Few will argue that the hot topic of conversation online is the debacle of the Japanese currency. Some traders at banks are speculating that the correlation breakout of Gold and the Yen represents a paradigm shift in the logic to trade the Japanese currency. I personally disagree and suspect that when a move is so aggressive without apparent justification, there is hot money ‘in the know’ preparing for a potential ramp up of further easing by the BoJ. It might well be, as an alternative, that Japan’s Government Pension Investment Fund has opted to reshuffle its strategy seeking out higher yielding opportunities via USD-denominated instruments. What’s clear is that no one can really pin point at this stage what’s caused such a dramatic fall in the Yen value, but through history and economics, out of the list provided below, some could help you contextualize it.
Geographics are playing a greater role in the adjustment of portfolio positioning as the COVID-19 plays out, with concerns over the spread now in Beijing and outside of China. When officials in China are even weighing the possibility of a “Wuhan-Level” lockdown, you know risk is that the market may go on ‘the defensive’.
The acceleration to buying into the USD portrays a market that is starting to diversify more aggressively away from Asian-based currencies (JPY, CNY, AUD, NZD) and into the allure of the world’s reserve currency. This comes as the seeking of yield continues in a world with excess liquidity and too limited places to park this capital.
The market is playing a ‘defensive’ card to start the week as COVID-19 anxiety continues on the rise as the international cases and deaths keep spreading from North Korea, through Iran, all the way to Italy, where over 130 cases are now detected. This has led to extraordinary containment measures by governments to slow down the spreading of cases, while the G20 group, in its weekend meet-up, pledges to be ready to step up to the plate with coordinated fiscal stimulus, stating that it sees heightened “prospects of further downside risk to global growth persisting as the coronavirus raises uncertainty and disrupts supply chains.”
Some authorities in the space of virology, via Twitter, are concluding that while it has taken a while for the spread to take off, we are finally seeing it come to life now. Note, The international spread of the virus means that monitoring of the COVID-19 stats outside China will serve as a more accurate representation of the true evolution of the virus. This, in m opinion, poses downside risks to further episodes of risk-off as these countries hit by the virus have far more robust processes of transparency to report the real situation as opposed to China, which as we know, has been criticized for downplaying the true magnitude of this tragedy.
It is fair to say that the market has definitely hit the panic bottom as equities suffer drops to the tune of nearly 4%, while bond yields continue the dramatic falls, all indicative of a market that is pricing in, at this pace, a global recession this year. The culprit? The spreading of COVID-19 to the West.
It is precisely this proximity of the virus to the West that the market is finally picking up, no longer complacent, as we clearly observe a developing and growing correlation between the proximity of the virus to the Western world and fear in market participants as well as government.
Risk-off is certainly back with a vengeance with no mercy for equities, which appear to finally be ‘catching down’ to the reality of a world that faces the prospects of a recession. News that more cases are popping up in European countries (Spain, Italy, Germany…) alongside the state of readiness by some states in the US for a virus outbreak keeps spooking the market. It feels as though the market has finally caved in and now prices convincingly an upcoming announcement by the World’s Health Organization that we are facing a ‘pandemic situation’.
The behavior in the Aussie and the Kiwi keeps playing into this view as the currencies suffer the most its proximity to China and are set to experience the greatest economic pain if the global economy stagnates. The US Dollar, although to a lesser degree, also joined the fragility in the Oceanic currencies, in what still looks like a technical correction in a very well-established uptrend this year. The weakness in the Canadian Dollar is a nascent development to also keep an eye on as the unwinding of the ‘carry trade’ back to old fashion ‘risk-off’ dynamics with Oil flirting with the $50.00 handle is far from the backdrop that would make the currency thrive.
The behavior in financial markets continue to portray how deeply concerning the COVID-19 situation has gotten as numerous agencies around the globe set the stage for an upcoming ‘pandemic’, even if that’s a term that the highest health authority (WHO) is yet to adopt. After two days of a meltdown in the equity market, a temporary pause ensued, even if that’s far from helping to turn around the ‘risk-off’ sentiment. The broader aggressive selling recently seen elsewhere from bond yields, Oil, Aussie/Kiwi, or the spike in the VIX, remember, encapsulates the huge ramifications of a COVID-19 pandemic as more countries impose airline/event cancellations, travel curbs and quarantines, with the social, economic and health-related costs associated with it. The increased exposure into funding currencies (EUR, CHF, JPY) and selling in the commodity-linked complex such as the Aussie, Kiwi and Canadian Dollar keeps on going. Of note is the acceleration in CAD weakness. The Euro and Swissy have shown the most demand interest, even if in the last 24h, the US Dollar starts to challenge that status as its likely transient spell of weakness is finally showing signs of reversing back up. The Pound, meanwhile, was engulfed by sell-side action since the early stages of Europe, as the market readies to hear the UK mandate for the upcoming post-Brexit trade talks.
Today’s aggregated G8 FX indices chart leaves no doubt, the torrid market conditions out there, with the S&P 500 shaving over 10% from its all time high, suggests the hold of carry trades has become way too risky. The immediate ramifications of this aggressive unwind is to witness funding currencies the likes of the Euro, the Yen and the Franc flying in style. It’s simply not the time to keep carry-trade exposure when we’ve had the worst week in US equities since the GFC and the VIX at a 2-year high. One can see in the chart below the considerable gap that has opened up between ‘the funding currencies’ and ‘the high yielding complex’ with the Canadian Dollar by a country mile the most punished. I salute you with huge respect if you’ve been able to capitalize it through EUR/CAD longs. What a move! When looking at the Aussie and Kiwi, it’s the same old story, with sellers firmly in control. Make sure you visit the ‘insights into charts’ section for an opportunity to explore the smart money footprint in the Oceanic currencies as short-inventory keeps being built. In this environment of funding currencies thriving, USD longs were too schooled not to marry to a single direction, in this case longs, despite the 2020 bull trend is still in place. Lastly, the Pound remains unloved as the political brinkmanship by UK PM Johnson with the EU ratchets up.
A replica of the story narrated in my last report played out last Friday as a market long carry trade structures kept imploding. The colossal weekly losses in equities - worst week since 2008 -, commodities and bond yields kept facilitating higher volatility in FX as the unwind of short exposure in funding currencies becomes the trend to exploit by market forces.
The ‘eye-popping’ miss in China’s PMI over the weekend - worst on record - has only aggravated the fears that the market is quickly headed towards a global slowdown, with coordinated Central Bank intervention through lower interest rates to start as early as tomorrow when the RBA meets. Powell’s ‘emergency’ statement on Friday, laying the ground for lower rates in the US this March, has served as a minor circuit breaker to halt the bloodbath in equities.
The European funding currencies (EUR, CHF) kept charging higher on Monday even if the aggregated flows, I am highly agnostic of this one-way traffic to continue. One of the much-awaited circuit breakers to see the bloodbath in carry trade long structures to come to an end was always going to be a coordinated intervention by G7 Central Banks.
That’s exactly the type of response that the market is now awaiting for after reports indicate a conference call has been set up at 11pm ET Tuesday by Central Bankers and Finance Ministers to discuss a response to the impact of the coronavirus. This call will be led by Mnuchin and Powell. Whether or not the massive turnaround seen in equities has further legs will largely depend on how much details they are able to provide in decisive actions to be taken.
Anyway we slice it, there is little room for ambiguity, the Forex market is well and truly alive with very healthy levels of volatility the new norm. With the Fed going above and beyond to avoid being schooled by the markets again, it resorted to a surprising 50bp rate cut as part of an emergency meeting, which was the first one since the 2008 global financial crisis, and speaks volumes of how rapid the economic prospects have deteriorated. And they may not even be done as more rate cuts may follow ahead of the March 18th FOMC. A return to Fed’s unconventional tools (QE) may not be such a distant prospect after all.
A reversal in sentiment to bullish in the US stocks market saw the need to tap into funding currencies reduced quite significantly. The main culprit behind the rally in equities came as Bernie Sanders’ Democratic nomination was decimated in favor of a Presidential race between Trump and Biden after the latter was the big winner of Super Tuesday. This temporary return of the groovy mood in equities and bond yields kept therefore the EUR, CHF and JPY stable. The other major story was the 50bp rate cut by the Bank of Canada, a move that follows the extraordinary action announced by the Fed the previous day to combat the virus-induced tightening of financial conditions. The decision was too heavy a burden for the CAD, which ended up as the worst performer as the BoC appears not yet done with its easing cycle. On the flip side, the Aussie keeps showing near-term strength as it extends the bounce off its 100% measured movement, an area susceptible to a mean reversal as warned. The Pound joined the Aussie at the top of the leaderboard on Wednesday after buyers made a comeback off a macro level of support judging by where the GBP index bounced off. The USD, on the back of the desperate move by the Fed to ease policy, tread water by consolidating recent losses. Last but not least, the Kiwi remains unloved with very poor interest to get off its depressed levels.
So far, the easing measures by the Fed, RBA and BOC have provided a very limited relief rally to the underlying risk-off dynamics, with the funding currencies’ complex still the place to be. Even the added groovy vibes via the major boost of Biden winning the Democration nomination have lasted barely 24h, with the market psyche still deeply rooted towards the COVID-19 as the big macro theme of 2020 as fears of widespread community transmissions in the US mount. As the day went on, risk trades softened and this led to Yen buying, while the Swiss Franc and the Euro followed in lockstep, although the buying flows were not as strong.
If the demand shock courtesy of COVID-19 was not enough of a stumbling block for the depressed outlook for the price of Oil, an all-out price war broke out over the weekend after Saudi Aramco cut its official selling price and announced that it plans to increase output well in excess of 10m bpd amid OPEC crumbling after a rejection by Russia to further curtail Oil production. The collateral effects have resulted in an absolutely epic hammering of Oil towards the $30.00 mark, another textbook case of what panic selling does to safe haven Yen - Yen crosses flash crash included -, while the max exodus off carry trade continues unabated, leading to also strength in the Euro as hedging and margin calls ensue. The S&P 500 was limit down after falling more than 5%. The most affected currency by the implosion of Oil prices has been, by a large margin, the Canadian Dollar and the Norwegian Krone. The US Dollar is also selling hard as chatter continues to grow that the Fed may soon have no option but to start considering opening the floodgates of money supply by reintroducing QE. Note, both the USD and CAD have also been severely affected by the bail out of carry trades. The Oceanic currency, amid this torrential dripping of negative news have been left out unloved once again, taken to the woodshed after the flash crash as liquidity remains extremely poor. A currency that keeps acting somehow as a ‘bridging’ fiat to diversify into is the Pound, the only one relatively immune to the dynamics at play (risk-off, carry trades) and more exposed to other idiosyncratic drivers such as the trade negotiations between the UK and Europe.
Monday, March 9th, will go down as one of those catastrophic days in history books. The Forex volatility traders are having to navigate through is unlike anything seen for many years and fair to say we can start drawing parallels with the dislocation and distortion in FX swings reminiscence of the Global Financial Crisis from back in 2008/2009. The incredible volatility implies pip ranges and spreads are much wider due to poorer market liquidity. To understand this perfect storm in FX, it just so happens that the market is freaking out at the prospects of a global recession amid the rapid international spread of Covid-19, at a time when an Oil price war just broke out. Risk-off moves were intense, disorderly, and unrelenting, circuit breakers in the S&P 500 or bond yields had to kick in only hours after the Asian markets opened. Central Banks are undoubtedly the next key focus as further rate cuts are baked in the cake while the market is once again bullying the Fed by forecasting another 75bp of rate cuts on March 18th. QE anyone? Many higher yielding EM currencies were absolutely destroyed, with a clear example of the calamitous movements suffered by perma long carry traders seen in MXNJPY, down more than 10% at some point. The AUD/JPY wasn’t far behind, even if the rebound was impressive too. The CAD and NOK were taken to the cleaners, unsurprisingly, as the oil exporters most vulnerable to the historical 30%+ collapse in the price of Oil. The Forex darling continues to be the Yen as safe havens draw disproportionate demand, while the Swiss franc and the Euro, continue to also outperform in times of huge uncertainty. The USD, hit by the prospects of Fed QE and the unwind of carry trades, kept falling and has shaved in two short weeks the gains it managed to register during the first two months of the year. Lastly, the Pound is a relative sideshow compared with some of the moves seen so far, in what I see as a fiat useful to tap into for diversification purposes amid the fall out of high-yielding currencies.
The harrowing ‘risk-off’ scenes recently witnessed abated as the market appears to be welcoming news that the US is preparing a rich stimulus package to support the economic fallout from the coronavirus outbreak. Further coordinated intervention by G7 governments has too contributed to add fuel to the risk rally. With the S&P 500 rising circa 5% and US bond yields sharply higher too, the USD was the clear winner, with aggregated gains when crosschecking its performance vs G8 FX, unlike anything seen since 2016. The magnitude of the upside move in the USD speaks volumes of the amount of volatility we are experiencing as traders. On the flip side, the main beneficiaries in this chaotic market phase (Yen, Swissy and Euro), all performed quite poorly as the bloodbath in the unwind of carry trade structures takes a temporary pause. The Pound, a currency recently permuting as a play for diversification purposes amid the fall out of high-yielding currencies, also suffered the consequences of an increase in risk appetite, hence reinforcing this new adopted role. Lastly, the outperformance of the AUD and NZD despite sharp gains in the equity and yields space is a bad omen for these two currencies as the market shifts the focus to QE and negative rates by the RBA/RBNZ in coming months, even if RBNZ’s Orr is still downplaying the odds.
The mass exodus of long-held positions in global equity markets amid an increase in margin calls, the disjointed movements in currencies, the sky-high volatility form part of the daily harrowing script the market has sadly settled into as the total loss of trust in policy actions flare up. The latest measures by US President Trump, the Fed or the ECB have not moved the needle and are a cruel reality check that the dire situation due to COVID-19 won’t be overcome through the type of policy actions we’ve been so accustomed since the GFC (liquidity injections). Don’t get me wrong, the Fed stepping in with more cheap money thrown into the system is still needed amid major stresses in the credit/funding channels to get US Dollars (explains the scramble to long the world’s reserve currency into fresh 2020 highs) but the market’s verdict is still turning a deaf ear and one wonders what’s the ultimate circuit breaker? The market is screaming that an even bolder response from the Fed must come, and I am not talking about rock-bottom rates or the confirmed QE resumption (that’s backfiring) but a clear commitment that they may be pondering to dip their toes into buying corporate credit and even equities outright, essentially a ‘Japanification’ of the US monetary policy, even if the blessing of Congress is needed for these extraordinary measures to see the light. The markets, with a VIX around the 60.00 market, at a level of panic not seen since the GFC, however, unlike that period, this time what will revert the treacherous and fluid situation is a vaccine and containment/mitigation measures by governments/health system, which is why this black swan event is so hard to cope with from a monetary/fiscal policy standpoint alone. The net result when aggregating the flows in the last 24h through G8 FX, illustrates a reigning USD, with the usual suspects (EUR, CHF, JPY) following miles away but still net positive. On the contrary, the AUD, NZD, CAD and GBP are the currencies most punished by the brutality of these markets.
There is no respite in financial markets as equity futures in the US (S&P 500) hit a limit-down just minutes after the open of markets in Asia as forced-selling and liquidation from those trapped long appears to still play out. Remember, selling originated from the longest bull market in history! That’s important to understand in order to put into perspective the sheer magnitude of positioning unwind going on.
This reaction in equities is certainly not what Central Banks would have wished for after yet another round of coordinated intervention to enhance the provision of global U.S Dollar liquidity and soften the economic blow. The Fed and the RBNZ, both cutting rates to the lowest bound, are the latest to step in (second time for the Fed), even if the market keeps telling us loud and clear such measures are insufficient.
If as a trader you are still baffled by the speed at which Forex market dynamics have morphed from bottom-rock depression by any historic volatility standards to the insane wild swings witnessed, this article will be a breeze of fresh air to help you navigate the new paradigm shifts taking place in the currency market.
By the end of it, you will have a better understanding of the total massacre by EUR shorts as carry trade unwound, but most importantly, why by drawing parallels with the last liquidity event from back in 2008 (Global Financial Crisis), going forward, we should be expecting the US Dollar to keep appreciating.
As authorities around the world continue in an unprecedented race against the clock to resuscitate battered stock indices, and laboratories ramp up resources to come up with a vaccine unlikely to see the light for distribution this year, there is a bigger problem at play. Governments simply can’t bring back to life an economy in comatose mode as global lockdowns are still in phase 1 and getting worse by the day. It’s a simple equation: No movement of people, no economic activity. So, what’s left? Governments must keep taking draconian measures on the fiscal front to mitigate the social unrest that is to come as the job is now to assert minimal decent living conditions as the ramifications in terms of job losses and bankruptcy is very ugly as the black swan of COVID-19 engulfing the whole world in a state of fear plays out. What does this backdrop mean for currencies? Well, same old dynamics, with a massive run towards the USD, which keeps its status as King of Forex. The JPY, CHF, and EUR, are also part of this group of beneficiaries, even if none is able to keep up with the fortitude in the USD. In stark contrast, Oceanic currencies and the Pound are being punished severely as the market behavior so far appears to be in strict resonance with movements in currencies from the last ‘liquidity event’ from back in 2008 when the GFC unraveled. Lastly, the CAD has been holding up firmer, but with such a perfect bearish storm in the background, still remains relatively expensive.
The same old story of US equities hitting a limit down has rapidly eventuated at the open of markets in Asia. So far, the relative calm in the form of short-term equity rallies as seen in the early stages of last Friday has been deceptive and continues to serve the purpose to offload the next round of further selling actions by a market mentally shifted to ‘sell the rally’. If all the mammoth-size actions by Central Banks, from rate cuts, new QE programs, swap lines, new funding facilities, has barely achieved a short lived 1 day rally in equities, there is clearly a statement by Mr. Market that the measures are not enough. Nobody knows where the bottom is as we are still in phase one where countries are busy shutting down cities. This week, the focus will shift towards more COVID-19 headlines, which are set to depress sentiment further as scientists predict that soon the US and UK, the two main financial centers, are the countries set to follow Italy in experiencing a creeping wave of COVID-19 cases and deaths. Traders should also brace themselves as we are in for another rollercoaster week. Be prepared not to be taken aback as the US is about to announce a staggering weekly surge in jobless claims the likes we’ve never seen in history (over 2 million eyed). Amid this unfolding negative backdrop, and with more economies to enter a state of semi-paralysis (Australia last one to join), the market can’t cling to any positive development, as the political brinkmanship in the US causes further delays for the multi-trillion fiscal package in the US to pass the Senate. As a final note, the performance in currencies remains quite predictable based on the central themes of a USD liquidity crunch and risk averse dynamics, which results in the world’s reserve currency as the undisputable king, followed by the JPY, CHF, EUR. The AUD, NZD, GBP are the three currencies most punished, while CAD remains surprisingly stable.