The Dollar Rolls Over as Virus Fears Escalate

The latest market highlights and our views on the key developments as the dollar rolls over; sentiment sours as the coronavirus spreads further outside China; the latest PMI surveys are skewed by supply chain disruptions; and German IFO sentiment surveys are eyed today

Previous Day's Market Highlights

The Dollar Runs out of Steam

The dollar rolled over on Friday, with the greenback's recent impressive rally coming to an end after chalking up gains in twelve of the last fourteen trading days.

The fizzling out of the dollar's recent bull run, which saw the greenback shed 0.5% on Friday, shouldn't have come as a surprise, with technical indicators pointing to the buck's recent gains having over-extended.

For example, take the dollar index (DXY) - which tracks the dollar's performance against a basket of peers. The DXY touched a near 3-year high on Thursday, just shy of the 100.0 psychological resistance, before pulling back.

More importantly, however, the relative strength index (RSI), which is a useful momentum indicator, rose as high as 80 on the daily chart, a long way into overbought territory, and a strong signal of a reversal in the price. Moreover, the DXY traded very close to the upper Bollinger Band, two standard deviations above the 20-day moving average, and a further indicator of an overbought market.

Similar warnings signs of a pullback were evident in other dollar pairings. Against the yen, for example, the RSI also rose well above the 70.0 mark, indicating over-bought conditions, while the pairing stalled at the 112.0 handle, ending the day 0.4% lower.

This pullback, which also saw the dollar lose around 0.5% against both the pound and euro, is unlikely to be the beginning of a longer-term trend, however. There remain incredibly solid fundamental reasons for the dollar to rally further, including continued economic outperformance, Treasuries holding among the highest DM bond yields, and haven flows set to underpin the greenback.

As such, Friday's move which saw the dollar roll-over, is likely to be short-lived.

 

Virus Fears Re-Emerge

Elsewhere on Friday, concerns over the spread of the coronavirus re-emerged, resulting in a risk-off feel as the trading week drew to a close.

Around 76,000 cases of the virus have been confirmed in China, however it is now the spread of the virus into other nations which is of more concern to markets. Particularly, investors are focusing on South Korea - which has reported more than 600 cases - and Italy, where 100 infections have been confirmed and two northern regions are in quarantine. Japan is also an area of concern, particularly given the already fragile state of the economy.

The below map shows the scale of the outbreak; the larger the circle, the greater the number of cases confirmed.

Signs that the virus is spreading into other developed economies have resulted in investors becoming increasingly concerned about the impact that the epidemic will have on the global economy. Having largely written off Q1, and priced in a 'V' shaped recovery in the Chinese economy for the remainder of the year, a spread into other nations may cause a revision of this base case, and may necessitate a policy response.

Should the assumed 'V' shaped recovery turn into a more prolonged 'U' shaped one, investors would have to reposition, resulting in a rotation into safer assets.

The first signs of this rotation were in evidence on Friday, with a strong, steady bid into US Treasuries. 10-year bond yields (which move inversely to price) ended the day 7bps lower, sending the 3-month 10-year spread - a recession indicator - deeper into inversion.

Meanwhile, the long end of the curve saw particularly significant demand, with 30-year bond yields falling as much as 8bps, hitting a record low 1.892%.

The bid for havens also extended into the gold market, with the precious metal adding 1.5% in the spot market, hitting a fresh 7-year high well above the $1,600/oz mark. In a sign of the solid demand for gold last week, prices gained 3.6% over the last 5 days, the best weekly advance since August.

In equity markets, the risk aversion made for a soft end to the week. In Europe, the pan-continental Stoxx 600 ended the day 0.6% lower, while London's FTSE 100 shed 0.45%.

Across the pond, the benchmark S&P 500 had its worst day since January, shedding 1.1%, while all major indices sank to their first weekly loss in three.

Oil prices also declined amid concerns over a drop in Chinese demand. Global benchmark Brent ended the day 1.4% lower, while US WTI crude shed 0.9%.

 

Ignore the PMIs

Meanwhile, Friday's main data releases came in the form of February's flash PMI surveys - however the figures need to be taken with a hefty pinch of salt.

Data from Markit appeared to show, at the headline level, the eurozone economy firming in February. The manufacturing PMI ticked up to a 12-month high of 49.1, while the services PMI rose to 52.8. The increases in both measures pushed the composite PMI - which measures output across the economy - to a 6-month high of 52.8.

Meanwhile, in the UK, the economy appeared to consolidate last month's post-election 'Boris bounce'; the manufacturing index rose into expansionary territory for the first time in 10 months at 51.9, while the services sector pointed to a healthy pace of expansion at 53.3.

However, the indices were artificially skewed higher by the coronavirus outbreak extending supplier delivery times, and do not paint a true reflection of economic conditions.

Under usual circumstances, longer delivery times are a sign of increasing demand, and thus greater output in a given industry. However, at present, elongated delivery times are being caused by supply chain disruption owing to the shutdown of factories in China. As such, with the PMI methodology only taking into account the input - and not the reason for the elongation - the index was artificially inflated by the negative impact of the epidemic.

As a result, it is best to ignore the PMIs, and that is exactly what markets did on Friday. Instead, it will be better to focus on incoming 'hard' data - such as industrial production reports - which won't be skewed in the same way, and will provide a 'truer' representation of how the economy is reacting to the virus outbreak.

 

Any Other Business

  • Friday also saw the release of January's final eurozone inflation figures. The data brought no surprises, and no revisions from the preliminary estimate, pointing to headline CPI rising at 1.4% YoY, and core CPI rising at 1.1% YoY
  • On Saturday, the Nevada Democratic caucuses saw Senator Bernie Sanders cement his place as the front-runner, winning the most pledged delegates ahead of former Vice President Joe Biden
Currency Pairing 08:00 Today Vs 08:00 Yesterday Four-Week High Four-Week Low % Change
GBP/EUR 1.1960 1.2074 1.1712 2.85%
GBP/USD 1.2935 1.3209 1.2848 2.73%
EUR/USD 1.0815 1.1095 1.0777 2.87%
GBP/AUD 1.9610 1.9753 1.9164 2.98%
GBP/NZD 2.0490 2.0509 1.9988 2.54%
GBP/CAD 1.7165 1.7480 1.7020 2.63%

Today's Market Highlights

The Day Ahead

The trading week gets underway with a relatively light economic calendar today, with the latest German economic sentiment figures taking centre stage, though risk appetite will continue to be driven by developments in the coronavirus outbreak.

February's sentiment surveys from the IFO institute are due this morning, with investors set to pay close attention to any detrimental impacts of the ongoing coronavirus outbreak. The headline business climate indicator is expected to tick up slightly from last month, to 96.0, while expectations of future activity are expected at 93.3.

Elsewhere today, the US calendar brings regional economic activity indices from the Chicago and Dallas Federal Reserves, with the former expected to fall to a 6-year low, and the latter set to rise to an 18-month high.

Meanwhile, today's speaking calendar brings remarks from Cleveland Fed President Mester, and hawkish BoE Chief Economist Andy Haldane.

 

The Week Ahead

Looking ahead to the remainder of the week, the data calendar is especially busy with US releases. Of the highlights, February's CB consumer confidence index is expected to remain at a healthy level of 132.0; durable goods orders are set to increase by 1.3% in January, rebounding from last month's disappointing 2.4% fall; the 2nd estimate of fourth quarter GDP is set to show growth remaining at 2.1% on an annualised QoQ basis; and February's final UMich consumer sentiment figures are also due.

Elsewhere in G10, the calendar is lighter. A host of Japanese releases - including unemployment, retail sales and industrial production, due overnight Thursday, will be eyed as the land of the rising sun appears to inch closer to recession. Meanwhile, fourth quarter Canadian GDP is set to point to a sluggish end to 2019, while a host of eurozone sentiment figures are also due. This week's UK data calendar is devoid of any major releases.

 

US Politics in Focus

Finally, US political developments will remain in focus, as the Democratic primary process continues. The remaining candidates will again take to the debate stage on Tuesday, before the South Carolina primary concludes the early state voting on Saturday.

Then, the race heats up further on Super Tuesday - 3rd March - when around a third of all delegates are allocated, and former mayor of New York Mike Bloomberg enters the race.

Today's Economic Calendar

Time Currency Release Consensus Previous
9.00am EUR Germany IFO Survey - Business Climate (Feb) 96.0 95.9
1.30pm USD Chicago Fed Activity Index (Jan) -0.92 -0.35
3.30pm USD Dallas Fed Manufacturing Index (Feb) 11.8 -0.2