Europe’s Second Virus Wave Triggers Sharp FX Sell-Off

Currencies and equities sold off sharply on Monday as virus cases in Europe hit new record highs. Everyone’s greatest fear this summer was a second wave and unfortunately that fear has materialized.  Spain reported 14,389 new cases on Friday while France reported nearly 13,498 new cases Saturday. These numbers which are far beyond the peaks set back in March triggered a series of tighter social restrictions in Europe’s second and third largest economies. Even Germany which has not seen a significant uptick in virus cases tightened mask and contact regulations in a bid to prevent a broader spread in Munich. In the UK, cases are below their spring peak but doubling every day, leading the country’s Chief Scientific Adviser to warn that there could 50,000 new daily cases by mid-October if further action is not taken. 

50K cases a day is not just a risk for the UK, but all European countries experiencing spikes. The problem is that while these cases are higher than where they were in spring, the measures taken by the Spanish, French and UK governments are more localized which raises concern about their effectiveness. Given the severity of the pandemic spread in Europe, more restrictions are on their way for these countries. Considering the economic toll caused by lockdowns in April and May, the second wave poses a significant risk for euro and sterling. Both currencies fell sharply on Monday and we think more losses are to follow with EUR/USD targeting 1.15 and GBP/USD 1.25. Even ECB President Lagarde seems to be concerned as she talked about an uncertain and uneven recovery along with the availability of options if more stimulus is needed.  Her most notable comment was on the euro – she previously urged investors not to overreact to its rise but today, she said they are “attentive to the euro’s appreciation,” which is a greenlight for euro’s decline. For euro and sterling, aside from virus headlines, the main focus are the PMIs. If this month’s reports show deterioration, we will see further losses in these currencies.

The US dollar traded higher despite US troubles. The election is nearing and with the death of Justice Ruth Bader Ginsburg, politicians are gearing up for some tough battles in Washington. There’s a lot at stake and the political fall-out will be significant. Election uncertainty is a serious risk for equities and currencies. Even in 2016 when the polls showed Hillary Clinton in the lead, stocks trended lower in the weeks leading up to the election. At the same time we saw a sell-off in EUR/USD and choppy trading in USD/JPY. The history of volatility will repeat itself in 2020 but in more magnified way given the strong opinions around Trump’s push for to replace her seat quickly. With no major US economic reports scheduled for release this week, US dollar traders should watch 3 things – headlines out of Washington, Fed Chairman Powell’s testimonies and equities as investors are likely to take their cue from risk appetite.

The commodity currencies also sold off with the New Zealand dollar leading the decline. While Europe is desperate to prevent the second wave from worsening, New Zealand ended all pandemic restrictions in all parts of the country except for their largest city Auckland. Yet instead of rising, the currency is falling because of risk aversion and concerns about this week’s Reserve Bank meeting. When the RBNZ last met, they were open to the idea of negative rates and traders worry that while the country has pushed out COVID-19 a second time, uncertainty abroad leaves that option on the table.  For Australia, the biggest problem is worsening relations with China.  Apparently Australia is turning away investments from Chinese companies after China lost access to Australia’s space tracking station. The Canadian dollar also declined with USD/CAD rising to its strongest level in more than a month. 

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