The spread of COVID around the globe has altered the dynamic in the currency markets.  Most central banks have stepped up to the plate and generated stimulus that has buoyed economic output. While it is likely that certain central banks will continue to alter their programs, the bazookas that initially shocked the market out of their doldrums are complete. As Q2 comes to an end, traders will be watching to see which countries can emerge from their economic slumps and which will continue to suffer due to the spread of the virus.

The Global Economy

The global economy is contracting according to the International Monetary Fund (IMF). The IMF altered its forecast for global growth in 2020 to show a contraction of 4.9% a downgrade from its previous estimate in April which estimated a contraction of 3%. Their projections in April viewed the drop in global output to be the worst since the Great Depression, and that was before economies were beginning to open. The silver lining is that the IMF is still predicting that global economic growth will expand in 2021. It sees global GDP rising by 5.4% next year.

The hope is that the world experiences a “V” recovery, but that will depend on how quickly countries around the globe can emerge from the “lockdown”. There will also be a debate as to whether consumer behavior had changed and if consumer-driven economies will continue to be able to drive consumer-led growth.

The Dollar

The US Dollar experienced a wild ride as the pandemic took hold. Initially, the greenback moved higher before the spread of COVID in California and New York. One it was clear in March that the US economy needed to close down the dollar started to slump. Fed action which took US interest rates initially down by 150-basis points and then to zero, put downward pressure on the greenback. The move by the Fed to start a bond purchase program which entailed purchasing treasuries and agency bonds put additional pressure on the yield differential between US yields and European and Asian yields.

The drop in the US yields to zero, altered the yield differential between the US and Euro, which reduced the value of the US dollar versus the Euro. The same can be said about Japan. Since the ECB and the Bank of Japan already had negative yields, the pace at which US yields declined was greater than the pace of the decline of both Euro and Japanese short-term yields which put downward pressure on the US dollar.

Fiscal Policy Around the Globe

The US acted very quickly when it came to a Fiscal Policy that can not be said for Europe, Japan, or India.  The US passed the CAREs act which provided stimulus checks to individuals who make less than a specific threshold. Additionally, they extended unemployment claims to last for 25-weeks instead of 13-weeks. The law also provided an additional $600 per week for unemployment benefits. During the pandemic, approximately 40-million people in the US lost their jobs or were furloughed. While initial jobless claims have decelerated, dropping to 1.48-million in the last week of June from over 6-million in March. The total number of individuals receiving claims also dropped below 20-million for the first time since March.

In Europe, fiscal policy is still in the making. European countries continue to deliberate over a plan to raise 750 billion euros in public markets. This compares to the 5-trillion already released in the US. Japan is planning to step up it’s spending. In fiscal 2020, which started in April, the government’s general-account spending is slated to a total of 160.3 trillion yen. In India, many perceive the stimulus to be more of a symbolic gesture. The Modi government has pledged to spend almost 10% of India’s fiscal-year 2020 gross domestic product, approximately 256 billion on economic relief measures.

Implied Volatility Surged

US dollar Implied Volatility in the forex market also exploded. The US dollar versus the Euro VIX, which measures the implied volatility on the EUR/USD currency pair, surged 500%, rallying from 5% to more than 25% in a period of 4-weeks. While it took longer to retrace, the EUR/USD VIX eased during the Q2 slipping back to 8%.

How Have Currencies Performed

As volatility has calmed, ahead of the Q3, the dollar is nearly unchanged against the Euro relative to the levels seen in January of 2020. The dollar has lost ground against the yen which is viewed by many as a safe-haven. The Rupee has lost ground against the US dollar in the wake of the spread of COVID, declining by approximately 7%. Looking forward, traders will focus on how countries exit the lockdown. Europe appears to be opening as many countries can close their borders and keep the virus out. The US and India are experiencing rising cases, which does not bode well for the greenback or the Rupee.

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