Risk appetite holding up; Deluge of US Treasury issuances and USD funding
FX: Risk appetite holding up
Commodity currencies rallied strongly on Monday. AUD rallied most and gained 1.5%, followed by NZD with 1.1%. In line with our expectations, AUDUSD held its 0.60 support and closed the session above 0.61. The Reserve Bank of Australia meets today and is not expected to follow through with more easing measures. The RBA surprised with an emergency rate cut of 25 bps to 0.25% and launched QE on March 19. Meanwhile, USDJPY has closed above 109 for the first time since March 26 after Japan declared a state of emergency and announced a huge stimulus plan to combat the coronavirus. AUDJPY, which held its 65 support, will be closely watched as a gauge of risk appetite.
The SGD appreciated most in Asia, by 0.5%, on Singapore’s third package to combat the coronavirus. Singapore has brought forward to April 9 its disclosure of forex intervention operations for 2H19 during which foreign reserves increased to USD279bn from USD274bn. This should not have much bearing on the SGD’s price-taker credentials. Put simply, the SGD will appreciate when risk appetite improves and vice versa. Hence, expect the SGD to remain firm on the first day of its month-long “circuit breaker” from the Dow’s sharp 7% rally in overnight markets on signs that the coronavirus may be peaking in New York, Italy and Spain.
Rates: Deluge of US Treasury issuances and USD funding
The US Treasury is starting to ramp up issuances, especially in T-bills, to fund the ~USD2tn cost of the CARES Act. We see sizable increases across all T-bill maturities. For example, in 13-week T-bills, the Treasury has gone from offering weekly sizes of USD42-45bn in January and February to USD54bn this week. Just in the first week of April, the Treasury has already issued USD270bn of cash management bills (bills outside of regular auction schedule).
Despite surging Treasury issuances, we expect US Treasury yields to be stable and continue to trade in tight ranges in the short-term. At present, the Fed remains a huge offsetting presence in the US Treasury market, buying USD50bn of securities per day. Other buyers like the Government Money Market Funds are also key - continued strong inflows into these funds should ensure healthy demand for T-bills and help to anchor yields close to zero. The Fed's recent buying results/patterns suggests that it hopes to stabilize yields and dampen volatility to avoid the large intraday ranges/swings we saw in March, in a state of quasi yield curve control.
The Fed's provision of USD funds to the rest of the world is something to watch. In the second half of March, foreign central banks have already pulled down ~USD350bn of USD funds via FX swap lines with the Fed. On 31 March, the Fed announced a "FIMA Repo Facility" which would allow foreign central banks and other international monetary authorities to swap their US Treasury holdings for USD cash. If we assume a take-up of 10-20% on the ~USD3tn US Treasury securities that these foreign entities hold with the Fed, that is another USD300-600bn from the Fed disbursed to the rest of the world. At the rate that the Fed is pumping USD funds out, the risk is that some could be caught off guard if we quickly flip from a world where people are scrambling for USD funds to one with USD surfeit.
We certainly see hints of that possibility in cross currency basis swaps. 3M EUR and JPY bases have quickly flipped from very negative levels (USD funding at a premium) to very positive levels (USD funding at a discount).
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