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.

Meanwhile euro was the worst performer with the single currency falling sharply after the European Central Bank's monetary policy announcement. The ECB left interest rates unchanged with central bank President Christine Lagarde maintaining a relatively positive outlook on the economy. She said incoming data is in line with the ECB's baseline scenario of ongoing moderate growth. She also noticed signs of a moderate increase in underlying inflation and felt that the risks to their growth outlook is now less pronounced. Yet there were concerns. According to Lagarde the inflation outlook is still subdued and weak international trade combined with global uncertainty dampens investment growth. All of this necessitates a highly accommodative stance for a prolonged period of time.  On a day where risk aversion dominated, traders saw the ECB rate decision as a greenlight for euro weakness. The central bank has no immediate plans to change monetary policy and it will be some time before they decide how their strategy needs to change. Lagarde kicked off the central bank's first strategic policy review since 2003. When asked how long it would take, she made it clear that there is no urgency. They'll be done when they are done which would hopefully be by November or December. The euro will remain in focus tomorrow with the Eurozone's January PMI numbers scheduled for release.