News & analysis

With the global economy sitting in a fragile state due to the impacts of COVID-19, news from Europe that Italy will ease lockdown measures for manufacturing and construction sectors starting today would normally equate to a brief euro rally.

Additionally, reports also suggested that the UK Prime Minister, Boris Johnson, will also set out plans for the UK’s exit from lockdown measures in the coming days should have amounted in a flurry of sterling strength. Despite the news, however, both the euro and sterling sit just shy of half a percentage point lower in today’s session.

The reasoning behind today’s market pricing stems from the US, as investors prepare themselves for another potential escalation in US-China tensions despite the current state of the global economy.

Both President Trump and Secretary of State Mike Pompeo have pinned the blame for the pandemic on China. Pompeo said on Sunday that there was “a significant amount of evidence” that the virus emerged from a laboratory in the city of Wuhan, while the President promised a “conclusive” report on the origins of the outbreak when speaking to Fox news.

The spat has renewed fears that the phase one deal negotiated between both sides in January won’t be enough to stop another flare-up in tensions. Eyes will be fixated on Donald Trump’s twitter page, which was a key source of information during the US-China trade war, as Chinese markets join Japan in a bank holiday. The offshore renminbi, CNH, is trading 0.2% higher, while the Japanese yen also rallies.

 

Performance of the Expanded Majors in today’s sessions

 

SEK

Sweden adopted looser containment measures than most other countries in its fight against the spread of COVID-19, leaving its citizens with the flexibility to visit bars and restaurants and left preschools and grade schools open as well. Gatherings of over 50 people are banned, however, along with museums, sporting events, and visits to nursing homes. While one may question if these measures suffice, it seems like the trend in virus cases and deaths in Sweden are not much different from any other country, signalling that the nation has so far been as successful in controlling COVID-19 as countries that did go in lockdown.

Although Sweden’s mild approach to the virus outbreak has somewhat cushioned the economic effects for the nation, compared with countries that are in lockdown, the Swedish economy has still taken a lot of stick due to its reliance on exports.

Finance Minister Magdalena Andersson stated that the economy is likely to shrink by 7% this year, but also acknowledged that the services industry will be far less affected compared to other countries.

Preliminary manufacturing Purchasing Managers’ Indices for April released this morning showed a slump to 36.7 from 43.2 in March. For perspective, the eurozone’s manufacturing PMI was revised downwards to 33.4 this morning, with Spain and Italy’s readings printing at 30.8 and 31.1 respectively. Sweden’s manufacturing sector performed slightly better but the largest distinctions between their economic activity and that of the eurozone remain in the retail and services sector because of the nature of the Swedish’ lockdown: the March composite PMI printed at 45.9 for Sweden, while the euro-area showed a crash of composite PMI to 13.5.

In terms of monetary response, the Riksbank has acted in a similarly laid back manner

Measures were taken, but simply not as aggressive as in most other countries. The central bank launched a SEK300bn asset purchase programme in March but had little room to further cut interest rates without entering negative territory again. In their meeting last week where the Riksbank left its key interest rate unchanged at 0.00%, the MPC stated that rate cuts at a later date are not ruled out and revised their yearly inflation forecast down from 1.3% to 0.6%. But in earlier months, the Riksbank’s Governor Ingves was clear in what he thinks about the negative interest rate policy (NIRP) and had signalled repeatedly that the central bank will not go back into negative territory without a strong basis.

Whereas last week’s announcement on the interest rate led to a rally in the Swedish krona, the single currency started off on the wrong foot this month and has weakened over 2% against the euro and over 1.5% against USD. However, some of this depreciation has been shaved off this afternoon as risk sentiment recovers somewhat with oil prices bouncing from their lows. That being said, seeing as today’s data release did little to shake the Swedish krona, it appears that the currency is at the mercy of broad-based dollar demand and developments in risk sentiment as the story continues between the US and China.

 

Swedish krona slumps substantially against the EUR and USD in May

 

LATAM on the way to exhaust its monetary firepower

Latin American countries face a deeply contractive economic outlook this year. With an already weak basis for growth in 2019, the pandemic hit is expected to trim the areas aggregate GDP by 4% this year. Such a contraction would exceed the economic drop in the region during the financial crisis in 2009 (2.1%) and the external debt crisis in 1983 (2.4%). The sharp downfall in commodity prices is set to be a large contributor to the economic contraction, as the region is structurally dependent on foreign commodity demand. Additionally, already weak fiscal positions along with downgraded or negative credit ratings will further fuel the constrained growth spiral.

With this economic backdrop, monetary policy has stepped up as one of the dominant counter-cyclical tools for most economies in the area.

Unlike other episodes of low growth in the region, the headline and core inflation backdrop remains comfortable for most economies, providing central banks with enough degrees of freedom to act. However, some countries like Chile or Peru have already met their lower bound or will do soon. For others with some policy space left, like Mexico and Brazil, concerns about currency stability and capital account pressures will likely restrict the extent to which monetary stimulus may be implemented further. Some forms of intervention in FX market will likely continue to complement monetary easing in the following weeks. This is especially the case in Brazil, where record-low interest spreads with the Fed and mounting uncertainty have triggered the highest currency sell-off in the LATAM space.

 

Interest rates in Latin American are hitting their historical lowest

 

This week will add some further clarity on the path for monetary policy in Latin America

With both Chile and Peru set to keep their policy tools unchanged on Wednesday and Thursday respectively, Brazil is the only one left that is expected to move policy on Wednesday. The BCB will probably cut its key rate for a seventh straight time to at least 3.25%, 50 basis points below its current stance. Further easing is expected given 2020 forecasts for below-target inflation and the deepest recession in decades, with additional 40 basis points already priced in by markets in the next 6 months. Looking forward, however, substantial currency drops might run out of steam. Although the balance of risks is mainly tilted to the downside, it would be safe to safe that most of the currency downfall is already accounted for in the recent price action. The real was heavily hit after the pandemic hit as investors flocked to safety. FX interventions via swaps and USD liquidity provisions, on the other hand, are also set in place to prevent currencies from dropping much further.

Percentage currency depreciation against the USD since the beginning of the year

 

Authors: 
Simon Harvey, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Ima Sammani, Junior FX Market Analyst

 

 

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