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The Week Ahead in FX Markets – Even more contagious than COVID-19 – the economic fallout

Published March 9, 2020

By Phil Lynch


The U.S. Dollar index posted its biggest weekly loss in four years last week, allowing the New Zealand dollar to climb its way back into the 0.63’s. The plummeting U.S. Dollar was caused by a huge slide in U.S. Treasury yields, which was caused by none other than the economic fallout from COVID-19.

The return on 10-year government bonds have shifted dramatically since the start of this year. The U.S. yield has dropped from 1.79% to 0.71% since January (down 1.08%), whilst New Zealand yields dropped from 1.61% to 0.97% (down 0.64%).

New Zealand government bonds now earn more than U.S. bonds for the first time since July 2018 – fuelling demand for the flightless bird. Of interest, the last time this occurred, the NZD traded more comfortably around the 0.68 cents mark.

COVID-19 Containment 

Globally, there are now more than 100,000 cases affecting more than 100 states and territories. COVID-19 containment measures have reached new heights over the weekend. Just one example is from Italy – where the Government has locked down as many as 16 million people, following a steep jump in new cases.

According to Professor Michael Baker from the Department of Public Health at the University of Otago, the risks to New Zealand are immense.

  • If containment doesn’t work in New Zealand, we could face more than 40% of the country getting infected with the virus.
  • Disruption will likely continue for two years.
  • New Zealand still has a chance for containment, but globally the fight for containment has been lost.

Globally, there have been approximately 700 deaths outside of China from the virus. Yet there are hundreds of millions of people on lockdown. There is proving to be one thing more deadly and more contagious than the COVID-19 virus: and that is the economic fallout.

The S&P 500 (U.S. stock market) had its third worst weekly decline over the last 20 years. Bloomberg are reporting today that the virus could cost the global economy $2.7 trillion dollars, which is output equivalent to the entire GDP of the United Kingdom.

The changing economics will leave people with supply chain disruption, increased unemployment, falling economic growth and decreased global trade. This results in people skipping visits to the doctor after falling ill and stopping buying regular medication. It is followed by reduced consumption of staple foods, utilities being cut, being forced to move, and having to sell assets – all documented as having a huge impact on peoples health.

The Week Ahead

Economic data this week will have a largely insignificant impact on the NZD, with markets instead reacting to COVID-19 developments. There are, however, two reasonably significant central bank releases to watch.

The first of these is a speech from RBNZ Governor Orr on how it would assess and use unconventional monetary policy tools if ever needed. Given that markets are now pricing in 75 basis points of rate cuts by July 2021, unconventional tools will be very much on the agenda.

It is worth noting this speech will not discuss current economic conditions or the Reserve Bank’s outlook for the Official Cash Rate. The next official OCR decision just over two weeks away on 25 March, and markets have priced in a 100% chance of a 25 basis point rate cut then.

The second major event is the European Central Bank’s Rate Decision. The ECB is already operating with a deposit rate of -0.5%, so markets are sceptical whether a further cut would be of any benefit. That said, markets are pricing in a further cut of 0.1% and expect other unconventional methods to be announced.

Chart of the Week – 10-Year Government Bond Rates

A significant driving force of interest rates is the potential yield on government bonds – sometimes referred to as the risk free rate. The chart below shows how bond yields have dipped over the past six months. Key observations include:

  • The U.S. yield has plummeted in recent days, causing a sell off of USD in favour of the AUD and NZD.
  • The NZD maintains a significant yield advantage over the AUD, supporting the higher levels currently seen on the NZD/AUD exchange rate.