The COVID-19 coronavirus and trade wars are provoking the most powerful global crisis since 2008, when the collapse of Lehman Brothers Bank sent the global economy into deep shock. Central banks and governments are trying to counter the impending disaster, but so far to no avail. Last week, the Federal Reserve at an emergency meeting lowered the rate by 0.5%, but this did not calm the markets, frightened by the epidemic and its consequences, but only added fuel to the fire of falling quotes. Rates were lowered by the Reserve Bank of Australia and the Bank of Canada. The Bank of England also cut the rate by half a percent at an emergency meeting today, on Wednesday, March 11.
On Tuesday, at a meeting with Republican lawmakers on Capitol hill, the US President Donald Trump proposed setting the payroll tax rate at 0% by the end of this year. As Treasury Secretary Steven Mnuchin later said, the president has support among both parties. As you can see, Trump not only writes messages on Twitter, but also takes measures to somehow stabilize the situation. Although his reaction last week, when he did not actually comment on the events taking place in the markets, indicated that he was completely at a loss. In addition to measures to reduce taxes, Trump proposes the introduction of state subsidies for shale oil producers, seriously affected by the collapse of the price. So the competition between low oil prices and the printing press may well be won by the printing press, which, apparently, can only be broken by sticking an iron scrap in its mechanism. However, the markets continue to be nervous while the decision on the tax incentive has not been made.
The volatility of the US market is at its highest levels in at least five previous years, exceeding the average values at the level of 15 by more than 5.5 times (Fig.1). And in contrast to previous years, in 2015 and 2018, the volatility of the stock market increases more and more every week, which drives investors into a stupor, forcing them to sell off assets, and this, in turn, causes prices to fall further.
Rice.1: volatility of the US stock market.
The decline in the US stock market led to a sharp rise in the euro. The fact is that starting in 2015, when the Fed stopped its quantitative easing programs, the European currency began to replace the US dollar as the funding currency. This stimulated massive currency arbitrage operations, which are known to us by the term carry-trade. The essence of such operations is that investors receive financing in euros at a zero interest rate, then buy dollars and place money at a rate in US dollars.
However, when assets start to fall in value, especially as it is now, investors rush to exchange dollars for euros, which causes its rate to rise. We observed this phenomenon at the end of February and last week. However, we must understand that there are still more dollars on the market than the euro, and the European currency has only recently become a funding currency and cannot replace the dollar. Therefore, the appreciation of the euro is rather temporary and will end with the decision of the ECB, which has not yet responded to the shocks.
The problem is that Christine Lagarde has almost no tools to respond, and the epicenter of the COVID-19 infection from China is gradually moving to Europe. Most likely, the central bank will announce additional incentives in the form of long-term financing programs and create some funds to help countries affected by the epidemic. For now, the situation in Europe is only getting worse. At the moment, more than 10 thousand people have been infected in Italy, more than one and a half thousand in Germany and France, and more than two thousand infected in Spain. However, when you read these lines, the situation is likely to get even worse. In addition, the idea that, for example, the United States, a wage tax can be abolished in Europe, will hardly occur to European bureaucrats.
Today, Merkel said that up to 60% of Germans are likely to be infected with the virus. It is easy to calculate that with a death rate of about 5% and a population of 83 million people in Germany, as a result of the epidemic, up to 250 thousand people may die, most of whom will be elderly. This is a terrifying figure.
If we assume an ideal situation in which there are no meetings of central banks, coronavirus and crazy volatility, then the dynamics of the EURUSD pair may look as follows. After receiving the sell pattern, the goal for pulling down the euro will be the 1.12 level. However, it is advisable that the position does not remain in the market during the announcement of the ECB decision and the press conference of Lagarde, when, in addition to the existing volatility, new uncertainties will appear.
Saudi Arabia’s announced plans, which decided to sharply increase production to 13 million barrels per day, which could be another negative for the oil market, should be highlighted from Wednesday’s news, but it cannot be ruled out that Saudi statements are no more than a bluff to force Russia to return to the negotiating table. In any case, the Russian economy looks more stable than the economy of Saudi Arabia, especially taking into account the fact that in Russia the budget is made up at an average annual price of oil of $42.5 and is surplus, and in the kingdom for $80 there is a huge hole. So Crown Prince Salman can raise rates as much as he wants, only hardly anyone will behave against his tantrum. In general, wait and see, let the coronavirus pass us, amen!
The material has been provided by InstaForex Company – www.instaforex.com