(Bloomberg) -- The dollar’s red-hot rally hit a speed-bump after the Federal Reserve’s unprecedented stimulus encouraged traders worldwide to take on risk.
The dollar gauge fell as much as 1.5%, the most since 2016 on a closing basis, ending a 10-day rally that took the greenback to the strongest level on record. Stocks in Asia and Europe surged, while an improvement in liquidity conditions spurred a drop in U.S. Treasuries.
Norway’s krone led gains against the greenback, jumping the most on record, Australia's dollar extended a rebound from a multi-year trough and the pound rose as much as 2.2%, even after the U.K. entered a full lockdown to contain the coronavirus. An index of emerging-market currencies was on course for its biggest advance in more than three years, a positive development for borrowers with debt in the U.S. currency.
“Markets are going to start feeling the full tsunami of liquidity the Fed is providing now,” said Nathan Sheets, head of macroeconomic research at PGIM Fixed Income and former FOMC economist. “The liquidity they’ve provided from their first line of defense -- swap lines -- to other domestic measures are all about the Fed making it clear to markets that they will play the role as an international lender of last resort.”
The relief sweeping over markets is in stark contrast to last week when investors sold almost everything but the dollar amid the growing fallout from the virus. A slew of emergency measures from major central banks including Japan and Australia failed to calm markets, with the worries centered on a liquidity crunch.
Those pressures now seem to be moderating. In the latest move on Monday, the Fed said it would buy an unlimited amount of government bonds to keep borrowing costs low and expand its Money Market Mutual Fund Liquidity Facility. It had earlier extended its dollar-liquidity swaps to other policy makers including those in Australia and Brazil.
A gauge of Asian stock markets advanced the most since 2009 on Tuesday, while European equities are headed for their best day since 2010. Meanwhile, the spread between more liquid current bonds, known as “on-the-runs” and older so-called off-the-run securities has tightened. The Bloomberg dollar spot index was trading down 0.9% as of 8:48 a.m. in New York.
Still, strains in funding markets remain, and options traders aren’t convinced that the dollar’s retreat will mark a complete turnaround in sentiment. The premium to go long the dollar over the next month versus its major peers still trades near its highest in eight years.
While China appeared to have contained the disease, it is still spreading in other places, with the death toll now exceeding 16,500. Investors are also waiting for a U.S. stimulus plan which has yet to be passed by Congress.
Weak economic data out of Europe and the U.S. are both likely to reignite haven appetite for the greenback, said Viraj Patel, foreign exchange and global macro strategist at Arkera Inc in London, who sees Tuesday’s drop as a technical correction rather than a fully-fledged sell-off.
“We are still in the eye of the storm,” he said. “You’re potentially seeing more countries in Europe going into lockdown and more states in the U.S. potentially going into lockdown, you’re going to see more demand for the dollar.”
Caution Abounds
As a result, the gains in risk and commodity currencies were small compared with their recent declines, with most still flirting with multi-year lows. The Australian dollar is still near the weakest since 2002.
While the pound gained after last week’s historically poor performance, few expect major gains are in store. Fears are still lingering about a hard Brexit at the end of the year, coupled with concerns about the U.K.’s support for self-employed workers thrown out of work by the lockdown.
Caution is particularly evident among developing Asian exchange rates. While Group-of-10 currencies rebounded strongly against the dollar, moves in emerging Asia were more restrained, led by South Korea’s won, which climbed about 1%.
The Fed’s policy “boost to EM assets should be more secondary,” said Ken Cheung, chief Asian foreign-exchange strategist at Mizuho Bank Ltd. “The yield-hunting investment should only take place when major markets started to stabilize.”
(Adds moves in other markets from second paragraph.)
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