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This year, COVID-19 has wreaked havoc on financial markets across the world. No country was left unaffected. The pandemic has highlighted the vulnerabilities of world economies. Due to lockdown measures, consumers were confined to their homes, and countless businesses went under. The repercussions are being felt across all spheres on human existence. The currency exchange was quick to react, but what does the future hold?
The American dollar is the key driver of the currency market. In comparison with stocks and commodities, it has been relatively stable. It remains to be seen whether this will last. The pandemic has a lot of unknowns and nothing is certain. It is time to take stock of the effects observed so far. Here is how the crisis unfolded.
Initial Market Impact
The contagion was officially declared as a pandemic in March. In the previous month, the Euro was gaining value against the US dollar. Back then, the virus was mostly encountered in Italy, and the spread was speeding up. Once the U.S. Federal Reserve announced its intention to take measures, the Euro headed downwards. In the middle of March, when the interest rate approached zero, the currency pair returned to its February levels (1.08 – 1.10).
The slashing of the rate reflected the initial market impact of the official pandemic. However, it soon became obvious that the entity had no definite program of action. The U.S. government came up with fiscal stimulus packages that were likely to fail. Vanishing revenues and mounting debt mean the economy is going downhill.
The decline is exacerbated by fears about the second wave of contagion. As economies are shattered, experts are racking their brains trying to project the total damage. At the moment, the task is unsurmountable.
Global economies are susceptible to the domino effect, as national systems are so interconnected. So far, we have seen risks and debt skyrocket, while revenues have been plunging. This crisis is a shadow looming over the currency market.
A second driver was the energy crisis. It ensued after the breakdown of the OPEC+ deal. In April, when Russia and Saudi Arabia failed to reach a production cut agreement, oil prices collapsed. This affected oil-exporting nations, as the commodity hit dramatic lows. Futures contracts for WTI were literally decimated as the lockdown wiped the demand. Even today, energy consumption is difficult to predict.
Economic and Political Obstacles for the Fed
Since 2014, the EUR/USD pair has been exhibiting a general downtrend. It was originally triggered by the failure of the European Central Bank to increase interest rates in comparison with the Fed. Meanwhile, the U.S. regulator was making efforts to boost its interest rate ahead of the next crisis.
An impasse was hit in the second quarter of 2019. The Fed’s insistence on rate increase was at variance with the political and economic agendas. Donald Trump forced the Federal Reserve to keep printing cheap money. As the interest rate began dropping, the national economy seemed to sustain momentum. And then the virus hit.
Economic forecasts were rendered useless as the pandemic started spreading like wildfire. Any previous plans and assumptions were discarded. In many countries, central banks were still recovering from the previous economic shock of 2007-2008, so they were especially vulnerable. Meanwhile, the US dollar has seen a steady uptrend. Now, the stimulus policy has exposed the U.S. central bank to a set of menacing unknowns. When can we expect the Fed to raise rates again?
How Does the Fed Raise Interest Rates?
This method is used by the Fed and central banks in other countries. Manipulation of short-term rates affects inflation and the pace of economic activity. The method is straightforward.
When the rates are down, money is cheaper to borrow. Individuals and institutions ted to spend rather than save. Meanwhile, the supply of money grows, and economic activity is spurred. The vital aspect is to keep the rise reasonable, so inflation does not skyrocket. Hence, lower interest rates point to more vigorous economic action.
How does the Fed raise interest rates? By mandating a higher rate or decreasing the money supply. Rising rates are aimed at limiting lending and inflation.
In March 2020, the fed funds rate fell to 0.00%-0.25%. Jerome Powell commented: “We do not see negative policy rates as likely to be an appropriate policy response here in the United States.” According to the Chairman, the Fed was focused on other “liquidity tools” to support the financial system. Now, when the rates have fallen, it is impossible to predict when they will rebound.
Projections for USD
Based on its previous dynamics, it is logical to expect the US currency to remain relatively stable despite the pandemic. It may, therefore, present a safe haven for currency traders. In the long term, however, the prospects are not so bright. There are quite a few skeptics who believe USD is finally about to take a plunge. If this happens, a vital question will arise: which other currency is best in this Forex market coronavirus crisis?
The first point to analyze is the source of confidence concerning the US dollar rate. The currency is backed by the government, which is now represented by Trump with his bizarre unpresidential behavior. While his rhetoric gets clownish all too often, it does not affect the core of the American political system. This is a solid centralized structure unified by the primary goal – giving the nation its working shape back. Different states may be taking different steps to achieve it, but the federal system directs them towards the same goal.
At the same time, another question arises. If your confidence in the U.S. government has faltered, does it mean you trust the European Central Bank in these uncertain times? Are there rational grounds for this?
Fiscal Disagreements in the EU
From 2000 to 2007, many experts believed Euro to be more valuable than USD. And then the economic crisis hit, and the currency collapsed. This situation revealed a lack of unity within the EU. Central banks were expected to help stop the devastation, but they failed to agree on a single fiscal and political policy. To add insult to injury, certain members lacked transparency. This became an additional driver of the downfall. The effects of the currency pair lingered for over a decade.
As the system is so disorganized, is the Euro reliable? Not everyone sees the European Union as operating on a single framework. Some experts view it as a set of separate nationalistic systems. While the core of US policy is robust, the core of the EU policy is divided. Most member states seem to be pursuing their own agendas focused on their national interests.
For instance, strong states like Germany seem to fear contagion from weaker EU members. The country rejected the notion of a unified bond, which would have generated a money supply for coping with the ongoing financial crisis. The refusal may have been motivated by distaste for the possibility of becoming the European lender of the last resort. If this was true, the nation did not want to help weaker member states and grapple with bad debt for years afterward.
Indeed, the EU has members with poor economic management and a record of bad debt. Moreover, they have already demonstrated their fiscal recklessness before. What would prevent them from saying, “We acknowledge our debt, but it is simply impossible for us to pay unless the interest is lowered or the term is extended.” Their fiscal failure will mean Germany and other strong countries will have to pay off the holders of the bonds.
Trading During the Pandemic
So, what does this all mean for the foreign exchange? Now, central banks are taking measures to alleviate the impact of the pandemic, but what will be their consequences in the second half of the year? How likely are negative interest rates in the U.S.?
Stimulus policies and packages released to corporations in many countries are seen as questionable. Some economic experts consider the situation a Ponzi scheme, as business elites are being saved from destruction. Societies are sure to react, and we are guaranteed to witness the political effects of this controversy.
Humans are irrational beings, so emotions are every trader’s arch enemy. Trading and investment must be free from any bias caused by the global economic disaster. Make sure you are not looking at the market through rose-tinted glasses. While the USD has been doing well over the past decade, this doesn’t mean it is guaranteed to withstand the current pressure. On the other hand, it is easy to give in to panic and make mistakes caused by fear.
Long-term predictions for the USD at this point are highly speculative. There are grounds for believing the currency will maintain strength in the coming months, but what can happen down the road is a mystery. Today, the Fed and the U.S. Government are focused on protecting corporate welfare. Now, like in the previous crisis, the term ‘too big to fail’ is topical again. Governments are coming up with fiscal packaged to support businesses from small to gigantic. But how effective are these measures?
It remains to be seen how severe the real economic problems of the U.S. are. Nobody has knowledge about the financial future in these circumstances – neither governments, not corporations. Consumers are yet to feel the full intensity of financial pain.
In the short-term perspective, we are bound to see the following issues, as people are simply trying to survive:
- defaults on mortgages,
- unpaid rent,
- missed car payments,
- mounting credit card bills.
In the corporate arena, falling revenues are combined with the failure to cover current expenses. This affects banks, supply chains, and regular citizens, as they are off work without pay or fired.
Now think about the methods allowing American institutions to help those in need. Where does this money come from? Their sources are taxes and government-issued debt. The parties that provide the funds (governments, businesses, and the public) view this as a secure investment because the country is seen as a trusted debtor.
Today, revenue streams have dried up. So, who will generate the money? In the short-term, the debt taken out by the U.S. Government may suffice to cover the rising expenses. But what if we take a long view? In the long-term scenario, we are likely to see that these measures are flawed. Debt that will keep mounting may cause the US dollar to falter.
Possibly, we are only witnessing the onset of the real economic turmoil. What will follow is unpredictable. What if the volume of collectible taxes shrinks along with the willingness to purchase government debt? State revenues will start to evaporate, and the ship will capsize.
Several crucial questions are plaguing economists. What if the entities your government lends to fail to ever pay the money back? Is it justified for the Fed to buy mortgage debt and substandard municipal bonds? What effects are we going to feel a few years from now if borrowers are unable to fulfill their obligations? Will the lending government resort to printing more money? When is the Fed going to raise interest rates?
Forex Market Coronavirus: Bottom Line
It is impossible to predict the long-term future of the market. The entire capitalistic system is now at stake. The pandemic along with another oil crisis triggered a domino effect across the world. In this situation, traders should try to overcome any biases and look at the cold facts only.
All major currencies – the US dollar, the Euro, the British pound, and the Japanese yen – are now in serious trouble. Traders and investors may benefit from the USD in the short- and mid-term scenarios. However, the American currency may eventually tumble. The next Presidential elections in the USA in November 2020 could also contribute to the fall. While the immediate consequences of the crisis are obvious, long-term projections are questionable.
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