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Dollar Mixed as Coronavirus News Stream Deteriorates

Summary:
The virus news stream continues to deteriorate Lower US yields and growing concerns about the spread of the coronavirus in the US are taking a toll on the greenback OPEC officials are trying to work out another supply cut; The outlook for Turkey is going from bad to worse Simply put, there is nothing the Fed can do to address the economic impact of supply chain disruptions and social distancing Japan reported mostly weaker data overnight; China reports official February PMI readings after North American markets have closed The dollar is mixed against the majors as the coronavirus news stream deteriorates. Yen and Swissie are outperforming, while the dollar bloc and Scandies are underperforming. EM currencies are broadly weaker. THB and CNY are outperforming, while

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  • The virus news stream continues to deteriorate
  • Lower US yields and growing concerns about the spread of the coronavirus in the US are taking a toll on the greenback
  • OPEC officials are trying to work out another supply cut; The outlook for Turkey is going from bad to worse
  • Simply put, there is nothing the Fed can do to address the economic impact of supply chain disruptions and social distancing
  • Japan reported mostly weaker data overnight; China reports official February PMI readings after North American markets have closed

Dollar Mixed as Coronavirus News Stream DeterioratesThe dollar is mixed against the majors as the coronavirus news stream deteriorates. Yen and Swissie are outperforming, while the dollar bloc and Scandies are underperforming. EM currencies are broadly weaker. THB and CNY are outperforming, while RUB and IDR are underperforming. MSCI Asia Pacific was down 2.5% on the day, with the Nikkei falling 3.7%.  MSCI EM is down 2.3% so far today, with the Shanghai Composite falling 3.7%. Euro Stoxx 600 is down 2.8% near midday, while US futures are pointing to a lower open.  10-year UST yields are down 7 bp at 1.19%, while the 3-month to 10-year spread has fallen 6 bp to stand at -22 bp. Commodity prices are mostly lower, with Brent oil down 2.5%, copper down 1.6%, and gold down 1.0%.

The virus news stream continues to deteriorate. Moody’s warned of a global recession on the back of a coronavirus pandemic while Japan suspended schools until March and Hyundai suspended production after a worker tested positive for the virus. News that 1,000 people were quarantined in Germany also didn’t help. Assets linked to global growth are likely to remain under pressure until the full scope of the coronavirus spread is known. That includes commodities, EM, and growth-sensitive developed economies such as the dollar bloc and Scandies. Please see our recent piece “Some Thoughts on the Coronavirus” for a deeper look.

Lower US yields and growing concerns about the spread of the coronavirus in the US have taken a toll on the greenback.  However, another theory as to why the euro is strengthening this week has to do with the carry trade. As a low-yielder, the euro was seen as the favored funding currency for carry trades involving EM and other high-yielders. With EM coming under significant pressure, those trades are being unwound as losses mounted. Once positioning has adjusted, we believe the euro will resume weakening as the virus spreads across Europe.  We remain bullish on the dollar due to the relative strength of the US economy.

OPEC officials are trying to work out another supply cut in light of the massive decline in crude prices. The cartel meets next week in Vienna, and the reports suggest they Saudi Arabia is asking for a joint cut of 1 mln barrels. Brent crude is down 23% this year to just over $50 per barrel, right about at the lows from 2018. Elsewhere in the commodity complex, copper is down 10% YTD and iron ore 4.5% YTD.

AMERICAS

There is a fair amount of US data today. January advance goods trade data along with wholesale and retail inventories will be reported first. Next, January personal income and spending are expected to rise 0.4% m/m and 0.3% m/m, respectively. Core PCE is expected to rise a tick to 1.7% y/y. Chicago PMI is expected at 46.0 vs. 42.9 in January, while final February University of Michigan sentiment is expected to drop a couple of ticks to 100.7.

Yesterday’s US data was unequivocally firm.  Q4 GDP growth was unrevised at 2.1% SAAR, while durable goods orders non-defense ex-airlines rose 1.1% m/m vs. 0.1% expected.  Pending home sales rose 5.2% m/m vs. 3.0% expected, while the Kansas City Fed manufacturing index was 5 vs. -1 expected. The Atlanta Fed’s GDPNow model estimates Q1 GDP growth at 2.7% SAAR vs. 2.4% previously.  Elsewhere, the NY Fed’s Nowcast model estimates Q1 GDP growth at 2.0% SAAR vs. 1.4% previously.  Both will be updated today.

Fed easing expectations have picked up sharply. Next FOMC meeting is March 18 and WIRP suggests a 25 bp cut is fully priced in and a 50 bp cut is partially priced in. A second cut is fully priced in by the June 10 meeting and a third 25 bp cut by the September 16 meeting. A fourth cut is about two thirds of the way priced in for January 2021. This seems way too overdone to us.  Why?

Simply put, there is nothing the Fed can do to address the economic impact of supply chain disruptions and social distancing. Period. At the margin, rate cuts might help boost confidence and perhaps support the equity market.  Neither would be long-lived as long as uncertainty remains about the length and breadth of this viral outbreak.  We believe the Fed should keep its powder dry until monetary policy can actually have an impact on economic decision-making.  Now is not the time to panic.

The Fed’s Bullard speaks today.  Yesterday, Evans pushed back against the market’s dovish take on the Fed, as others have already done this week. He said the market moves have been “notable” but he is looking for the actual economic impact of the virus.  For now, the Fed is taking a wait-and-see approach to the coronavirus. The Fed is likely to shift to a more dovish stance at the March meeting to calm markets and perhaps hint at a potential cut later.

Recent polls are giving Biden’s campaign a huge boost. After finishing a distant second in the Nevada caucus, he seems to be gaining ground in South Carolina and is up 15 ppts ahead of Sanders. This led to a huge reversion in implied odds in betting markets that brings Sanders back to around 50% chance of being the nominee and Biden rising toward 30%.

Canada reports Q4 GDP.  Growth expected at 1.6% y/y vs. 1.5% in Q3. However, this is old news and Q1 is likely to show some deceleration.  Commodity currencies like CAD are likely to continue underperforming as the coronavirus impact spreads. USD/CAD is trading at the highest level since June 2019 near 1.3440 and is on track to test the May 2019 high near 1.3565. After that is the December 2018 high near 1.3665.

 EUROPE/MIDDLE EAST/AFRICA

The outlook for Turkey is going from bad to worse and losses for the lira are accelerating.  An air attack in Syria killed at least 33 Turkish military, as the confrontation with President Bashar al-Assad (supported by Russia) over Idlib escalates. Reports claim that local banks sold some $1 bln to contain the decline in the lira yesterday, but to little avail. USD/TRY broke above the 2019 high yesterday, rising to levels not seen since mid-2018. We think there is a lot more to run. Even though positioning by foreign investors in Turkish local markets is relatively low, outflows continue to accelerate. CDS prices have also been increasing, but the moves have been a lot more constrained. One silver lining at the moment is the declining oil import price bill, an important positive factor for the country’s external balance. Also of note, data out today was upbeat, even if backward looking: Q4 GDP rose 1.9% q/q and the trade balance didn’t widen as much as expected (-$4.5 bln in January).

ASIA

Japan reported mostly weaker data overnight.  February Tokyo CPI saw both headline and ex-fresh food inflation come in a tick lower than expected at 0.4% y/y and 0.5% y/y, respectively.  January labor market data also came in worse than expected, with unemployment rising two ticks to 2.4%.  Retail sales and IP were slightly firmer than expected, rising 0.6% m/m and 0.8% m/m, respectively.  However, housing starts and construction orders came in weaker than expected at 10.1% y/y and -17.0% y/y, respectively.

The Japanese economy contracted in Q4 and there are few signs of improvement in Q1 so far.  The growing impact of the coronavirus has pushed forward BOJ easing expectations.  WIRP suggests 25% odds of a cut at the March 19 meeting compared to less than 10% at the start of the month.  Still, we believe fiscal stimulus will be the main policy lever for now.

China reports official February PMI readings after North American markets have closed.  Manufacturing PMI is seen plunging to 45.0 from 50.0 in January, while non-manufacturing PMI is seen falling to 50.5 from 54.1 in January.  Some estimates suggest that economic activity is picking up in China but remains at 60-70% of normal levels.  Policymakers are trying to get the economy going again but we think weakness is likely to persist well into Q2, if not H2.  Stimulus is in the pipeline but it won’t be enough to totally offset the growing impact of the virus.


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About Win Thin
Win Thin
Win Thin is a senior currency strategist with over fifteen years of investment experience. He has a broad international background with a special interest in developing markets. Prior to joining BBH in June 2007, he founded Mandalay Advisors, an independent research firm that provided sovereign emerging market analysis to institutional investors. He received an MA from Georgetown University in 1985 and a B.A. from Brandeis University 1983. Feel free to contact the Zurich office of BBH

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