Find out how the coronavirus outbreak is impacting the FX market

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28 January 2020

thomasdodds

Concerns surrounding the coronavirus outbreak have continued to rock the financial markets so far this week.

T
he death toll for the virus edged into triple figures yesterday, currently standing at 106 at the time of writing. More than 4,500 cases have now been reported in China – a big step up from the 2,835 that had been reported a day previous. While most of the deaths have been in the Hubei province, where the virus is said to have originated, it has now spread to at least sixteen different countries.

Amid the mounting death toll and heightened concerns over the economic impact of the virus, investors have sold-off hard their equity holdings – the S&P 500 index fell by over one-and-a-half percent on Monday. In the currency market, the safe-haven yen has strengthened sharply, with the USD/JPY cross edging back below the 109 level this morning.

EUR/USD has also been under heavy downward pressure, trading perilously close to the 1.10 mark as investors flock to the safety of the greenback. Yesterday’s disappointing IFO confidence data out of Germany also far from helped the common currency. The Aussie and New Zealand dollars, perceived as among the highest risk currencies within the G10, have also sold-off aggressively, the former’s losses being exacerbated by the country’s heavy dependence on demand from China.

That being said, the FX market has still not gone into full-blown panic mode just yet. So far the virus has been mostly contained within China, with the majority of deaths among the elderly or those with pre-existing respiratory issues. As we mentioned last week, should the spread of the virus become more aggressive, we would expect a continued flock to the safe-havens and a sell-off in emerging markets.

Federal Reserve set to keep rates unchanged

The rest of the week is expected to be an extremely busy one in the foreign exchange market, with no shortage of major announcements set to shift the major currencies. First up will be the Federal Reserve’s latest monetary policy announcement on Wednesday. Rates are almost certain to be kept unchanged, with no-one really expecting any move in rates either way for some time yet. The market will instead be paying close attention to the bank’s comments on the strength of the US economy and its external outlook. Given the easing in trade tensions since the last meeting, we expect the bank to maintain a mostly upbeat tone, although there is a risk that they sound a concerned note regarding the virus outbreak in China and its potential impact on the global economy.

In the meantime, this afternoon’s US durable goods orders could shift the dollar when released at 13:30 GMT (14:30 CET). We will also be paying close attention to the latest consumer confidence index at 15:00 GMT for signs of a pick-up induced by the easing trade concerns.

Will the BoE cut interest rates on Thursday?

With the UK’s exit from the European Union on Friday already signed and sealed, investors will instead by focusing on Thursday’s Bank of England meeting.

We think that the vote on rates will be a close one. As we noted in our Bank of England preview report: “At the December meeting, members Saunders and Haskel both dissented in support of an immediate cut, with the vote split 7-2 in favour of no change. Even following Friday’s strong PMI numbers, we think that there is a decent chance that Vlieghe and Tenreyro follow suit. On the other end of the spectrum, hawks Ramsden and Haldane are very unlikely to vote for a cut this time around, particularly given their recent arguments regarding the need for a more restrictive policy. Jon Cunliffe has recently warned that prolonged easing may risk financial instability. Ben Broadbent has also appeared to place a greater onus on UK labour data, which has actually remained pretty resilient of late. Governor Mark Carney himself appears to be the most on the fence, although we think he’s now more likely than not to side with the hawks at the January meeting.”

So while our base case is for rates to be left unchanged, there is a very reasonable chance that we see a 25 basis point reduction.