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Markets reverse course, risk aversion rises after dovish Federal Reserve

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15 June 2020

Written by
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

Last week was almost a mirror image of the one before.

E
quities sold-off worldwide while government bonds and safe havens bounced back. Interestingly, peripheral bonds in the Eurozone managed to end the week nearly unchanged, in spite of the general wave of risk aversion, in a sign that the massive ECB response to the crisis is working. This price action also lent support to the euro, which finished the week down only slightly.

In G10 we must mention the enormous volatility in Norwegican krone trading, which overreacts to moves in both directions on thin liquidity. Emerging market currencies generally sold-off, with Latin American ones the worst losers and Pacific Rim managing to close the week nearly unchanged.

This week is relatively quiet in terms of data releases, with the main event risk likely to be the Bank of England’s June meeting on Thursday. We will also be paying close attention to the new virus cases in the US, where certain states like California, Texas and Florida have shown an unsettling pattern towards caseload increases rather than decreases.

Bank of England

GBP

The April GDP numbers painted a truly dismal picture of the state of the UK economy at the worst of the lockdown. The economy contracted by an unprecedented 20.4% for the month, with falls in manufacturing and construction of over 40%. Markets looked through this somewhat outdated data to the more recent hopeful signs on the economy, and sterling held up fairly well in a week of risk asset sell-offs.

This will be a busy week for the pound, with a top level meeting between Boris Johnson and the EU on Brexit followed by the Bank of England meeting on Thursday. We see a strong possibility that the BoE will increase its bond buying programme, with the market bracing for a pledge for another £100 billion in asset purchases. With this largely priced in, we think that any accompanying dovish rhetoric that opens the door to the possibility of negative rates could weigh on the pound.

EUR

Last week was a quiet one for European data, and this one will not be very different. EUR/USD was instead driven largely by the aforementioned shifts in overall market sentiment, rallying to a fresh three-month high at the beginning of the week, before falling back below the 1.12 level on concerns regarding a possible second wave of virus infection.

Inflation data on Wednesday should provide insight into the relative damage wreaked by the lockdown on the supply and the demand sides of the economy. Beyond that and the potential for progress in the Brexit talks early in the week, we expect the common currency to mostly trade off events elsewhere.

USD

The Federal Reserve’s communications following its June meeting last week were decidedly dovish, with an emphasis on reassuring markets that rates will not go up for years and that the Fed is committed to a policy of extreme monetary easing. This message, together with worrisome signs of an increase in the pace of infection in certain US states, meant that the dollar did not benefit as much from its safe-haven status when the equity market sell-off began Wednesday night.

This week, retail sales and industrial production data for May should give a clearer picture of the extent of the bounce back in May. As always, the most timely data point during this crisis will come on Thursday, when the weekly initial and continuing jobless claim data are published.

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