Until about a fortnight ago global FX markets had been reasonably well behaved. Some currencies were trending higher (such as the safe-haven Swiss Franc and US Dollar) or lower (the Australian and Kiwi Dollars) but daily spot moves remained reasonably modest.
In particular Asian and emerging market central banks were seemingly intervening in their FX markets to curb volatility in their currencies and maintain a degree of order in their financial markets.
However, the draconian measures which governments have enacted in recent weeks to stop the coronavirus epidemic, unprecedented outside of war times, are having a disproportionately negative (yet difficult to forecast) impact on global economic output, trade, retail sales and tourism. Recently released February PMI and external trade data for China paint an ugly picture for the economy at the epicentre of the outbreak.
Some central banks, including the Federal Reserve, have reacted forcefully but without the degree of coordination which markets welcomed in 2008-2009. The ensuing global risk aversion (read carnage) in equity, bond, credit and commodity markets has bled through to FX markets, with central banks unable or unwilling to keep their currencies on a tight leash.
Figure 1: Global FX volatility has spiked as global risk aversion bleeds into major currency markets
Source: 4X Global Research, BIS, investing.com
Note: * Spot/closing price. Basket weighted by currency-pair turnover in 2016; currency pairs versus US Dollar are AUD, CAD, CHF, DKK, EUR, GBP, JPY, NOK, NZD, SEK, ARS, BRL, CLP, COP, MXN, CZK, HUF, PLN, RON, RUB, ZAR, TRY, ILS, CNY, IDR, INR, KRW, MYR, PHP, SGD, TWD and THB.
Our measure of global realised FX volatility against the Dollar, which hit a 5-year low on 29th November, has spiked above its 10-year average (see Figure 1), in line with our forecast that the risk for global currency volatility is clearly tilted to the upside in coming weeks and months.
Investors, for over a decade accustomed to US equities’ almost metronomic rise and often subdued FX markets, are now staring at market moves not seen since the Great Financial Crisis in 2008.
We would argue that, assuming the coronavirus epidemic is contained in coming months (and does not become a pandemic), central bank rate cuts and fiscally stimulative policies could spur a V-shaped recovery in global economic growth next year.
Figure 2 indeed points to a historically robust inverted, 4-quarter lagged relationship between the global central bank (nominal) policy rate and global GDP growth. Note also that the reasonably closed US economy remains in good health (for now) with the reliable Atlanta Fed GDPNow estimating US GDP growth in Q1 at 3.1% qoq annualised, the fastest rate of growth since Q2 2018.
Figure 2: History suggests that central bank rate cuts will have lagged, positive impact on global GDP growth
Source: 4X Global Research, IMF, national statistics offices, national central banks, OECD, World Bank
Note: * 4X Global Research measure (IMF PPP methodology). Q1 and Q2 2020 are 4X Global Research forecasts. ** Latest data point is average for Q1 2020 based on data up till 6 March 2020.
However, central bank rate cuts can do little to address supply-side constraints and a year is a long time and “old” macro data matter little when months or years of equity gains have been wiped out in days and crude oil prices can collapse 30% – as they did this weekend after OPEC and Russia failed to agree to supply cuts.
For the time being, markets’ current thinking of “sell/buy now, think later” is likely to prevail, even if the timing and magnitude of (almost certain) further central bank rate cuts may (temporarily) give pause for thought.
Markets are currently pricing in:
- The European Central Bank (ECB) to cuts its (deposit) policy rate 10bp to -60bp at its meeting on 12th March;
- The Federal Reserve to cut rates 68bp in the rest of March and 100bp by early 2021, which would take the policy rate back to its financial crisis low of 0-25bp;
- The Bank of England to cut rates 50bp in this cycle (to 25bp), potentially kicking off proceedings by announcing a 25bp inter-meeting rate cut on 11th March alongside the annual budget announcement;
- The Reserve Bank of Australia (RBA) to cut 25bp at its 7th April meeting.
There is also talk that some central banks will be forced to introduce QE programs (e.g. RBA) or beef up existing ones (e.g. ECB).
Conventional wisdom of how FX markets should behave in this environment has arguably been up-ended. The AUD/USD cross actually rallied in the wake of the RBA’s largely priced in 25bp rate cut on 3rd March (and was broadly stable in the subsequent 2-3 trading sessions), with the currency’s carry now seen as largely irrelevant and markets instead giving weight to policy-makers’ speed of action.
With this in mind, if the Bank of England decides to wait until its policy meeting on 26th March to cut rates 25bp (our core scenario), Sterling – which has appreciated 1.6% in trade-weighted terms in the past week – may wobble.
For further information about 4X Global Research or to discuss a subscription to its research products and services, please email odesbarres@4XGR or call Olivier Desbarres on +44 (0)20 3811 0454