COVID-19: What’s the impact on forex trading?
- COVID-19 is having a profound impact on financial markets and forex trading, and will continue to do so for a long period of time. A Refinitiv webinar analyzed the factors that will affect demand for the U.S. dollar.
- In the U.S., the unemployment rate has climbed to levels higher than those seen at the peak of the great financial crisis. This has caused demand for the dollar to soar as investors seek a safe-haven currency.
- The current movements in dollar demand are driven by short-term emotional gauges, which do not appraise the impact of long-term factors such as mass unemployment and vast government borrowing.
In a webinar hosted by Refinitiv, Wilson Leung outlined why this crisis caused by the COVID-19 pandemic will continue to have a huge impact on forex trading and financial markets for a long time.
To illustrate his analysis, he used a range of market data points to explain why he was taking a “cautious, bullish tone”, and that he expects global demand for dollars to continue.
In normal times, a forex analyst can rely on market charts and interest-rate scenarios to predict trends. In this fast-changing situation, however, Leung has had to go beyond his usual data points to understand what is driving major currency pairs.
Rising unemployment
Other, broader factors of the COVID-19 pandemic need to be analyzed to assess the current state of forex trading and that these factors go beyond simply crunching the data.
One of the biggest factors is unemployment, which is skyrocketing around the world as a result of lockdowns in fear of the coronavirus. The mounting job losses are what make COVID-19 as bad as — and potentially worse than — previous crises such as the 2008 global financial crisis or the Great Depression.
Leung puts the current situation into perspective. He noted that at the outset of the Great Depression in 1929, U.S. unemployment stood at 3.2 percent. A decade later, by 1938, it had risen to 19 percent.
Unemployment was not as badly affected during the global financial crisis; peaking in early 2009 at 9.9 percent in the U.S., and then steadily improving to a low of 3.5 percent in 2019 and into earlier this year.
No longer.
In just a five-week period, more than 26 million Americans applied for unemployment benefits. Some economists, such as Justin Wolfers at the University of Michigan, calculate current unemployment may be as high as 13 percent, and still rising sharply.
U.S. unemployment rate
Stock markets and forex trading
Another lead indicator of currency is the stock market.
Leung says the crisis has been marked by fear driving ‘risk-off’ trading patterns, which has seen demand for the dollar soar as a safe haven, because of its status as the global reserve currency.
Amid the market volatility, there have been moments of optimism. These were first reflected in stock indices such as the S&P 500 and the Dow Jones Industrial Average, signalling ‘risk-on’ patterns, at which point traders sell dollars.
This is evidence that emotion, rather than reliable data, is driving these indicators. They are short-term gauges. It is unlikely current prices reflect the longer-term impact of mass unemployment, the risk of overleveraged corporate debt, restructuring in markets such as commercial real estate, or how government borrowing and spending will play out.
What does the Dollar Index say?
For the time being, Leung is looking at U.S. equities, U.S. interest rates, and unemployment as data points. Movements in these indicators suggest sustained dollar strength, as measured by the Dollar Index, or DXY.
All of these indicators are suffering volatile swings, but in the short run, support traditional haven currencies such as the dollar, the Swiss franc and the Japanese yen, as well as gold. But we are still in the early stages of the economic response to COVID-19, both in terms of the damage being caused, and our understanding of it.
The Dollar Index (Q4 2007 — Q1 2020)
