No nuance in FX markets, assessing the economic damage in a fast-moving crisis

A largely unavoidable mention of the “B” word, but during the General Election and the United Kingdom’s formal withdrawal from the European Union, we highlighted the need to look at sampling periods when assessing the short-term impact of Brexit. With the incredibly fast-moving nature of the COVID-19 pandemic, measures brought in by governments worldwide to arrest its spread, and the impacts of the pandemic and those measures on business activity, the importance of looking at that sampling period is even more important. Anything pre-lockdown in Europe is mostly only useful as a before and after comparison. MARCH PMI SURVEYS BAD AND ONLY THE BEGINNING We all knew that the latest Purchasing Managers Index numbers were going to be brutal for some pretty obvious reasons (although their greatest utility is perhaps in seeing the parts of the economies surveyed that haven’t been hit as hard rather than picking over the rubble in the bits that have been smashed). Released this morning, the ‘flash’ IHS Markit Eurozone Composite PMI for March indicated the largest collapse in business activity ever recorded. According to IHS Markit, printing at 31.4 in March, the Composite PMI collapsed from 51.6 in February to register the largest monthly fall in business activity since comparable data were first collected in July 1998. The prior low was seen in February 2009, when the index hit 36.2. Inevitably, the biggest losses come from the services sector, particularly in consumer-facing industries such as travel, tourism and restaurants. According to the survey, service sector business activity index slumped just over 24 points from 52.6 in February to reach 28.4, surpassing by a long way the survey’s prior low of 39.2 (recorded in February 2009). The damage in the manufacturing sector was less widespread, but there was nonetheless a steep drop with the survey’s gauge of factory output dropping just over nine points, down from 48.7 to 39.5 - the largest monthly contraction of production since April 2009. RECORD BREAKING DECLINES FOR UK DESPITE MEASURES LAGGING EUROPE UK data also registered record-breaking declines, despite the area not having yet been hit with the same levels of restrictions in place in much of the rest of Europe. The IHS Markit/CIPS Flash Composite PMI indicated that the combined monthly decline in output across manufacturing and services exceeded that seen even at the height of the global financial crisis. The survey printed at 37.1 in March, down from 53.0 in February. The reading from IHS Markit was pretty bleak, stating that “Any growth was confined to small pockets of the economy such as food manufacturing, pharmaceuticals and healthcare. Demand elsewhere has collapsed, both for goods and services, as increasing numbers of households and businesses at home and abroad close their doors.” Sadly, the PMI surveys released this morning are only going to be the tip of the iceberg, with unemployment numbers for any relevant period of time yet to print. We may see some disparity based on countries with high levels of state-employed workers versus countries with highly liberalised labour markets, but there’s going to be a lot of pain all round. UN-NUANCED RISK-ON/RISK-OFF FX MARKETS In the foreign exchange markets, it goes without saying that we are not operating in a nuanced environment. Fear and thin markets make for binary risk-on/risk-off moves. In the G10 risk-on camp, the Norwegian Krone is hugely correlated with oil price moves. Aussie dollar is the big proxy for Chinese demand, with Kiwi correlated into that. GBP has been slammed by a lot more risk-off trading than might have previously been the case, with Brexit uncertainty taking away a lot of the haven cachet it might have otherwise had in this environment. EUR had been given plenty of support on a big unwinding of carry trade positions in the early days of the Coronavirus outbreak, where the euro had been used as a funding currency for holdings of higher-yielding, higher risk currencies. However, it’s pretty safe to say that at this point in time those positions are now long closed. The European Central Bank will not be sad to see some of this strength come off against the dollar and it’s unlikely we will see any formal intervention, but we might hear a bit of jawboning if there is too much of an acceleration. The US dollar is the only big winner in this space given the extreme levels of risk aversion driving demand for the safety of a reserve currency. EURUSD has fought back some ground on today’s trading on overbought convictions, but we haven’t seen the worst of the economic data yet and as that starts to filter through then that revival is likely to come off again. At some point dollar strength could start to cause a real problem for the US economy, but at the moment a strong USD is a very long way down the list of reasons why US exports aren’t breaking any records right now. MONITORING ONGOING CONDITIONS As a footnote, given the aforementioned issues with the sampling period of economic data in such a fast-moving environment, this release from the European Central Bank on a framework to measure the degree of weakness of the global economy in real-time makes for interesting reading To discuss any of the items we have covered in today's market update, contact us via or call us on (+44) 0203 3488 1169