Virus fears knock risk assets, emerging market currencies

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27 January 2020

thomasdodds

The spread of the Coronavirus infection in China and abroad impacted financial marketing sentiment late last week, leading to sell-offs in equity markets and rallies in traditional safe-havens like G10 government bonds.

I
n currency markets, the effect was felt in emerging markets that sold-off against the US dollar, led on the way down by Latin American currencies, which have become quite sensitive to developments in China. The yen was the top performing G10 currency, buoyed by its traditional role as a safe-haven, while sterling also managed to outperform.

The focus this week should remain on the headlines regarding the Coronavirus infection. Past outbreaks, such as the SARS infection, had little long term impact on the financial and economic environment, and we are hopeful history will repeat itself here. The Federal Reserve meets Wednesday, but we expect it to remain on hold and essentially repeat its previous communications.

There is a lot more uncertainty about the Bank of England meeting on Thursday, with markets evenly split on the likelihood of a cut. We will also receive a raft of important macroeconomic releases on both the Eurozone and the US, including GDP growth Thursday, and inflation data out on Friday. We think that the Eurozone core inflation release on Friday is of particular importance for the common currency.

GBP

Stronger-than-expected data out of the UK last week is supportive of our base case scenario that the Bank of England will keep interest rates unchanged at its monetary policy meeting this Thursday, Mark Carney’s last as MPC governor.

The labour market report and, more critically, the timely PMI indices of business activity all surprised to the upside. We think that this will tip the scales in favour of unchanged interest rates, though the decision is finely balanced. As we mentioned in our Bank of England preview report, should this is the case, expect a strong rally in sterling.

EUR

The ECB meeting left interest rates unchanged last week, and there were minimal changes to the central bank’s communications to markets. The PMI surveys showed that the manufacturing recession is easing, while services activity was softer-than-expected; all in all, mixed news.

This week GDP data and, in particular, the early read on January inflation on Friday are quite critical. Markets are expecting a pullback in the core inflation reading, so an unchanged result at a 1.3% annual rate could provide the excuse for a euro rally.

USD

The holiday-shortened Martin Luther King week is usually a slow one in the US, with few key data releases and little policy news – last week was no exception.

This week the focus will be on the FOMC meeting on Wednesday. The US economy seems to be in a good spot right now, growing at around a 2% pace, generating employment in excess of the growth of the labour force, and with no signs of inflationary pressures. The Federal Reserve is likely to be content to stand pat and leave interest rates unchanged while this lasts. Economic data (GDP and inflation) later in the week should be supportive of that decision.