MUFG: USD support as Europe agrees to discuss further

24 april 2020

By Derek Halpenny, Head of Research, Global Markets EMEA and International Securities

EUR: Europe fails to act with investor sentiment fragile

There has been quite a lot of anticipation all week ahead of EU Leaders summit that took place yesterday but nothing at all has come from the meeting it appears apart from a commitment for the European Commission to seek a compromise plan for the next meeting on 6th May. The summit did not agree on any crucial aspects of this fund – it’s size, how it would be financed or whether distribution would be through loans or grants. President Macron did state that “real budgetary transfers” would be needed, consistent with calls from Italy and Spain. The lack of immediate progress is a negative for sentiment and for the euro but in a sense the proximity of the next gathering means the fallout from limited signs of progress should be limited for now. We still see scope for further EUR/USD downside over the short-term given the fragility of investor sentiment, underlined last night by the notable reversal in US equities, which is evident in Asian equity market performance today.

The sell-off was triggered by the accidental release by WHO of a report indicating that a trial testing an antiviral drug by Gilead Sciences has not gone well. The initial story on this had sparked a rally in equities. The sell-off is a reflection of how tenuous this equity market rally could be and how prone sentiment is to day to day developments related to defeating COVID-19. For sure, the sell-off is not large relative to the size of recent moves but it underlines to us the importance of good news on COVID-19 developments and on central bank and government policy responses in order for the markets to brush off the ongoing inflow of dire economic data. We certainly expect there to be episodes when good news will not be forthcoming.

Hence, why we maintain our upside bias for the US dollar for now. The S&P 500 remains 25% above the low on 23rd March and at this level plenty of good news is priced for the smooth reversal of lockdowns in Europe and the US. The relatively low levels of testing and the shorter periods of lockdowns relative to China (where there have already been numerous pockets of 2nd waves) points to those reversals from lockdown being far less than smooth.

G10: Activity looks to be at a turning point

With the COVID-19 data continuing to turn and slowly trend slower, market participants will increasingly be looking at countries that are reversing their lockdowns – to what extent will these unfold. Where economic activity turns up in countries with low COVID readings or credible testing/lockdown policies will potentially see their currencies outperform. This may not be immediate with still plenty of negative Q2 data still to unfold like we got yesterday with the PMI data. But high frequency mobility data (Apple & Google for example) provide some colour on where we are seeing some early signs of pick-up. Based on phone requests for directions, the data can gauge mobility on driving, transit and walking. The data is showing a pick-up already underlining the shift in policy to focus to actual partial reversals of lockdowns or discussions/speculation of lockdowns being reversed.

Germany, which has only very partially reversed its lockdown has seen the driving indicator pick-up to 68.02, (a baseline of 100 was set on 13th Jan 2020) the highest level since 16th March. Italy’s index is far lower at 24.26, but here too is close to the recent high (24.65 on 17th), which was the highest level since 13th March. Spain’s index is the highest since 15th March. In the UK the index is close to highs not seen since the lockdown began on 23rd March and in the US the level is at the highest since 20th March.

So the evidence is there suggesting this is the turning point for real economies and we will start to see activity pick-up. The data points to the Nordics’ and Germany’s economies reverting more quickly than elsewhere. We suspect Spain and Italy could then be next to turn higher based on COVID figures and testing. On this basis, the risk is that the UK may prove slowest given the lack of testing relative to the rest of Europe and even the US where testing has picked up in recent days. A slower reversal of the lockdown in the UK is a risk we believe is not fully reflected in GBP yet.

As the Economic Cycle Research Institute (ECRI) points out, the “3 Ds” measure of the severity of recessions means the current COVID recession looks to differ from the 1930s Depression in one crucial way (and it’s why equity markets are so resilient). The 3 Ds refer to : Depth, Diffusion and Duration. On depth and diffusion (the spread across the economy) this recession will trump the Depression but is assumed will differ greatly in terms of duration (way shorter). Smooth lockdown reversals and timely high frequency data will be very important in the coming months.

JPY: BoJ unlimited JGB purchase move meaningless

USD/JPY jumped yesterday on the news reported in the Nikkei that the BoJ at its meeting on Monday will among other steps announce the removal of the annual JPY 80trn JGB net purchase cap. But as can be seen in the Chart on the front page, the BoJ’s focus shifted a long time ago from a quantity target to a target of Yield Curve Control (YCC). In order to ensure yields did not drop to levels too low and inconsistent with the 10-year yield target range the BoJ has had to slow quite dramatically its purchases. As of March, the annual net purchase total stood at just below JPY 14trn.

So we are not surprised to see the USD/JPY jump reverse quickly. The BoJ has been criticised for a while now over maintaining the communication in regard to the JPY 80trn amount and the COVID crisis is an opportunity to abandon it with a message of unlimited purchases. The BoJ may announce other steps (increased Corporate bond / CP purchases) which would be more meaningful although we doubt any steps announced by the BoJ will be meaningful enough to alter the trajectory of the yen in the FX markets.