Markets reacted to the news of possible new lockdowns on Monday in a classic ‘risk off’ mode, with investors spooked that weaker demand in Asia’s largest economy could hurt global growth. These concerns have been exacerbated by recent hawkish rhetoric from many of the world’s major central banks, notably the Federal Reserve, which have indicated in no uncertain terms that interest rates are set to be raised aggressively in the coming months in order to combat rising prices. While the process of policy normalisation should have the desired effect of easing the surge higher in global inflation, it is also likely to have the unwanted side-effect of triggering a slowdown in domestic demand and, in turn, economic growth.

Equity markets opened for the week sharply lower, with most of the main stock indices in the US, UK and Europe ending Monday down anywhere between 1.5-2%. In FX, the traditional safe-haven currencies rallied, led by the Japanese yen and, to a slightly lesser extent, the US dollar. Risk currencies traded lower across the board, led by the likes of the Norwegian krone and Swedish krona, which were both down around 2% for the day against the US dollar. The euro and sterling also both fell in excess of half a percent – the former declined to its lowest level since March 2020, with the latter dropping to its lowest level since September 2020. Emerging market currencies have actually held up rather well under the circumstances. Sell-offs in the EM spectrum were mostly contained yesterday, aside from those in Central and Eastern Europe, which have also continued to be weighed down by the ongoing war in Ukraine.

Probably the most notable exception was the Chinese yuan, which has suffered from one of its largest sell-offs in a number of years in the past few trading sessions. CNY ended the London session almost one percent lower on the US dollar than where it began Asian trading, and extending its losses to nigh on 3% in a little under a week. While domestic economic data is holding up relatively well so far, the imposition of the tough virus restrictions are causing analysts to revise lower their 2022 growth forecasts for China at a time when the PBoC is taking steps to ease monetary policy. This is providing an environment conducive of a materially weaker yuan, which is currently trading around its lowest level in six months on the greenback.

Figure 1: USD/CNY (March ‘22 – April ‘22)

We expect investors’ appetite for risk to remain the number one driver of currencies in the next few days, particularly amid a lack of major economic data. Tuesday’s US durable goods order data may receive some attention among investors, as will Thursday’s first quarter GDP data. That said, we expect central bank communications to take on greater significance, particularly remarks from ECB President Lagarde on Wednesday.

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