04-Feb-2020

1) Dollar Soars as SGD, MYR and IDR Drop on China Woes, Can it Sustain?
2) Australian Dollar Gains As RBA Leaves Interest Rates On Hold
3) Stock Markets May Struggle Even If Coronavirus Fears Subside
4) Commodity Dollars, Stocks, Energy Will See Worst Coronavirus Hit

 

1) Dollar Soars as SGD, MYR and IDR Drop on China Woes, Can it Sustain?

It was a tumultuous week for ASEAN currencies such as the Singapore Dollar, Indonesian Rupiah and Malaysian Ringgit against the haven-linked US Dollar. As expected, concerns about the impact of the coronavirus on regional and global growth sent the USD/SGD, USD/IDR and USD/MYR to the upside. My ASEAN-based US Dollar index experienced its best 5-day climb since May.

Meanwhile the Philippine Peso fared relatively better off with USD/PHP prices still largely in consolidation mode since late October. Newswires have attributed this to the Philippines’ relatively lower tourism exposure to China, of which Thailand has a larger share. USD/THB rose to its highest since June 2019 last week, wrapping up its most-aggressive 5-day advance since the Summer of 2018.

The sensitivity of ASEAN currencies to sentiment makes them vulnerable to ongoing risk aversion. On the chart below, a proxy of emerging market capital flows can be seen falling alongside the EEM. The latter is the MSCI Emerging Markets Index, which tracks the underlying performance in developing economies such as China and India.

Last week, the U.S. Centers for Disease Control and Prevention (CDC) called the Wuhan virus an “unprecedented public health threat”. Countries across the world have stepped up efforts to help quarantine the outbreak by reducing travel. A few international companies have also partially shut down business in China for the time being such as Starbucks.

This has raised concerns about the health of the world’s second-largest economy and the impact the coronavirus can have on first-quarter GDP. Expansion is near a 30-year low and much of investors’ optimism around the US-China “phase-one” trade deal has been unwound. The latter is reportedly seeking flexibility on U.S. trade targets which if is denied by the White House, may further dampen market mood.

Focusing on regional economic event risk, the Indonesian Rupiah is already off to a weak start. On Monday, USD/IDR rose as local CPI data showed headline Indonesian inflation running at 2.68% y/y in January. That was unexpectedly the softest pace since March. On Wednesday, the Rupiah will also be closely watching local GDP data. Fourth-quarter growth is expected to clock in at 5.00% y/y, little changed from the previous one.

A top-tier ASEAN economic event risk that USD/PHP is awaiting will be the Philippine Central Bank (BSP) rate decision on Thursday. The markets are expecting a 25-bp reduction in the overnight borrowing rate from 4.00% to 3.75%, especially after Governor Benjamin Diokno hinted at 50-bp of easing in 2020. The proximity of the BSP may dampen the impact of Philippine CPI data due the day before.

USD/SGD may look past upcoming Markit Singapore PMI data for January which will show the impact of Wuhan virus concerns on local output surveys. The Singapore Dollar’s attention will likely be on sentiment which is seeing a cautious improvement early into the week. Chinese trade numbers for January will reveal how external flows are being impacted by the Wuhan virus.

Focusing on the US Dollar, Friday’s non-farm payrolls report could undermine dovish Fed expectations. Economic outcomes relative to forecasts have been tending to surprise to the upside as of late. More of the same flow may boost the Greenback alongside local government bond yields. Though if it also improves market mood, gains against ASEAN FX could be rather mute.

2) Australian Dollar Gains As RBA Leaves Interest Rates On Hold

The Australian Dollar as the Reserve Bank of Australia did as expected and kept its Official Cash Rate on hold at the record low of 0.75% in place since October 2019.

The chances of a move at this meeting had been dramatically cut by futures markets through January. The Australian economy has thrown out some fairly strong data in the last couple of weeks, with inflation rising for a fourth straight quarter and job creation strong.

Admittedly the headline optimism from both series masked serious underlying weaknesses. Full-time employment actually fell last month, with part-time roles accounting for all gains. Moreover, once volatile elements are stripped out, the Australian economy still lacks pricing power to an alarming degree. Inflation remains below target.

However, those headline figures may well allow the RBA to continue with its view that gradual recovery is in train without the need for much further stimulus. That said, futures markets still think rates are going lower again, probably in April.

The central bank stuck to standard fare in its statement, standing ready to ease policy if needed and expecting growth of 2.75% this year, 3% next. It sees inflation ‘close to 2%’ this year and in 2021.

The Australian Dollar has been hit hard by the general retreat from growth correlated assets which has accompanied headlines around the spread of coronavirus out of China. AUD/USD has fallen hard and fast this year, and is now flirting once more with eleven-year lows.

It is possible that sentiment has weakened for reasons beyond the coronavirus, and that optimism had got out of hand toward the end of 2019. While the US and China have signed an interim trade deal, it’s no more than a tariff truce. A lasting settlement could yet be years away. The UK’s general election may have moved the Brexit story on after years of political gridlock, but a no-deal exit from the European Union remains possible.

The Aussie benefited from rising hopes on both counts and may now be suffering as reality bites. Indeed the RBA Tuesday cited US-China trade worries as well as coronavirus as sources of uncertainty for global growth.

While unlikely to explicitly welcome this development, the RBA may not be altogether hostile to it. A weaker currency is one of the best ways to import inflation. A central bank with an inflation mandate that it can’t hit can ill afford to be too fussy about how pricing power is generated, after all.

In any case, immediate market focus will now turn to RBA Governor Philip Lowe. He has been quiet in public so far this year but will speak in Sydney on Wednesday and give semi-annual testimony to parliament on February 7.

3) Stock Markets May Struggle Even If Coronavirus Fears Subside

Technical cues warning of ebbing upward momentum – a frequent precursor to topping – were flagged across multiple major stock indexes recently. These signals have proven to be prescient. Equity benchmarks in the US, Eurozone, Japan, Australia, mainland China and Hong Kong have since plunged.

The coronavirus outbreak emanating from China’s Wuhan province has been pegged as the nominal catalyst for the selloff. A rapidly growing docket of cases reported at home and abroad along with Beijing’s sweeping containment efforts have stoked worries about the epidemic’s impact on global growth.

This is, to be sure, a fair concern. And yet, the appearance of those topping cues preceded the virus’ emergence as a driving narrative. That suggests that it may amount to a trigger for forces that were already conspiring to sour sentiment rather than a standalone catalyst inspiring recent turmoil.

The markets’ anti-stress defenses looked diminished at the start of 2020. Global growth appeared to steady a bit in the fourth quarter and the flow of incoming economic data brightened relative to baseline forecasts. Nevertheless, activity growth remains near the lowest levels in three years.

As noted last week, this is “problematic in that it would not take too much stress to bring recession back into view. That makes assorted risks like the US presidential election, the lingering threat of a no-deal Brexit, violent escalation in the Middle East, and now the coronavirus, appear relatively [more potent].”

Meanwhile, “comments from bigwigs at the World Economic Forum in Davos, Switzerland…flagged worries about the dual risk posed by fiscal dysfunction and central bank impotence whenever the next downturn invariably arrives.” The ECB conspicuously launched a comprehensive review of its mandate in tandem.

Finally – as pointed out soon thereafter – “late-2019 successes appear priced in. Building on the ‘phase-one’ US-China trade deal, [which tellingly landed with a thud], seems unlikely for at least a year and failing to secure an EU/UK trade deal before 2021 may yet [make for a messy divorce].”

All this means that containing the Wuhan virus is unlikely to give stock markets a lasting lift. It is unclear if it will be enough to smother the nascent upturn in the global business cycle. If it is not, it will nevertheless diminish the markets’ immune system further, making the next bump in the road more dangerous.

The ultra-loose setting of worldwide monetary policy means the opportunity cost of owning liquidity – i.e. cash – looks rather low. Against this backdrop, defensively-minded investors may continue to push capital into the US Dollar, which accounts for a commanding 88 percent share of global FX market turnover.

4) Commodity Dollars, Stocks, Energy Will See Worst Coronavirus Hit

The ultimate global economic hit from this year’s outbreak of Wuhan-strain coronavirus is unknowable, but whatever it turns out to be it will come at a time when the world economy is manifestly ill-equipped to cope.

As the old year faded out, 2020 seemed to offer promise for growth-linked, assets such as commodity currencies, commodities themselves and stock markets. However, that promise seems to have faded appreciably even before January is through, with haven assets such as the Swiss Franc and gold ruling instead.

The system of global trade remains under political pressure of an order not seen before in the modern era. The US and China may have signed a ‘phase one’ trade deal, but it’s really no more than a tariff-war truce. The real meat will have to be in a subsequent settlement and, although the two sides are still talking, that’s not coming anytime soon. Trade freedom is threatened elsewhere too, with the US eyeing both Japan and Europe as trade surplus sinners.

The Brexit story which has troubled markets since 2016’s British vote to leave may have finally moved on but the shape of the final trade and political arrangement between the United Kingdom and the European Union is unknown. ‘No deal’ is not likely but remains possible. Whatever happens, torturous brinkmanship surely lies ahead with the specter of unintended consequence hovering above.

Then there’s China itself. Growth there is already near thirty-year lows and the fact that this was not in any way unexpected does not lessen its importance. Plenty of China watchers including those at Dutch bank ING think that the coronavirus hit will contribute to a deceleration of growth to below 6% this year. Given China’s astonishing debt levels it’s not difficult to see problems ahead, especially if the effects of the virus worsen.

The global monetary system is arguably where the minefield gets really tricky to cross. Interest rates are at or close to record lows all over the developed world. The Federal Reserve has managed to raise its own lending rates substantially from their financial-crisis lows but, even in the US, monetary policy remains very loose by historical standards. Central bankers have less ammunition to fight any coming downturn than they’ve ever had before and their Davos commentary this year suggests they know it.

And don’t forget that we are already quite late in the cycle, with stock markets’ bull run the longest bear-free charge ever seen.

The outbreak of Severe Acute Respiratory Syndrome (SARS) in 2002/3 provides a very imperfect guide to potential coronavirus costs but is still worth looking at. A 2004 study suggested that SARS cost the global economy $40 billion. So far coronavirus appears to be comparably contagious but notably less lethal. A similarly sized-hit need not be catastrophic for the global economy, of course, and that may be one crumb of comfort.

It has already been detected in the US, France, Australia, Singapore, Malaysia, Canada, Japan, Vietnam, Nepal and South Korea. This count will grow so the potential for economic damage and lost revenue will go well beyond China’s borders.

The Australian Dollar can serve as an exemplar of the problems already sown in the market by coronavirus worries. The clearly growth-correlated currency’s home country is China’ biggest supplier of raw materials so it stands especially exposed to any virus-linked slowdown.

AUD/USD has been sliding effectively since the start of the year and is now approaching the eleven-year lows plumbed in 2019. Until there are signs that coronavirus has been contained, especially in China, support for it and assets with similar risk profiles will remain fragile.