Modest risk is being applied across the various asset classes, with investors believing that major political concerns that drove stocks lower, and bond prices and the dollar higher last week have abated. The market continues to distinguish between the ‘humanitarian crises’ in Gaza and Iraq and the Ukraine conflict, which has far more potential to influence asset prices. The news that Russia was reported to have ended its military exercises on the Ukraine border is risk-positive, as too is the Gaza ceasefire. Nevertheless, the fear bid continues to be seen in the bond market, with yields in Germany (+1.06%), UK (+2.49%) and in particular the US Treasury market (+2.43%) only backing up a few-ticks.
Forex thus far has seen little volatility in the overnight session, preferring to keep to its relatively tight ranges. The 18-member single unit trades just below the psychological €1.3400 handle. USD/JPY continues to stray north of ¥102 level despite the European Central Bank and Bank of Japan both expressing interest in having a higher dollar last week during their respective press conferences.
Capital markets continue to look for interest rate clues and the central bank in the pole position – the Bank of England (BoE) — could indicate a possible change to these seemingly uniform monetary policies. The pound is floundering just below £1.6800 level in quiet trade. Though there are no central bank rate announcements due, the market will get to hear from BoE Governor Mark Carney midweek. On Wednesday, the BoE will publish its forecasts for growth and inflation and investors will be focused on the timing for the U.K.’s first post-crisis rate hike. If the BoE happens to lower its expectation of slack in the U.K. economy it could be supportive of sterling.
Investors’ Geopolitical Fears Ebb
Investors have much to consider with a variety of key releases due this week, notably two out of the U.S. The manufacturing sector has put up strong figures of late. The Federal Reserve releases its industrial production report on Friday — confirming or not the strength seen in recent surveys. For the Fed, its go-to support has been the consumer, whose sector is showing moderate renewed strength — especially in the improvement in weekly jobless claims. Investors get to react to July’s retail sales report this Wednesday and the latest consumer sentiment report on Friday. Even though some risk applies, both the bund and Treasury yields remain not far from last Friday’s lows. The Ukrainian situation is likely to remain “both fluid and tense,” and reason enough for many to want to hold risk-aversion strategies.
The latest Commodity Futures Trading Commission report (up to August 5) reflected the large jump in risk-aversion trades. Dealers have been piling into long USD positions and were at +66% of their three-year maximum. Of late, investors have been turning against both the JPY and the EUR. The market ended last week applying a small squeeze, mostly on the back of some individuals believing that those trades or positions may have gone a bit too far. The EUR has managed to rally from its nine-month low (€1.3333), but continues to lack conviction. The yen, on the other hand, has seen USD/JPY fall from its four-month high print in July (¥103.15), but continues to have BoJ Governor Haruhiko Kuroda’s backing to underperform for Japan’s economic survival. Also of notable help, a Nikkei report noted Japan’s Government Pension Investment Fund has temporarily scrapped its cap on the proportion of domestic shareholdings from August 5 until September to allow an increase in purchases of domestic stock.
Eyes on European Government Bonds
Markets will continue to keep a sharp eye on European spreads (bunds/periphery) for direction. With the peripheries expected to see a supply-free week with no slated issues coming, and Germany to come to the market on Wednesday to sell 10-years, it should have dealers tightening that spread to make room to takedown supply. This should be an ideal chance for spread tightening positions to gain some lost ground. Geopolitical concerns have managed to push German 10’s to record low yields (+1.02%), while even shorter product has been trading negatively. The market expects Spanish paper to continue to outperform Italian on a better domestic growth scenario. Spain’s second-quarter gross domestic product print came in better-than-expected with a +0.6% headline while Italy has slipped back into a technical recession.