At the best of times, investors have difficulties handling risk and the current trading environment is no different. It seems that the idea of trading risk is not easily transferable among the asset classes. The slight rise in risk appetite in equities is failing to make its way directly into the foreign exchange market. U.S. equities closed yesterday well off their lows after President Barack Obama and company refrained, thus far, from further sanctions against Russia. Nevertheless, this morning’s European Union (E.U.) foreign minister meet in Brussels could require investors to once again to change their trading strategies if stiffer sanctions are imposed. The most market-friendly outcome from today’s E.U. ministers’ meet is that they talk tough, but don’t intensify sanctions against Vladimir Putin’s Russia.
The mighty dollar has gained since last week on geopolitical risk and that trend is likely to continue for a while. Geopolitical fallouts have not lasted long this year but this is still a very tricky period for asset markets. The investor’s current positioning needs still reflect a desire to buy riskier assets, but are mainly focused on emerging markets, stocks, and Asia rather than peripheral Europe. This alone should have the 18-member single unit continue to grind lower, pushed even further by tough talk against Russia.
Sinking Euro a Bear Necessity
Already this morning the single unit has managed to penetrate through the psychological €1.3500 handle with its sights locked on January’s lows below €1.3477. The market should be expecting the EUR-crosses to be leading the way rather than the EUR outright. On a cross-weighted basis, the EUR is trading below when the European Central Bank cut rates last November. The risk-reward now favors the EUR-funded carry trade rather than being outright short the single unit. Through this year’s January low, the EUR should be capable of gathering further downside momentum, dragged by the crosses and pushed lower by the dollar on the back of Federal Reserve tapering due to end in the fourth quarter. The techies like a EUR with a €1.32 handle for starters. Perhaps the EUR will get a helping hand from the U.S. market today. Its focus will be on a U.S. consumer-price index (+0.2% versus +0.3%) where a high print would be more damaging to asset markets than a low print would be positive.
Aside from the EUR’s immediate plight, the dollar continues to retain a decent bid tone against the major pairs, where a few are not helping their own cause. The JPY has aided the dollar (¥101.53) by its own slip up directly after the Japanese government cut both its inflation and growth estimates (1.2% from 1.4%) for 2014. Finance Minister Taro Aso has conveniently put the blame on Japan’s lagging exports amid soft demand from emerging economies. Even the Prime Minister’s office has come under some scrutiny — a Sankei survey revealed the disapproval rating for Shinzo Abe’s cabinet climbing +6pts to a record high above +40%. Aside from German Chancellor Angela Merkel, all major leaders are experiencing the same populous disapproval. In Japan, the thorn in Abe’s side has been the April sales tax; an outcome not fully comprehended or that has filtered through to the Japanese economy yet. Economic Minister Akira Amari has managed to reiterate that the Japanese government will not make a decision on another sales tax hike until this December — another way for the government to bide some time.
Japan cannot have all the fun. The island nation’s return from a long weekend has led to a positive session in the Asian equity space. However, geopolitical tensions have never been far away, and any underlying market weakness has led to the facilitation of dealers to add to their fixed-income curve flatteners — whether it’s Japan, Europe, or the U.S., the market continues to pick away at a back-up plan. The 2’s and 10’s German curve is now atop of levels not seen since 2008. No trade seems to have “full gusto” support, but the fact that investors and dealers are picking away at ‘flatteners’ highlights some of the precarious current positions that have been taken on.
Aussie Inches Higher
Ignoring most of the signs of late has been the Antipodean currencies. They seem to prefer to march to their respective central banks’ beats. The AUD ($0.9387) has managed to stay within striking distance of the psychological $0.94 handle and now more so, especially after Reserve Bank of Australia Governor Glenn Stevens neglected to mention or to attempt to ‘jawbone’ the exchange rate overnight as had been widely speculated by the market. Instead, he left open the possibility that the next move in interest rates would be down in a following question-and-answer period. Dealers will look to Australia’s quarterly consumer-price index data this evening for further currency direction inspiration rather than central bank insinuations.
Meanwhile, Governor Mark Carney at the Bank of England (BoE) is under pressure from the U.K. media. Following his stint at the Bank of Canada, the market understands that he is certainly a governor unto his own, one who will not be persuaded by outside sources. Tomorrow the market will find out if any of the members of the Monetary Policy Committee at the BoE has finally pulled the trigger and voted to raise rates from a five-year record low (+0.5%). An itchy trigger finger would be the market’s first major indication of possible rate divergence among the ‘biggies.’ Rate divergence equates to volatility, and up or down, the market does not care as long as it moves. The question will be, “Is the U.K. economy strong enough to withstand a hike that could help deflate a rampant housing bubble?”