Risk aversion spiked dramatically on Thursday as fears over the US, European and global economies increased.

Risk aversion spiked dramatically on Thursday as fears over the US, European and global economies increased.

The ECB announced further measures but did not cut interest rates which reinforced equity-market selling as European growth fears intensified. The aggressive drive for cash had a very substantial impact across asset classes.

Global equity markets registered very heavy losses with a slide of around 10% or more for major US and European bourses, the sharpest daily declines since 1987.

A dollar shortage triggered a US currency surge of over 2.5% before a limited retracement as the Fed added liquidity aggressively. Sterling registered heavy losses on global risk aversion with GBP/USD lows near 1.2500. Scandinavian currencies declined rapidly as fear dominated.

The ECB made no changes to interest rates with the refi rate at 0.0% and deposit rate at -0.50%. Market expectations were for a cut of at least 10 basis points in the deposit rate. It did announce additional bond purchases of EUR120bn for the remainder of 2020 and will provide additional cheap funding to the banking sector to help credit flows to the business sector.

Markets were disappointed at the lack of rate cut and fears over the economic outlook increased sharply as coronavirus cases increased rapidly. Although EUR/USD briefly made gains to near 1.1300, it weakened sharply during President Lagarde’s press conference, especially after her apparent lack of concern over Italian yield spreads also unsettled sentiment.

Overall confidence in the US outlook continued to deteriorate with fears over a major coronavirus outbreak and extensive damage to the economy. Futures indicated more than an 85% chance of a full 1% Federal Reserve rate cut next week.

Market volatility increased sharply with evidence of a major dollar shortage as international banks scrambled to meet US currency demand. In this environment, the dollar moved sharply higher across all major currencies despite an adverse move in yields. The currency index moved sharply higher with a gain of over 2.5% on the day with EUR/USD lows near 1.1050.

The New York Federal Reserve offered up to $500bn in a 3-month repo operation which helped alleviate the dollar shortage and the US currency retreated from its best levels. Volatility eased only slightly on Friday with EUR/USD trading below 1.1200. There will be another aggressive Fed liquidity injection, but with a high risk of further very sharp swings during the day.

The Bank of Japan reiterated that it was prepared to take additional action, but global fear dominated. The yen gained defensive support as equity markets declined very sharply and posted gains against commodity currencies. The dollar, however, was resilient and made net gains in New York despite a slump in US equity markets. Strong global dollar demand and margin calls pushed USD/JPY to highs above 106.00 before a retracement as the Fed increased liquidity.

Asian markets moved sharply lower in early trading as fear dominated. The Japanese government pledged a bold response to beat the virus fallout with a large spending package and also pledged to work with the Bank of Japan. Finance Minister Aso, however, stated that there was no need to fret over the yen with the underlying trend stable, dampening expectations of intervention to weaken the currency.

There were also reports that the central bank was reluctant to cut interest rates further. Asian equity markets rallied during the session which eased fears to some extent with USD/JPY trading near 105.50.

Sterling volatility increased rapidly during Thursday as global financial market stresses intensified. Although the Bank of England rate cut and aggressive fiscal package were received well, the potential positive impact was overwhelmed by wider risk aversion and fear over the domestic and international economic outlook amid a raft of profit warnings and global impact.

There were also fears that the underlying current account vulnerability would undermine the currency when risk aversion dominates while the FTSE 100 index declined close to 10% on the day, the sharpest 1-day decline since 1987, which reinforced underlying currency vulnerability.

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