Coronavirus, ugly dogs and a Euro squeeze

We’ve once again seen GBP take a kicking against EUR at the start of today’s session, as well as EUR momentum against USD, but while we’ve had a bit of data out this morning, the move has been largely driven by events and data releases elsewhere. Right now its all about how much damage Coronavirus has done both on the demand side as well as disruption caused to supply chains and the latest Caixin Purchasing Manager’s Index data released overnight indicates that the COVID-19 outbreak had “a severe impact on China’s manufacturing sector” in February due to efforts to contain the spread of the virus. In addition, the private survey indicated that the extended Lunar New Year and factories operating well below capacity pushed production volumes and new order intakes to the lowest level surveyed. The survey wasn’t all pessimism. It is worth bearing in mind that the Caixin PMI data was collected 11-21 February, however panel comments from the survey indicated that firms expected the situation to be temporary, with the Future Output Index rising to the highest level in five years. While it’s a bit of a case of things can only get better (although they could obviously get a lot worse), the weak survey leaves space for a rebound and with it renewed confidence. As things stand though, the surveys out of China confirm much of what had been dragging on markets through last week, with risk assets being hit hard. UNWINDING CARRY FUNDING Back to that EURGBP rate – while European data hasn’t been as much of a basket case as we all know it can be, it hasn’t exactly indicated that the Euro area is in fine health. The European inflation data that came out on Friday was weak, but not notably any less so than trend. Italy scraped 0.4 percent year-on-year (0.3 percent EU normalised). French consumer spending and GDP down, but inflation stayed at 1.6 percent. Harmonised German inflation edged up to 1.7 percent year on year. None of this particularly earth shaking – although there was some mid-week talk coming from the European Central Bank about adjusting the framework of its inflation targeting away from the current wording of “below but close to 2 percent”. But this morning we’ve seen GBP break below EUR1.1500 to 1.1493, the majority of which hasn’t come from strong Eurozone data or UK weakness but from a short squeeze in the common currency. The Euro has been held down by its use as a funding currency for carry trades – where investors borrow in Euros at ultra-low rates and invest in higher-yielding currencies. With concerns increasing over the impact of Coronavirus, we have seen market risk appetite dive, and with it investors have pulled out of higher-yielding riskier assets and carry trades, helping the Euro to rally. It’s not just against sterling that we’ve seen EUR gain ground – EURUSD has broken above that EUR1.1100 point this morning, and is carrying upside momentum. EUROPE FAR FROM IMMUNE While this unwinding of carry trade positions has given EUR plenty of support, we do not see this momentum remaining. The Eurozone is highly exposed to risks stemming from the coronavirus outbreak – as always it’s important to look at the reporting period for data being released (we saw this with GBP price action following the general election) – should we start to see disruption on both the demand the supply sides of up-to-date European data, expect to see this EURUSD strength come off pretty quickly. AESTHETICALLY-CHALLENGED CANINES On the EURGBP side, we could be set for a bit of an ugly dog fight in the short term. As with EURUSD, the momentum for EUR on unwinding carry trades is limited, but nervousness over Brexit-related concerns continue to hamper the GBP side of things. GBP took a 2 percent hit against the euro over the month, and there is space for clawing back some ground, but we could be dependent on the tone of the Budget on 11 March. Expectations are for the Treasury to abandon all semblance of fiscal restraint and ramp up spending. Regardless of the wisdom of big government spending, Boris Johnson attempting to buy friends and admirers by throwing money around will help to reassure in the short term that Brexit impact will be limited somewhat. However, while Boris Johnson and Dominic Cummings may be happy to get the Treasury cheque book out to make friends at home, they’re a lot less enthusiastic about doing so in Europe where trade negotiations continue to be a long way from happiness and smiles – something that will drag heavily on any GBP enthusiasm generated by Budget generosity with taxpayer cash. DOWNSIDE RISKS A bullish case from GBP will take a dissipating of the fear over the spread of coronavirus and its associated economic impacts, as well as confirmation of the big spending urges of Boris Johnson’s government. But as previously underlined, there are plenty of near-term risks to the downside. To discuss any of the items we have covered in today's market update, contact us via info@labardemanagement.com or call us on (+44) 0203 3488 1169