Last week saw global equity markets suffer their worst weekly performance since the financial crisis amid growing concerns of a coronavirus pandemic. The S&P 500 fell 9.3% (the loss was even larger if we include the gap between where the market closed on Friday 21st Feb and where it opened on Monday 24th Feb) while the FTSE 100 fell 11.1%, the Dax in Germany fell 10.1% and the Nikkei was down 7.8%. Meanwhile, oil prices fell another 14% and we saw a significant increase in FX volatility amongst the majorpairs.

On a positive note, reported cases in China remain relatively steady at 80,026 (growing less than 1% per day on average). However, the international aggregate (excluding China) now stands at 8,334 (+30%) with cases in 65 different countries. Italy and Iran (part of the first tier of breakout countries) have continued to see a steady rise although South Korea has stabilised at around 20% growth for the past two days.  

Chart 1: COVID-19: Cumulative Cases, Daily Growth Rates, International vs China ex Hubei

In the US, there have been 29 reported cases (excluding the 47 repatriated cases) with the majority on the West Coast, however the first two cases in New York were reported this morning. As of Saturday, the US CDC has only carried out 472 tests. This number is likely to rise significantly this week and as such, it seems likely that the number of new cases will rise dramatically in the coming days.

Chart 2: COVID-19: US Confirmed Cases (excluding Repatriated)

Clearly, we’re not Virology experts here at Validus, so having provided a brief overview, we’ll stick with opining on market related risks…

Of the currency pairs we focus on, EURUSD has had a significant move over the past week and a half, rallying from a near three year low of 1.0780 to a high of 1.1164 earlier today. In recent weeks, we’ve come to expect a stronger dollar during times of uncertainty (the greenback benefiting from its reserve currency status) so the move we’ve seen over the past week has been somewhat counterintuitive.

The move is almost certainly the result of speculators unwinding short EUR positions (funding carry trades) which according to the chart below, had reached their most extreme levels since December 2016. We’ll have to wait for next week’s data print to confirm, but in the absence of any significant fundamental change, this appears the most likely explanation and ties in with the broader risk-off theme. A second influence (which may have been the initial catalyst before the speculators caused the move to snowball) is intervention by the Swiss National Bank which is reported to have been buying foreign currency to prevent the CHF appreciating beyond $1.06 vs the EUR.

If the euro has suddenly become the darling of the market, the exact opposite is true of sterling. Over the past week, the pound has fallen from $1.3010 to $1.2740 this afternoon. A portion of this is attributable to renewed talk of an interest rate cut but in the main, the market is also concerned about trade discussions with the EU. Meanwhile, sterling has always been a high beta currency so we probably shouldn’t be too surprised to see it under-performing in a risk off environment.

Chart 3: EURUSD positioning

Source: Bloomberg

Official data is yet to reflect the impact that coronavirus is having on the global economy, but it is clear that most sectors of the economy will be negatively impacted. Disruptions to the supply chain are now having a notable impact on the manufacturing sector while travel and tourism are starting to suffer. The Bank of China were quick to react with stimulus measures two weeks ago, but it remains to be seen how the Fed, ECB, BoE et al. will respond. There have been rumours of coordinated actions (similar to what we saw back at the height of the crisis in 2008) and Bill Nelson, formally at the Federal Reserve and now Chief Economist at the Bank Policy Institute believes it could happen this week.

At the very least, the market is now pricing in a 50 basis point cut from the Fed when they meet later this month and the Bank of England are expected to follow with -25 bps by May. If the Fed proves to be an outlier in providing stimulus, we may see the dollar come under pressure, particularly in the short term, but if others follow, expect a more broad boost to risk appetite (which should help currencies like GBP, CAD, AUD at the expense of the EUR and JPY). Either way, the increase in volatility that we’ve witnessed over the past week looks set to stay in the short term as markets try to gauge the impact on the global economy going forward.    

Author: Marc Cogliatti