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US Dollar Outlook Bullish on FOMC as Virus-Induced Recession Risks Swell

US Dollar Outlook Bullish on FOMC as Virus-Induced Recession Risks Swell

2020-04-25 12:00:00
Dimitri Zabelin, Analyst
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USD chart

US DOLLAR OUTLOOK: BULLISH

  • US Dollar may rise on liquidity demand amid virus-induced risk aversion
  • FOMC rate decision and outlook in press brief may amplify this dynamic
  • Deteriorating global growth prospects driving demand for haven assets

US Dollar May Rise on FOMC Rate Decision, Outlook

Overnight index swaps are not pricing in a rate cut at the upcoming FOMC meeting on April 29, though the subsequent press briefing and commentary therein may induce cross-asset volatility. The US Dollar may rise if Fed Chairman Jerome Powell paints a worrisome picture for global growth in light of the coronavirus pandemic as the central banks pumps trillions of dollars of liquidity into the financial system.

Bloomberg Correlation weighted currency index US Dollar

At the time of writing, the Fed’s balance sheet stands over $6.6 trillion. In an attempt to calm inter-bank stress, monetary authorities also announced a temporary suspension on limits of uncollateralized intraday credit exchanges. However, the most controversial measure – arguably – that the Fed has done is agree to purchase junk-rated bonds as part of its broader asset-purchasing policy measure.

The $2.3 trillion in programs would allow midsized businesses and US cities and states access to credit that they would otherwise find far more difficult to acquire in tumultuous times. After the measures were announced, corporate bond-tracking ETFs surged while the US Dollar slumped and junk-rated fixed income assets saw their biggest capital inflow in two decades. However, investors are not out of the woods yet.

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Greenback May be Lifted by Demand for Liquidity

Following the market-wide selloff in global equities and other growth-anchored assets, the US Dollar surged along with signs of increased stress in credit markets. The spread on credit default swaps (CDS) widened to crisis-era highs as the coronavirus undermined confidence in the ability of highly leveraged companies to service their debt. I briefly wrote about the fragility of corporate debt markets here in 2019.

While the Fed has managed to quell some of these fears, the possibility of a cascade of corporate downgrades is not far off on the horizon. Some sovereign debt like South Africa has already been downgraded to junk with a negative outlook – what’s to stop this financial contagion from infecting sub-investment grade bonds? The answer is it hasn’t – and markets have still not seen the end of it.

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The coronavirus poses an unprecedented threat to global growth and stability in financial markets, particularly in the so-called leveraged loan market. Borrowers with high debt payments thrive in an environment of strong global growth, but weakening demand means the prospect of them paying back their debt becomes less likely. The result could be an onslaught of defaults.

Uncertainty in the Global Economy Has Reached Unprecedented Heights

Global Economic Policy Uncertainty Index

IMF Managing Director Kristalina Georgieva warned that the global economy will experience the biggest economic and financial shock in 2020 since the Great Depression. This in large part had to do with governments initiating shelter-in-place orders that IMF Chief Economist Gita Gopinath cleverly dubbed “The Great Lockdown”.

After China and Europe, the United States Became the Epicenter of the Coronavirus

Johns Hopkins Covid-19 map

Last week, Markit PMI data out of the US and Eurozone printed some of their softest numbers on record as Covid-19 continues to hammer the global economy. If growth prospects continue to deteriorate and signs of financial stress are amplified, demand for liquidity – where the US Dollar reigns supreme – may rise and subsequently push the Greenback higher.

US DOLLAR TRADING RESOURCES

--- Written by Dimitri Zabelin, Jr Currency Analyst for DailyFX.com

To contact Dimitri, use the comments section below or @ZabelinDimitrion Twitter

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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