As the U.S. stock market falls amid coronavirus concerns, forex has sprung to life, hinting that the sudden weakness in the S&P 500 is real.
In a very concerning sign for the U.S. stock market, the sleeping giants of the global forex markets have awoken.
Amid coronavirus-related travel and supply chain chaos in China, safe-haven demand for the Japanese yen (USD/JPY) surged, and the offshore-Chinese Yuan (USD/CNH) plummeted. The U.S. dollar, usually also a haven in times of market stress, lost 0.5% against the euro (EUR/USD).
Until recently, the world’s most heavily traded forex pair, EUR/USD, had been experiencing historically low volatility. That changed today.
The euro rallied aggressively against the dollar as fed funds futures priced in a slight probability of another rate cut at the Fed’s next meeting [CME].
The euro is traditionally a popular candidate for a carry trade (where a low yielding currency is sold against a higher-yielding partner). These positions are often liquidated during periods of genuine stock market stress, which may have fueled the impetus behind today’s EUR rally.
Here’s why that’s significant for stocks. Previous moves in equities have not been enough to shake the carry trades out of the tree. That changed today, and Wall Street took notice.
High volumes raced into the S&P 500, which fell 1.4% after the U.S. made the surprising decision to raise the coronavirus threat level to “do not travel” to China [U.S. State Department] and U.S. airlines began suspending flights to the mainland.
Investors had remained relatively confident that the epidemic in China would not meaningfully hit growth in the United States [Fox Business]. Until now.
The latest moves in the forex market suggest that this idea may now be cracking, as the dollar loses out to the common currency – even after the eurozone posted miserable inflation and GDP data on Friday.
Even the British pound rallied against a stricken U.S dollar. GBP/USD surged 0.8% to 1.3190 despite it being Brexit day in the U.K.
In India, the rupee dropped to 71.470 against the greenback.
Australia relies heavily on trade with China – especially for mineral exports – so it was unsurprising to see AUD/JPY hit a 90 day-low around the ¥72 handle.
Another stark indicator blared a warning sign after the offshore Chinese yuan hit the politically sensitive 7.000 level for the first time since the trade war was de-escalated [Yahoo Finance].
While China utilized their currency to offset the impact of Trump’s trade war, they allowed their currency to strengthen heading into the signing of the phase one deal. Their decision to allow the strength in the CNY prompted the White House to remove them from their list of currency manipulators.
Amid a bold effort to restore confidence as the coronavirus threatens to ravage economic output, USD/CNH has hit that level again. This presages a weak fixing for the CNY when markets open next week – assuming the epidemic continues to expand.
In a note shared with CCN.com, senior economists at Euler Hermes said that some of the weakness in the yuan comes as Beijing makes significant efforts to pump additional stimulus into China’s highly-leveraged economy.
The PBOC is increasing liquidity injections, large state-owned banks are offering more favourable credit conditions to firms affected by the epidemic, etc. Going forward, further monetary easing is likely.
Our forecasts for 150bp worth of cuts in the reserve requirement ratios and 30bp in the loan prime rate over 2020, which previously seemed ambitious, may now look highly probable. On the fiscal side, authorities can increase public spending beyond the 2.7% of GDP we currently expect for 2020.”
While the U.S stock market ranks among the largest and most valuable trading centers in the world, the forex market’s volumes are larger than all of the world’s equity markets combined [Investopedia].
Today’s breakout in volatility shows that big money is suddenly taking the coronavirus very seriously indeed.
This article was edited by Josiah Wilmoth.