FX Week - 15th March 2020

The intensification of unprecedented financial market volatility combined with the sense that the coronavirus lockdown is only in its early stages does not lend itself to markets recovering properly.

By Emirates NBD Research

The intensification of unprecedented financial market volatility combined with the sense that the coronavirus lockdown is only in its early stages does not lend itself to markets recovering properly anytime soon, but it does mean that extreme policy reactions will probably become the norm and should now be assumed. With the world hunkering down massive monetary and fiscal stimulus helped equities recover on Friday, but underlying factors remain weighted to the downside as the markets struggle to see the end to this crisis. While equities fell bond yields rallied as a result of a rush to cash, creating a liquidity squeeze that threatened financial stability and necessitated record Fed repos and Treasury purchases.

After the Bank of England surprised with an emergency 50bps rate cut last week and the UK government announced a GBP30bn fiscal stimulus, while the ECB announced liquidity easing measures as well, it is probably fair to assume that the FOMC will face pressure not to hold back at this week's FOMC policy meeting either. As governments embrace increasingly extreme measures to contain the virus, central banks are doing the same, in order to maintain the orderly functioning of the financial system as best they can. Accordingly the Bank of Canada and Norges Bank also slashed policy rates by 50 bps in emergency actions, while the BoJ, RBA, and PBOC have been adding liquidity, with the PBoC also cutting reserve requirement ratios. These on top of government spending increases, including President Trump’s declaration of a national emergency which freed up over 50 billion of dollars in federal funds, while the House passed a COVID-19 bill which the president also endorsed, and which will also release funds. Fiscal measures were also announced in the EU, as they finally caught up with the pressure from outside and from within for action.

In the face of steep drops in equity markets and widening credit spreads overall financial conditions became the tightest they have been since the global financial crisis. In response the Fed significantly stepped up its repo offerings last week to help calm liquidity concerns and resumed Treasury purchases across all maturities. Following on the from these steps the Fed will probably bring forward its move to zero interest rates this week, with a full 100 bps cut in the Fed funds rate priced in, seeing little benefit in holding back until future meetings.

FX markets are not surprisingly reflecting the liquidity challenge, seeing sharp movements. Of these GBP’s losses were perhaps the most pronounced last week, dropping 6% against the USD, following the UK authorities’ huge stimulus steps and as the government’s coronavirus measures accelerated. With the a European (and probably worldwide) recession looming, markets are less confident about the upcoming trade negotiations between the UK and EU, with the UK's wish to leave the post-Brexit transition period by the end of the year looking more and more difficult. Needless to say another volatile weakness across FX markets looks in store.