USD likely to continue downward drift

The likelihood of more stimuli by the US Fed sent equities sharply higher, but USD fell as investors’ attention shifted to other currencies. NZD was the best performer followed by AUD and CAD. The rally in EUR was more tempered ahead of the European Central Bank’s monetary policy announcement.

The US Fed is taking the economic toll of COVID-19 very seriously.  In the FOMC statement, they said the virus poses big risks over the medium term and the crisis will weigh heavily on economic activity. In response, rates will need to remain on hold until they are confident that the economy is back on track.

Fed Chairman Powell provided additional clarification in his press conference, but also warned that the jobless rate could hit double digits in the next report and Q2 economic activity will fall at an unprecedented rate. The Fed expressed commitment to use a full range of tools and to continue to use its powers forcefully.

Powell also feels that more may need to be done but their hands are tied because the Fed has lending and not spending powers. There was no sugar coating in his comments, sees the virus shock as extraordinary and warns that they’ll be putting out the fire for a while.

The US GDP report was a disappointing. The US economy contracted by 4.8% in the first quarter and the steepest decline in over a decade. The lackluster reaction in USD coupled with the strong rally in stocks post data tells that investors were bracing for an even weaker report.  Q2 data is the one that matters and there would have only been a big reaction, if GDP contracted by 6% or more. The jobless claims, personal income and personal spending data will be released on Thursday and given that everyone expects incomes and spending to fall. New jobless claims are expected to ease to 3.5 million from 4.42 million the previous week.

The focus is now likely to shift EUR and the European Central Bank. The single currency is trading strongly against the USD but the gains have more to do with greenback weakness rather than EUR strength. Like the US, the Eurozone economy is expected to contract by its largest amount since the great recession. Economists are looking for GDP to fall by 3.7% but for the Eurozone, the actual number could be much worse.

The US economic lockdown did not begin until the last two weeks of Q1 but the Eurozone went into lockdown mode in mid-February, 3 weeks before major US states so the economic toll will be more significant. It will not be surprising if the contraction in the Eurozone matched US levels, which may plunge EUR further.

European Central Bank meeting is important. It is not expected to change policy having launched under Pandemic Emergency Purchase Program (PEPP) only 5 weeks ago. ECB President Lagarde believes that the economy could contract as much as 15% this year and with business and investor confidence dropping to record lows, more needs to be done.  They are looking to increase asset purchases but could delay the decision for another month. ECB President Lagarde is expected to be very dovish.

The commodity currencies continued to power higher with the NZD and AUD leading the gains. This is no surprise considering that both countries eased lockdown restrictions this week. Data was good with New Zealand’s trade surplus growing in March on the back of stronger imports and exports. In Australia, CPI growth also increased in the first quarter with the annualized inflation rate rising to 2.2% from 1.8%. While these currencies are likely to outperform, New Zealand’s ANZ activity and business confidence surveys could dip lower. Chinese PMIs are also scheduled for release and how AUD and NZD responds will depend on whether China gives back some of the improvements reported last month.

USD/CAD traded lower for the fifth out of six trading days. Oil prices finally rebounded supporting the move. Canada’s monthly GDP report is due tomorrow and unlike the US and Eurozone, these numbers could be good because they were for February, when retail sales and trade increased. Of course investors look ahead to the March and April data.

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