What does Covid-19 mean for the FX market?

What does Covid-19 mean for the FX market?

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The extent of the economic impact of the pandemic is still unknown, but currency markets remain volatile

When the Covid-19 outbreak began in early 2020, the FX market appeared unconcerned as the economic impact was expected to be limited and at a far enough distance from the UK. Fast forward more than a year and, while the full extent of the impact won’t be fully known for years to come, the implications to global trade, as well as the travel, tourism and hospitality industries around the world have been huge.

The pandemic has posed immense risk to even the most advanced economies, and market volatility has ebbed and flowed in line with the evolution of the virus. As a general rule, countries with rising cases typically see their currency weaken, and those who manage to contain transmission are often rewarded with a stronger economy. However, the trajectory of the pandemic has been highly reactionary with innumerable unforeseen road blocks along the way. As a result, the FX market has experienced increased volatility and has been even more difficult to predict.

 

Is the pound under pressure?

As the UK has navigated the pandemic and Brexit almost in unison, it is difficult to decipher the isolated impact of one versus the other on the economy as a whole. That being said, we know that with various versions of lockdown, travel restrictions, business closure, job loss and the strain on the healthcare system that the virus has caused, the economy has suffered immensely. In fact, after the first lockdown in March 2020, UK GDP shrank by a record 19.8%, and the pound plunged to its lowest level against the US dollar in over 30 years.

Like many nations, the UK has largely struggled to contain the virus and the impact has been felt across the country despite the implementation of various government funding schemes. Naturally, investors have been somewhat pessimistic, spooked by the high level of cases throughout the country as well as Brexit-related trade concerns and the subsequent instability of the pound. However, with the beginning of a new year came new hope in the form of a successful vaccine and the possibility of a return to normality that it brought.

While it hasn’t been a straight road and the currency markets have waivered as aspects of the vaccine have been met with scepticism and even criticism, the UK has implemented a world-leading vaccination program and cases have subsequently reduced to very low levels. As a result of this success, the economy is tentatively but confidently reopening in line with the government’s staged roadmap to freedom, and analysts have predicted a rapid recovery for the pound, which they say is set to return to pre-Covid levels as early as 2022.

 

Compounding the euro’s woes

Covid-19 has had a significant impact on the euro for a variety of reasons. The Eurozone is more closely enmeshed with world trade and has more extensive links with China, which means the slowdown was quicker to impact the euro in the beginning. In addition, the economy was in a more fragile state compared to the US and the UK, which was already putting pressure on the central currency and so the virus came at a time when the economy was already struggling. 

The Eurozone has been hit hard by the pandemic, sparking fears of a double-dip recession. Economic recovery is predicted to trail behind that of China and the UK and will depend strongly on the restoration of supply chains and implementation of a successful vaccine rollout, the latter of which has experienced harmful interruptions related to production, distribution and fears around side effects. The vaccine rollout is now picking up momentum, which will likely improve economic outlook, though it is still far behind that of the UK and USA, respectively.

 

The resilient US dollar

At the start of 2020, the US dollar remained unperturbed by the outbreak. The relatively positive performance of the US economy and distance from China meant that the US dollar was outperforming a basket of currencies, including the safe haven Yen, which was marked down as investors feared greater risk in Asian currencies.

Fast forward to 2021 and the USD came under pressure following the uncontrollable spread of the virus throughout the nation in 2020. Analysts’ expectations for the state of the safe haven currency were unanimously pessimistic, predicting a sharp and sustained decline in Q1 and Q2. However, with a contentious election now in rear view, a successful vaccine rollout in full swing, and the implementation of ambitious measures to drive strong economic growth, those predictions have been largely discredited thus far and the greenback has conversely managed to outperform other major currencies.

Going forward into the second half of 2021, investors will be keeping an eye on how other countries rebound from the pandemic, as global economic recovery may pull down the value of the USD.

 

Commodity-based currencies continue to struggle

Commodity-based currencies such as the Canadian dollar were among the first to feel the impact of the pandemic. A decrease in demand for oil from China had an immediate impact on oil prices, which, in turn, put pressure on the Canadian dollar. However, the CAD has remained relatively buoyant, emerging into 2021 in a strong position against major currencies and reaching a six-year high at the beginning of Q2. Driven by surging commodity prices, the CAD is steadily on the rise. That does, however, come with its own risks as, for example, further gains could make Canada less competitive as a commodity exporter, dragging down projections and weakening their investment profile.

In Australia and New Zealand, the impact on trade routes and tourism was similarly immediate as they were quick to completely close their borders. While both countries have been largely envied for their success in containing the spread of the virus and their subsequent ability to enjoy an open domestic economy and the freedoms of normal life, Australia in particular has come under fire for its staunch border policy. Many analysts believe that while closed borders have served public health and protected freedoms, the economic impact will be disastrous, as the Australian economy is making rapid losses without, for example, international students and tourism.

With both Australia and New Zealand now picking up speed with their vaccine rollouts, as well as negotiating fruitful trade agreements with the post-Brexit UK, there is a potential turning point on the horizon. Investors will be keeping a watchful eye over how they reintegrate themselves into the global economy after a sustained period of detachment.

 

What lies ahead for the currency market in light of the pandemic?

There is a lot of variables to consider when attempting to predict the global economic recovery of the pandemic. Time and time again we have witnessed how quickly things can change, whether it’s the arrival of a new virus variant or changing perceptions of the vaccines’ efficacy, making the FX markets even less predictable.

At present, the landscape is optimistic in the UK, as the most vulnerable members of society have received their immunisation, which is considered a highly-effective defence against serious illness. Approaching summer and the reopening of businesses across the country, the pound is expected to spike in line with a surge in domestic tourism and consumer spending after a long period of lockdown.

The currency market continues to operate with a high awareness of risk and the many variables in play, which may mean further volatility, with fluctuations in currency values to be expected as various areas embark on their own versions of a roadmap to recovery. 

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