Calling G7….For what?! 3 Ways they Can Help
Daily FX Market Roundup March 9, 2020
Pandemonium hit the financial markets today with the Dow Jones Industrial Average falling -2,013 points. Currencies felt the pain as Treasury yields skid to record lows. The US dollar dropped to its weakest level against the Japanese Yen in 3 years as the greenback fell sharply against the Swiss Franc, euro and sterling. Volatility hit multi-year highs and for some currencies like USDJPY 3 month vols reached their highest levels since 2008.
The market’s appetite for US dollars is disappearing quickly with investors pricing in another 50 to 75bp of rate cuts by the Federal Reserve over the next two months. The rapid decline in the dollar is creating problems for other countries who are already suffering from the economic and social impact of coronavirus.
Investors have turned to the Japanese Yen and Swiss Franc for safety but that puts undue pressure on the Bank of Japan and Swiss National Bank. Japan’s economy is at the risk of recession after having contracted 7% in Q4. When you combine that with a rapidly rising currency that hits the export sector, the Bank of Japan has no choice but to act. In the next 24 to 48 hours, we expect verbal and possibly physical intervention from the BoJ.
We also expect the ECB to ease on Thursday to halt the rise in the euro. The drop in crude prices will force the Bank of Canada and the Bank of Mexico to lower interest rates again so expect further weakness in those currencies. Mexico in particular, has plenty of room to ease. Theoretically lower oil prices should help consumers but if they are unwilling to go out and spend their extra cash, the benefit will be limited.
Investors are waiting for a response from Washington. We know that President Trump is actively considering fiscal stimulus. While some investors are looking for another intermeeting cut from the Fed, their actions are ineffective without fiscal support. We saw just how quickly the market shrugged off their last 50bp of easing. We are just over a week away from the March rate decision – they can wait to combine their efforts with the White House or their G7 counterparts for a stronger punch.
Looking at fiscal stimulus options is a priority for Washington and over the next 24-48 hours, they could drop hints on what the package could look like in an attempt to stem the slide in equities. How the market responds will depend on whether economic stimulus is targeted like Larry Kudlow suggests or broad, like the market requires. The broader the package the greater chance of a bottom in stocks.
Traders should also be on the lookout for coordinated G7 response. It has become clear they agreed to try easing individually on their last call but with the market not responding and losses accelerating, their next move needs to be coordinated one. Dollar swap lines would be low lying fruit. Other options include coordinated easing and fiscal stimulus. If a coordinated G7 response happens expect an explosive rally because there’s no fiercer rally than one in a bear market.