Currency contagion: monetising virus responses

To explore these influences, ANZ Research developed a number of measures to rank the relative performance of countries and their response to the virus.

"Despite a strong response to the virus outbreak, the direction for [the AUD and NZD] is likely to be set by broader shifts in market sentiment.”

Using these metrics, Australia and New Zealand are in a relatively solid position. Both have strong virus containment, relatively high shares of primary industries sheltered from the consumer-centric slowdowns, and strong fiscal responses. A few Asian economies also look well-positioned to rebound from early COVID-19 outbreaks.

At the bottom of the pack are many European nations. Political and debt constraints are hampering policy, large manufacturing bases are exposed to falling consumer demand and a large portion of their export base is contingent on the US which will be slow to recover.

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While these measures are helpful in understanding recent currency market dynamics, notably the resilience in the Australian dollar (AUD) and New Zealand dollar (NZD), they don’t capture broader capital flow dynamics. Despite a strong response to the virus outbreak, the direction for both currencies is likely to be set by broader shifts in market sentiment.

A sectoral lens to economic vulnerability

No industry is insulated from the global shock created by COVID-19 but some are more susceptible to the collapse in discretionary spending than others.

To assess how the structures of different major economies might amplify the consequences of shutdowns, ANZ Research categorised major industries by their exposure to the virus and compared them across countries.

The graphs below provide a sample of how the industry groupings were dissected by risk and looks at the differences in activity and employment concentration in Australia, China, and the US.

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Countries with a higher share of primary industry and business services should be more sheltered from the shock than those with a high concentration of household-facing service industries, which are at the epicentre of the slowdown. Countries with high exposure to manufacturing are also likely to be at risk. Some manufacturing sub-categories, like medical supplies and processed foods have benefitted, but most, particularly consumer goods, are likely to suffer contracted weakness.

Recovery from the crisis will also be sectoral, with large employment areas like travel, tourism, leisure and hospitality, and retail unlikely to fully recover until a vaccine is widely available.

Expanding this analysis to include most of the G20, global manufacturers such as Japan, South Korea, China and Taiwan are tending to fall into an ‘at-risk’ region. Australia, Canada and Norway fall at the lower end of the risk spectrum given they have relatively large shares of their economy devoted to business service sectors, as well as mining or agriculture.

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Export markets open for business

Domestic economic vulnerability is only part of the story.

As China is discovering, export orientated economies are going to struggle if they don’t have anyone to sell to. Emerging from the crisis will be difficult but arguably easier for economies with a diversified export base directed at countries with stronger virus containment and less economic damage from the shutdowns.

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An inspection of the top 10 trading partners across the G10 shows two things.

Firstly, commodity producers like Australia, Canada and New Zealand have a more concentrated export base than other countries. Canada, for example, is highly exposed to the US which accounts for nearly 80 per cent of its exports.

Secondly, Australia and New Zealand have many of their major export destinations emerging from lockdown sooner than the US and much of Europe. The restoration of outbound trade will be a critical source of growth for both economies given the impending collapse in discretionary consumer spending.

Virus progression and policy response

The ability of nations to control the pandemic has been a key determinant of sentiment and asset prices.

As a crude measure of how each country has contained the outbreak, ANZ Research measured the number of days that had passed since the peak in daily new cases. The origin of the outbreak means China and its neighbours have seen the worst in daily infection numbers though their fiscal response has not kept pace with the likes of the US, Australia or Japan.

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Bottom line

Traditional drivers of currency markets like relative data surprise and interest rates have taken a back-seat in recent months to a new set of metrics like progression on virus containment, economic vulnerability and scale of fiscal stimulus.

On this new set of measures, Australia and New Zealand are performing well — helping to explain some of the resilience seen in their respective currencies recently.

John Bromhead is FX Strategist and Daniel Been is Head of FX & G3 Research at ANZ