Risk-on and -off trading remains the order of the day at least until the investor is convinced that the geopolitical landscape has changed for the better. If one eliminates geopolitical aggressive pricing actions from the equation then investors are left dealing with tenuous global growth to price. In a week stacked with central bank meetings and speeches, perceived safe-haven assets remain in demand.
Currently, U.S. 10-year Treasury yields trade at a 14-month low, their German equivalent trade sub-1%, which may also suggest that the market is questioning the European Central Bank’s (ECB) next move after some soft German data was released last week. With European yields trading at a new record low, it would indicate that ECB President Mario Draghi might have to proceed with quantitative easing (QE) to jumpstart growth, and fight the deflation demon that’s toying with the embattled eurozone. In retrospect, the market is probably getting too far ahead of itself — expect Draghi and company to insist that policymakers will want to see how their June rate cut and increased credit plan plays out.
Draghi’s Options Limited
The EUR remains contained outright, mostly handcuffed by record short positions and options. Nevertheless, EUR/CHF has managed to drop to a 20-month low, trading atop of €1.2100; CHF remains one of the most attractive currencies in times of stress. Under this scenario, investors will want to take into consideration the Swiss National Bank’s views before pushing the CHF much higher. The market will need to gauge Swiss policymakers’ determination and ability to defend the highly publicized €1.2000 EUR floor or minimum exchange rate. Despite the CHF trading at 12-month highs on safe-haven demand, further downward pressure on the EUR/CHF may be limited because of Swiss policies.
The EUR’s failure to overcome the top-end of its recent range at €1.3445, supported by ongoing arguments between the European Union, U.S., and Russia, will keep the EUR bear happy for now. Ideally, for the single unit to kick-on to lower levels will require a momentum break through €1.3330 — this is expected to trigger a further two-handle slide. However, the significant size of EUR shorts being reported is likely to remain problematic for immediate further currency weakness. These shorts are a big factor in the EUR’s resilience to geopolitical factors. Heavily defended option barriers are expected to continue to appear ahead of €1.3300. The longer the market is capable of sitting in a tightly contained range, the more vulnerable the weaker EUR-short positions become — they will eventually be squeezed higher, and only because they can. The Russia-Ukraine crisis will weigh on the already fragile eurozone economy if it escalates. Under this scenario last week, market concerns manifested much greater in the eurobond and equity markets rather than a direct currency play.
The “Policy Chameleon” Gives Sterling a Lift
Bank of England (BoE) Governor Mark Carney, aka the “policy chameleon,” is certainly keeping capital markets on its toes when it comes to signposting a potential shift in U.K. interest rate policy. In overnight price action, the pound gained ground against both the EUR (€0.8000) and USD (£1.6734), fueled by a Carney interview published over the weekend. Last week, with the release of the BoE’s quarterly Inflation Report, Carney proceeded with what the market interpreted as a dovish tone, saying that the BoE remains on course to raise rates in the first quarter if wage growth in the U.K. picks up. A large percentage of the market had been pricing in a year-end rate hike. Sterling came under pressure across the board, while gilt prices rallied.
The pound has managed to reverse its course this morning, after Carney said that interest rates could be raised before real wages turn positive. In a Sunday Times article, Carney indicated that a rise in U.K. real wages was not a pre-condition for a rate hike. The governor is confident that real wages will “sustainably grow and that the +17% rise in GBP since last March was not a deterrent to a rate hike.” He is even content for the BoE to take the lead and be the first of the major central banks to hike interest rates. U.K. gilt prices have opened up lower on Carney’s hawkish comments. The U.K. debt market will seek out tomorrow’s consumer-price index data and Wednesday’s Monetary Policy Committee minutes. The market will get to see if any ‘hawks’ have split from the consensus and voted for a rate hike.
The remainder of this week is be dominated by CBank rhetoric. The Reserve Bank of Australia will kick proceedings off this evening followed by the highly anticipated BoE midweek call. The Federal Reserve is not expected to deliver any surprises, however many will be looking for any hawkish comments from Fed Chair Janet Yellen at the Jackson Hole Economic Symposium. Sandwiched between the minutes and the Symposium will be China, France, and German flash manufacturing purchasing managers’ indexes. The U.K. and Canada deliver their retail sales reports before Friday’s labor market speech from both Yellen and ECB President Mario Draghi.