FX: Quiet end to Q2 as Q3 uncertainty looms

As the second quarter draws to a close, we reflect on the gains in equities and currencies. While the COVID-19 pandemic scarred the markets at the end of the first quarter, recovery was the primary theme of Q2. Countries went into lockdown in February and March and began to ease those restrictions in May and the latest June. For investors, consumers and central banks, fear and panic gave way to optimism. The Dow Jones Industrial Average gained 15% over the past 3 months while the NASDAQ rose a whopping 28% to record highs. Markets around the world recovered with double digit rallies seen in the DAX, Nikkei, SPX and TSX.  High beta risk on currencies like euro, Australian and New Zealand dollars performed particularly well with AUD and NZD reaching multi-month highs. Safe haven flows eased out of the US dollar, which weakened against all of the major currencies in Q2.

However, as the third quarter begins, tides are shifting and fear is returning. Q2 gains offer cold comfort in uncertain times. The US government is losing its battle with the coronavirus pandemic as some of the most populous states report alarming increases in case numbers. Many governors paused or reversed reopening measures and the economic impact could be significant if more follow. The recovery could slow dramatically as Americans go back into lockdown mode. The US is not alone in experiencing fresh flareups. Australia imposed a strict 4 week lockdown in 10 areas of Melbourne, its second most populous state. The government announced fines for anyone leaving their homes for any activities not deemed essential. Other states in Australia also barred travel from the Victoria region. The Australian dollar reversed earlier gains and traded sharply lower as a result. The US may still be in its first wave but second wave fears are returning for other countries. Unless governments take the necessary steps to get the virus under control quickly, end of Q2 growth could disappear in Q3 quickly.  

Investors continued to buy US dollars ahead of Thursday’s early non-farm payrolls report. Economists are looking for more job growth but the unemployment rate could be revised higher or worsen. Consumer confidence rebounded in June but everyone knows that American moods are souring with COVID-19 cases rising. The Chicago PMI manufacturing index rebounded less than expected from a 38 year low. Federal Reserve Chairman Powell and Treasury Secretary Mnuchin testified before Congress today. Their comments were relatively optimistic with Powell saying the US entered its new phase sooner than expected with recent data offering positive signs. Mnuchin said the White House and Senate are working on additional financial relief by the end of next month. 

With ADP and Challenger due tomorrow, the focus will shift quickly to NFP. The June FOMC minutes are also due for release – central bank liquidity is the only factor propping up the market.

Risk aversion drove euro and sterling lower against the US dollar today. According to the latest reports, the Eurozone avoided deflation in June. After falling -0.1% in May, consumer prices rebounded 0.3% in June.  Investors shrugged off this report as it was telegraphed by yesterday’s German CPI and more importantly has zero impact on near term ECB policy. The uptick in CPI won’t encourage the European Central Bank to consider raising interest rates. UK GDP growth was revised lower in the second quarter to -2.2% from -2%. Private consumption was weaker than initially estimated falling -2.9%, down from -1.7%.

The Canadian dollar shrugged off better than expected GDP numbers because at -11.6%, the contraction in April was deep even if it beats the -12% forecast. Risk aversion and mixed data kept the New Zealand dollar under pressure. Business confidence was revised lower in June while the activity outlook was revised higher. Chinese PMIs also improved last month. Looking ahead, we have Australia’s manufacturing PMI index and New Zealand’s building permits report due for release this evening. Japan’s Q2 Tankan survey is always worth watching but there’s no question that deterioration in sentiment is expected all around.