FX Fear Trade Gains Traction

Currencies sold off sharply today as the coronavirus virus spreads to new countries. China may be aggressively trying to contain the virus but as we warned in yesterday’s note, the respite should be brief as more cases will be reported before it all peaks. The direct impact on China and neighboring economies is a key concern but in an overbought market where record highs were made on a near-daily basis, a serious disease like this one is bound to have a significant impact even if ground zero is far from US borders. Fear is a powerful driver of market flows and in many cases can lead to quick and aggressive corrections. The Japanese Yen has been the biggest beneficiary of safe-haven flows and we expect that to continue. Not only should the Dow extend its slide towards 28,000 but USD/JPY should break 109 causing further losses for all of the yen crosses. The sell-off also spread to euro, sterling and the Australian dollar.

Last night, Australia reported an improvement in their unemployment rate which drove AUD/USD initially higher. It held onto its gains into the New York session but when US stocks started to tumble, A$ succumbed to selling pressure. The jobless rate dropped to 5.1% as more than 29K jobs were created at the end of the year. While we firmly believe that the wildfires and coronavirus will take a big bite out of growth, for the time being there have been more upside than downside surprises in data. With that said, all of the job growth was part-time, which is les than ideal. The New Zealand dollar rebounded ahead of tonight’s fourth-quarter inflation report.

The Canadian dollar was surprisingly resilient. Having sold off hard in Asia and Europe, the loonie did not follow EUR and AUD lower in the North American session. Don’t expect this to last as the Bank of Canada’s dovishness and the decline in oil prices weighs on the currency. Canadian retail sales numbers are scheduled for release tomorrow and the risk is to the downside given the sharp drop in wholesale sales and slower wage growth.

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