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Given the recent outbreak of the swine flu (or H1N1 virus), let's take a look at what happened to currency and commodity markets following the outbreak of Sudden Acute Respiratory Syndrome (SARS) back in 2003, in order to draw some comparisons. We start in mid-March 2003, as the World Health Organization (WHO) first issued a global alert about a new infectious disease in Hong Kong and
Vietnam on 11 March, and issued a heightened global health alert on 15 March, after cases were also identified in Singapore and Canada.

In the first couple of weeks after outbreaks were reported, the USD gained about 3%, using the Bank of England’s effective exchange rate measure. CHF also gained a bit of ground, while the other typical safe-haven currency, JPY, did not, probably because of Japan’s proximity to the SARS epicentre. Looking at commodities, crude oil was the clear under-performer, down about 25% in the first couple of weeks after the WHO announcements. Gold also sold off, but the 5% move looks paltry next to the huge decline in oil prices.

Looking further out after the SARS outbreak, one of the biggest surprises was probably CAD; although Canada was the country most affected by SARS outside of Asia, CAD still managed to outperform all the other majors in the two-month
period following the outbreak of SARS. While at least some of these gains were probably aided by the Bank of Canada rate hikes on 4 March and 15 April (which were soon reversed at the July/September FADs), the outperformance of CAD is all the more remarkable given the huge drop in oil prices.

The big question is what the SARS episode can tell us about what might happen in global financial markets over the next couple of weeks if the swine flu outbreak continues to spread. And on that point, we think there’s a good chance that we see the same USD strength and crude oil weakness that we experienced in 2003. That was actually the original reaction to the swine flu stories earlier this week, with EUR/USD falling just below 1.30 and crude oil falling as low as $48; although the moves have faded over the last 24 hours or so, that could easily change if the flu situation deteriorates further.

While “conventional wisdom” would point to weakness in CAD or AUD upon falling crude oil prices, the short-term relationship between oil prices and both CAD and AUD has broken down recently, with both correlations falling to near zero. Instead, EUR has been the major currency that correlates best with crude oil prices lately, with a 22-day correlation of around +0.75. So if the swine flu story blows up to the same extent as SARS, then we expect to see EUR take a lot of the heat and move back toward the 1.30 region, where it sat earlier this week.