Back to ZIRP, Here are the Implications for FX

ZIRP is BACK! In a dramatic announcement Sunday night, the Federal Reserve cut interest rates by a full percentage point to a range of 0-0.25%, which is basically zero. They also restarted Quantitative Easing with a new $700 billion asset purchase program. All of this follows an emergency 50bp interest rate cut on March 3rd and is accompanied by an announcement by major central banks to lower rates on swap lines to ensure dollars are readily available.  

But that’s not all….

The Reserve Bank of New Zealand cut interest rates by 75bp to 0.25% on Sunday. The Bank of Japan also introduced a new zero interest rate loan program and ramped up asset purchases by doubling its active ETF purchases. The IMF said it is ready to mobilize $1 trillion loan capacity and called on central banks to intervene in FX as a complement to interest rate and other policy actions.  While the timing of central bank moves this month were not perfectly in sync, they are close enough to be coordinated. The G7 has another emergency call this morning and some of their remaining options include currency intervention, a global ban on short selling or closing financial markets. 

Unfortunately all of these measures failed to sooth the market as stocks are poised to traded sharply lower at the NY open. Investors see the latest moves by central banks as band-aids for a rapidly bleeding wound. Governments around the world are shutting down schools, restaurants and shops, moving into full lockdown mode. This will have a major impact on their economies plunging many if not all countries into recession. War time measures are being announced with no actual war to boost industrial activity. Losses will be reported across all industries with massive bankruptcies and unemployment to follow.  Stocks are falling because none of these measures are enough to stop the bleed. They will help ease the pain for businesses, their employees and consumers but at the end of day with everyone hunkering down in their homes, no one is spending. The breadth of the impact on business activity can be seen through the Empire State manufacturing index, which dropped by its largest amount ever to its lowest level since 2009 and that was before NY went into lockdown mode.

So what are the implications for currencies or FX?

Risk aversion is here to stay and the biggest beneficiaries of the continued slide in equities will be the Japanese Yen and Swiss Franc.  As for the other currencies and crosses, how they move will depend on what happens next with rates.  

To start, here’s where interest rates are at:

Federal Reserve 0-0.25%
RBA 0.5%
SNB -0.75%
ECB 0%
BoJ -0.1%
RBNZ 0.25%
BoC 0.75%
BoE 0.25%

Currently Canada has the highest interest rate followed by Australia. The Bank of Canada will most likely take a breather after two emergency moves this month. However oil prices are below $30 a barrel and Canada will suffer greatly from the double blow of COVID-19 and the downtrend in oil. The Reserve Bank of Australia was one of the first to lower interest rates but their reduction was small. They are next in line to ease but they could opt for another quarter point move which would be nominal compared to actions taken by other central banks. The Fed doesn’t have any more room to ease, the ECB refuses to lower rates further but their economies will be hit the hardest. The RBNZ who eased on Sunday suggested that rates will stay at current levels for an extended period of time. They are opposed to negative rates and prefer a large scale asset purchase if more support is need.

With all of this in mind, we believe that the Japanese Yen and Swiss Franc will continue to rise, euro will underperform, the Australian and New Zealand dollars will outperform and the US dollar will remain under pressure. For USD/JPY we expect a move to 102 and for EUR/USD, we’ve entered bear market territory so most carry trade flows are done so 1.10 will be tested.