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.
The Fed has gone all in with QE infinity and yet stocks, despite a short-term spell of strength, are largely unfazed, with the S&P 500 closing down near the 3% mark. In a world where demand and supply have been decimated amid the fastest descent into a bear market in history, week after week, we have further evidence that the Fed’s old tricks are no longer working. Still, they are necessary to provide a backstop in the avalanche of bankruptcies that would eventuate otherwise in a global economy that is imploding for desperate measures. It’s precisely this state of despair that is forcing Germany to break its own long-held rules of a balanced budget by signing off a €750 billion economic package to combat the virus fallout, the US soon to approve the release of $2 trillion in fiscal stimulus, RBA/RBNZ testing the waters of QE, etc. The last country to cave in and go into lockdown is the UK, which only reinforces the notion that since the countries where the main financial centers exist (NY, London) are just getting started to toughen the rules, we should be expecting worsening virus stats before they turn the corner. In the currency market, even if QE infinity has done little to lift the equity valuations, the US Dollar has seen a temporary pause in its macro bull phase after recently breaking into all-time highs at an index level. The Oceanic currencies benefited from the Fed announcement, as did the Euro and the Swiss Franc. The worst performers included the GBP, CAD, and JPY.
Risk continues to be buoyed as the market keeps pricing in what appears to be an imminent approval by the US Senate of a huge $2 trn covid-19 relief bill. The equities in the US, which acts as a barometer of risk, recorded back to back gains, even if the rally was far from impressive as after a 5%+ rally, the S&P gave up over 80% of the gains. In the currency market, with volatility stabilizing between 4 to 5 times what we were used to pre-COVID19, the Canadian Dollar was the outperformer, the Sterling went nuts by trading in a wild 300 pips range all over the place, while the USD continues to weaken from grossly overextended levels. The gap in performance between the world’s reserve currency and any other currency since the onset of the ‘liquidity event’ has been impressive to say the least. The dislocations in the market, forced selling on margin calls amid sky-high vols led to an epic scramble towards cash. The Oceanic currencies, especially the AUD, were once again pressured and much of the ability to find a stronger footing lies on risk sentiment and the US bill to pass the Senate without further delays. This is precisely the next driver today, whether or not risk can be thrown another lifeline or instead politicians decide to throw a curveball with further delays in this much-needed action.
Shorting the US Dollar has been without a doubt the best play over the last week as the Fed inundated the market with a new level of liquidity/funding capacity. The signing of the $2trn stimulus package by Trump, while not aiding stocks in the last 24h, has nonetheless alleviated the near-term economic stresses in the US. But it’s month-end books’ re-balancing that the Global FX Committee (GFXS) is warning us to be vigilant for the next 2 days, as “FX market participants may execute larger than usual FX volumes during end-of-month benchmark fixings.” The late weakness in the USD out of the blue in the last US session after a promising start shows how it all can turn on a dime in the blink of an eye. The currencies are flows’ driven, especially as Q1 ends, and prove of that is the out-performance of a Pound despite in the UK, PM Boris Johnson and Health Secretary Matt Hancock both tested positive for COVID-19, while at the same time, Fitch downgraded the UK’s credit rating to AA- with the outlook negative. The Oceanic currencies also did well last Friday even as equities and bond yields dropped. The CAD was a big mover last Friday too, as the BOC exhausts its ammunition by announcing an extra 5-bp rate cut and the introduction of QE as part of another emergency meeting. The Yen, Euro and Swiss Franc, the 3 funding currencies and poster children of the now terminated era of ‘long carry structures’ went through balanced flows on Friday.
The ebbs and flows in the Forex market were rather subdued on Monday, with volatility measures dropping to the lowest in the last month as the progressive decrease in vol stays the course. Nonetheless, the new normal is for currency swings of a much larger magnitude than we were used to before all hell broke loose. Besides, with a VIX index still above 50.00 and month/quarter end to kick in, there is a real potential for increased activity in equity/bond and FX today.
As an aperitif, we’ve seen sudden spikes in the Yen, US Dollar and Aussie crosses during Tuesday’s final fiscal day in the Tokyo fix. At the risk of sounding too reiterative, it’s worth emphasizing that while the short–term picture has worsened for the US Dollar amid the flooding of dollars into the system by the Fed and a better tone in equities, do not underestimate the phase where we are at, in which based on the bullish breakout in the USD index, further upside is still justified.