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Markets tumble as investors brace for global recession

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17 March 2020

Written by
Matthew Ryan

Senior Market Analyst at Ebury. Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

Stock markets continued to tumble on Wednesday, with the Federal Reserve’s giant-sized interest rate cut providing very little relief for risk assets.

T
he Fed cut rates by an unprecedented 100 basis points on Sunday, while announcing a host of additional unconventional methods designed to protect the US economy from the COVID-19 virus. Unfortunately, this failed to shore up equities, which continued to sell-off sharply. The Dow Jones index opened over 10% lower on Monday morning with stocks in Europe, including the FTSE 100, down around 7-8%.

The view in the market is that clearly there is only so much that central bank policy can do to alleviate the situation. Cutting rates and pumping liquidity into the market can’t offset the disruption caused by the strict containment measures now in place. All but essential travel has now effectively been banned across much of Europe. Schools, restaurants and cafes are closed, with a number of countries in the worst affected areas now in full-on lockdown mode – France was the latest to enforce such measures yesterday.

We think that it is now not a question of ‘if’ the global economy will enter into a recession, but how significant this downturn will be. Given the above containment measures, the answer to the latter is likely to be very, although there is hope among analysts that this could be a short, sharp contraction. We see no reason why the global economy can’t come roaring back once the worst is over in the few months time. The situation we’re facing now is totally different from the one witnessed in 2008, one which was triggered by deep systemic issues in the financial system. This is not the case this time around.

What is behind sterling’s sharp sell-off?

With news developing all the time, it’s difficult to know where to look in the currency markets at the moment. Among the majors, sterling was just about the worst performer yesterday, down another one percent versus the dollar. The pound is now trading over 4% lower versus the dollar and 6% down against the euro since the beginning of March alone (Figure 1). We outline below some of the factors that may be behind the currency’s recent downturn:

1) The UK’s large current account deficit. The UK garners a huge inflow of foreign investment, in part due to its thriving financial services industry. These inflows provide good support for sterling when everything is all good and well, but during times of stress these inflows unwind.
2) US dollar, euro acting as safe-havens. The dollar, and to a lesser extent the euro, are seen as safe investments during times of market uncertainty.
3) More stimulus from the Bank of England likely. Unlike the Fed, which has already reached its so-called ‘effective lower bound’, we think that another rate cut from the BoE cannot be ruled out, even if the size of the move is of an unconventional magnitude (i.e. less than 25 b.p). More likely would be an increase in the bank’s QE programme, which investors now see as very much on the cards.

Figure 1: GBP/USD & GBP/EUR (Feb ‘20 – March ‘20)

EM currencies sell-off as investors favour the dollar

As mentioned, the dollar is continuing to act as a safe-haven of choice, even following the Fed’s big rate cut on Sunday. As is customary during times of intense uncertainty, investors are fleeing emerging markets and piling into the safe-havens. The Brazilian real and Mexican peso have been among the worst affected, down over 10% in the past couple of weeks alone.

The Aussie and New Zealand dollars are also being hit hard, particularly the latter after the RBNZ’s shock 75 basis point rate cut last week. As things stand, there are now only a handful of major central banks that have room to cut rates, the Bank of Canada (0.75%) and the Reserve Bank of Australia (0.5%) being the two clear standouts. The next major central bank meeting will be the Swiss National Bank of Thursday. While we don’t expect a rate cut here given how little room they have, additional easing measures are highly likely.

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