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US Dollar Outlook Bullish as COVID-19 Spurs Haven Demand

US Dollar Outlook Bullish as COVID-19 Spurs Haven Demand

2020-02-29 13:00:00
Dimitri Zabelin, Analyst
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US Dollar Basket

US DOLLAR OUTLOOK: BULLISH

  • US Dollar may rally on haven demand as coronavirus pandemic triggers recession fear
  • Greenback is gaining despite downward pressure of swelling Fed rate cut expectations
  • Equity selloff may amplify risk aversion, boost USD amid concerns of financial stability

US DOLLAR MAY RISE ON HAVEN DEMAND FROM COVID-19 VIRUS

The US Dollar may prosper in a risk-off environment as the coronavirus spurs haven demand amid a market-wide selloff in global equities. Not surprisingly, easing expectations from central banks – notably the Fed – have swollen but have failed to drag USD down with growth prospects. This in large part has to do with the Greenback’s unparalleled liquidity and position as the world’s reserve currency; but more on that later.

Two weeks ago, the IMF Managing Director Kristalina Georgieva sent a chilling message at the G20 summit in Riyadh about the coronavirus. She warned that it is the most pressing uncertainty in the world today, and that its impact on global growth is a “stark reminder of how a fragile recovery could be threatened by unforeseen events”.

Global PMI JPM

For a few months, markets enjoyed a comparatively less-uncertain environment as US-China trade tensions and concerns about a no-deal Brexit temporarily fizzled. This allowed investors a moment of respite after a politically-turbulent 2019. However, global stabilization is now at risk of being derailed by COVID-19, and the demand for easing measures will likely swell along with demand for haven assets like the US Dollar.

NONFARM PAYROLL DATA MAY INFLAME FED EASING EXPECTATIONS

Nonfarm payrolls data is expected to show 195k new jobs added for February, though pessimism around the effect of the coronavirus may be reflected in softer employment statistics. This comes after the prior report registered the strongest figures since November 2019. Consequently, this reinforced the Fed’s notion that current economic circumstances do not warrant an adjustment in interest rates. COVID-19 may change that.

Fed Rate bets

COLLAPSING EQUITY MARKETS AMPLIFYING VOLATILITY, HAVEN DEMAND

Global equity markets continue to experience aggressive selloffs with the benchmark S&P 500 index dropping over 12 percent after topping on February 20. It is currently hovering at a four-month low with scope for additional losses. The upside pressure of haven demand amid risk aversion from collapsing growth-oriented assets may be strong enough to push the US Dollar higher despite mounting easing expectations.

Federal Funds Futures Implied Rate (December Contract – March Contract), S&P 500 Futures, US Dollar Index – Daily Chart

US Dollar Index, USDJPY,AUDUSD, SP500 Futures

US Dollar Index chart created using TradingView

Much like throughout most of 2019, the US Dollar rallied against its G10 and emerging market counterparts despite several rate cuts from the Fed. What kept the Greenback afloat was sustained demand for a highly liquid asset amid a fundamentally deteriorating environment. Over the past few days, it appears the US Dollar has taken on this characteristic again as the growth outlook wilts in the face of the coronavirus.

WILL FED COME TO THE RESCUE, DELIVER EASING TO BUFFER COVID-19 IMPACT?

Despite growing expectations of Fed rate cuts, there is no guarantee that the central bank will be as eager to deliver stimulus as markets are hoping they will be. Consequently, if officials maintain their neutral stance, market panic may ensue and further pressure equity markets while simultaneously buoying the attraction of the anti-risk US Dollar. Fed speak throughout the week may help give a better idea on where officials stand.

Coronavirus cases and fed funds

Having said that, even if the Fed loosens borrowing costs, investors may still panic and boost the US Dollar amid the pandemonium. If monetary authorities fail to live up to the market’s ultra-dovish expectations, cycle-sensitive assets may experience another aggressive selloff if their hopes for liquidity injections are dashed. Consequently, the US Dollar may be in a relatively favorable position in either scenario.

USD GAINS MAY BE EXTENDED BY GROWING FINANCIAL STABILITY CONCERNS

A peripheral risk that may become a bigger issue is the stability around corporate debt which has come under greater scrutiny over the past few months. Leveraged loans and the growing market for collateralized loan obligations (CLOs) could accentuate a selloff and increase the risk of a global recession. Amid the decline in the S&P 500, credit default swap spreads on corporate entities have widened to multi-month highs.

S&P 500 and financial stability

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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