Rabobank: “Second Wave”

Authored by Jane Foley and Piotr Matys of Rabobank

Second wave

Stock market investors failed to maintained their glib optimism in Asian hours this morning in the face of mounting evidence that a loosening of lockdowns risks an increase in the number of infections. Six locally transmitted cases reported in Wuhan, the original epicentre of the virus, has resulted in officials ordering the city’s entire population of 11 million people to be tested. In S. Korea, which has been the poster child for tracking and tracing, a new cluster of cases linked to its capital’s gay nightclub district could be presenting authorities with a new problem. It is suspected that fear of a backlash could prompt LGBT people to avoid being tested. Meanwhile the new cluster of cases has prompted a decision to push back the re-opening of schools by a week. In Russia a surge in cases has pushed the country’s tally of total infections to the third highest in the world, behind only the US and Spain. Despite this President Putin has announced that the ‘non-working days’ imposed by the Kremlin at the end of March would come to an end from Tuesday. The Russian‘s government’s attempt to re-start the economy in the height of the pandemic has drawn likenesses with Trump’s policy. That said, while the Russian decision will be related to the need to re-start the struggling economy, it can be argued that outside of the capital most of the rest of the country is experiencing only small clusters of the virus.

In the UK, PM Johnson took the opportunity yesterday to defend his roadmap out of lockdown against accusations that it was confusing, contradictory, divisive and vague. The government announced that the public would be advised to wear face coverings in public and that a lockdown could be swiftly re-imposed. Unions welcomed new safety at work guidance. That said, so far fear of a lack of safety has kept many workplaces closed in the UK. The criticism weighed on GBP yesterday morning. The UK government had already come under fire for being slow to order the lockdown in March, for a lack of testing and for poor handling of the procurement of PPE. For GBP investors the fact that no real progress was made in the latest post-Brexit talks between the UK and the EU is also a concern given that the end of the transition phase is looming. Additionally, no positive headlines have emerged from the US/UK trade talks either.  The UK government desperately need some positive press from these talks to strengthen its non-EU trade ties. However, the UK consumer has been pommelled by scaremongering suggesting a trade deal with the US could open the UK to lower agricultural standards and to higher drug prices for the NHS. There are also reports that Washington wants to introduce a clause into any trade deal which would allow it to veto the UK’s ability to strike a deal with ‘non-market’ economies. This would clearly be aimed at China. This week, President Trump has threatened to block a US government retirement fund from investing in Chinese stocks on the ground of national security. Even though a phone call between US and Chinese officials on Thursday night appeared to reduce trade tensions, it is clear that the relationship between Washington and Beijing will be fractured at least in the run up to the US Presidential election.

The US is not the only country with a difficult relationship with China. Australian shares and the AUD were hit this morning by the news that China has banned exports from four Australian abattoirs, a move which followed threats to place tariffs on barley exports. China is Australian’s most valuable export market for beef, though neither meat nor barley top the table for domestic exporters. Tensions has escalated between the two countries in the past few weeks following Australia’s push for an investigation into the coronavirus outbreak. China’s ambassador last week warned of economic reprisals. That said, Australian trade minister Birmingham has downplayed today’s beef concerns suggesting that the tariffs are ‘technical.’ Any sign that Australia’s larger coal and iron ore exports could be impacted would spark greater pressure on the AUD.

The EM currencies can be split into three groups when assessing their performance since early April: the outperformers led by the Indonesian rupiah and followed by the Russian ruble, the Chilean peso and the Colombian peso; the underperformers represented by the Brazilian real and the Turkish lira which both plunged to a record low and the third group of currencies which have been relatively stable (the Philippine peso, the Indian rupee, the Polish zloty). This differentiation can be attributed to specific domestic factors that make currencies more or less attractive to investors who, following one of the biggest sell-off in the history of financial markets, are very picky. However, even the best performers may struggle to hold to their recent gains amid worrisome signals that easing lockdowns increases the risk of a second wave of the coronavirus. Even if we were to assume that the risk of a second coronavirus wave is extremely low and that the measures announced by central banks and governments will prove adequate to generate a V-shape economic recovery, we would be still reluctant to adopt a solid constructive view on the vast majority of the EM currencies with perhaps a very few exceptions. The reason is worsening relationship between the US and China.

To recall, it was the trade war between the two largest economies that caused a major sell-off across the EM universe in 2018 and weighted on risk appetite for the better part of 2019 until sentiment improved towards the end of that year. This was on the back of trade talks that culminated in the phase one trade deal being ratified. The selling pressure on the EM currencies is likely to increase if the US-China relationship deteriorates further ahead of the US presidential elections in November. We are sceptical that within next few months we will witness substantial capital inflows into EM assets and because of that the EM currencies will struggle to gain a sustainable bullish momentum against the US dollar.

Day ahead

The USD may take a cue later today from the speeches of the Fed’s Bullard, Harker and Kashkari, though the bigger billing is tomorrow’s appearance by Chair Powell. The topic of negative Fed interest rates has inevitably arisen and Fed officials are expected to play down this risk, at least for any time soon. Last week investors had started to use the futures market to bet on negative rates by the end of the year. In February Powell stated that “Going forward, our inclination would be to rely on the tools that we did use as opposed to negative rates.” Yesterday St Louis Fed President Bullard was reported as stating that negative rates in the US would be ‘problematic’.

In Europe, politicians and lawyers will continue to dance around the topic of whether the European Court of Justice still has primacy over national law in EU countries. Either way, the discussion has re-opened concerns about fragmentation and, going into a deep recession, there is a risk that this may worsen if politicians fail to pull together. The issue is a cloud over the EUR and the Italian BTP market. This background threatens to push EUR/CHF back below its recent low.