The Fed has thrown the kitchen sink of easing measures at the coronavirus crisis.
This may take the edge off the dollar strength seen recently but will not cause broad weakness. US yields have fallen and liquidity stress is likely to ease due to the scale of the Fed’s repo and swap arrangements, so currencies with limited space to ease monetary policy may find some support against USD.
EUR, CHF and JPY are the obvious candidates but given Europe is now the centre of the coronavirus outbreak globally, real economic concerns may trump the ECB’s limited war chest and result in further euro weakness. The same is true for sterling.
Policy responses and news about coronavirus itself will be the key items for markets this week. We have seen a raft of monetary and fiscal measures over the past week, the most recent ones are summarised below with a few additional thoughts:
- The limited USD weakness we’ve seen indicates the extent to which markets are trading in a crisis dynamic. Monetary policy moves will have limited FX impact compared to changes in global risk appetite. This is especially true for USD.
- Much of the Fed’s concern seems to have been over USD liquidity – essentially a global demand for dollars that was widening spreads and causing volatility in important instruments. If scarcity of US dollars worldwide causes tightening of financial conditions in the US, this is a major concern for the Fed. Hence last night’s decision to open swap lines.
- The success of these efforts will be crucial for FX markets, as easier dollar liquidity will relieve the current pressure that is causing USD appreciation. The initial signs on this front are mixed. Early this morning, the three month cross-currency basis for dollar-yen swaps – an indicator of funding demand for USD – briefly spiked this morning before settling at around 64 basis points. This is roughly consistent with the middle of last week, suggesting there has been no immediate relief for USD funding requirements.
- US equities have opened very badly, with the S&P 500 plunging 8% on open. Financial conditions have not improved materially, with most credit spread measures still generally wider compared to a week ago.
- EUR: MNI is reporting eurozone finance ministers are considering a total virus stimulus amounting to 1.5% GDP. This comes after the European Commission floated the possibility of relaxing its budget rules last week.
- JPY: The BoJ announced an increase in their ETF purchase target last night, while avoiding rate cuts.
- RBNZ: Cut rates by 75 basis points last week, and hinted QE is the next policy option.
- RBA: Will announce further measures on Thursday, with QE on the table.
3m USD JPY cross currency basis swap still showing signs of funding stress
Agressive Fed measures barely dent USD
Author: Ranko Berich, Head of Market Analysis at Monex Canada.