Aussie's latest decline, which began at the beginning of the year.

Graphically, the single currency, which is sometimes seen by some as a safe haven because of the low interest rates backing the currency, does indeed decline when risk appetite diminishes. After rallying to 1.10, however, we may need to take a breather and remain on the lookout for potential rebound sales. Ideally in contact with 1.1096 and 1.1152.

More or less condemned to suffer the same fate, the cable nevertheless manages to preserve 1.30 in the wake of the BoE decision on Thursday 30th January. If we are rather neutral on the pair, the uncertainties could quickly come back to the forefront as the transition period begins. Therefore, we remain more interested in bounce selling, preferably around USD 1.3260 and 1.3473.

For its part, the Loonie is stumbling and the USD/CAD pair could now consolidate below CAD 1.3255, not without having already closed a quotation gap dating back to December 11. Anticipating actions by the Canadian central bank, we are rather pessimistic about the CAD's strength in the medium term. We therefore logically favor purchases of greenback notes, preferably over declines to CAD 1.3163 and CAD 1.3067.

Taking advantage of the climate of risk aversion, the Yen is recovering after the USD/JPY pair crossed the psychological price of 110. Now in contact with 108.60, the downside potential is drastically reduced, especially as uncertainties remain as to the real impact of the Chinese virus on the world economy. We are once again neutral on parity.

As for the unstoppable EUR/CHF, the expected upward reaction to the CHF 1.07 is slow to emerge due to the strong appeal of the franc in times of uncertainty and falling stock market indices. However, the Euro is holding on to this key level despite everything and we remain convinced that the upside potential here is largely dominant. We are maintaining long positions for the long term.

Finally, the Australian dollar is the most successful major currency in 2020. A bearish acceleration that could cause a sharp technical rebound, especially if prices manage to slide into a very liquid area, which is materialized by a large quantity of stop orders placed below the lowest levels traded in nearly 11 years (0.6670). The next RBA meeting could materialize such a scenario and provide a great opportunity to take action. We would aim for a return to 0.6853.

Mathieu Burbau
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