Talking Points- Dollar’s Haven Appeal Slow to Build as Global Headlines Shake Volatility
- Yen Crosses Start to Slip Below Critical Levels as Risk Rises
- British Pound Rate Expectations Confronting Global Stability, 2Q GDP
Dollar’s Haven Appeal Slow to Build as Global Headlines Shake Volatility
The usually sanguine global markets shuddered this past session as conflicts arose in two particular prominent hotspots. News that a passenger airliner was shot down near the border between Ukraine and Russia sharply escalated the tensions over the disputed region. This was shortly followed by headlines that Israel was launching a ground offensive in the Gaza Strip. The geopolitical, economic and energy market implications of these conflicts readily reverberate across the interconnected global financial system. The question for investors in benchmark assets and currencies though is whether these issues will fade from the collective consciousness like so many other troubles during this extended period of speculative contentedness, or if this could prove the inflection point of a long overdue normalization of risk assessments.
While both of the aforementioned events are serious and unlikely to be resolved without further troubles, their influence on the financial market has just as much to do with backdrop of speculative sentiment as the direct implications of the events themselves. Peak complacency brings with it an obstinacy that calls up short-term speculators to fade most of the swells in risk premium we’ve experienced so far in 2014. That said, the environment of extremely low volatility and exceptional reach for yield cannot last forever. This combination of troubling headlines adds to a general deterioration in growth forecasts, a deliberate shift in global monetary efforts and debate over asset fair values. So far, we have seen a moderate level of ‘risk aversion’ with global equity indexes retreating, volatility measures soaring and Yen crosses pushing support levels (some like EUR/JPY and NZD/JPY breaking). Tapping the dollar’s safe haven status requires a further deterioration.
For the dollar, the haven designation is founded in the currency’s liquidity. Demand for liquidity represents an exceptional aversion to risk – even panic. That is a significant sentiment threshold to breach. In the meantime, key technical moves from one or more of the most heavily traded majors can exact significant influence – for example, if EUR/USD breaks below 1.3500.
Yen Crosses Start to Slip Below Critical Levels as Risk Rises
Far less resistant to sentiment tides, the Yen crosses have more readily followed equities into their retreat. This pullback has exacerbated some existing moves and subsequently led to provocative technical breakdowns. EURJPY dropped below 137.50 and has progressed to its lowest level in five months. NZD/JPY accelerated a three-day, nearly 2 percent tumble that has tentatively broken a two-year rising trendline. Unlike the dollar where its appeal really kicks in when demand for market depth is tantamount, the Japanese currency finds a bid well before that extreme as the market looks to first unwind risky positions before proactively seeking out the havens. As a funding currency driven down by a BoJ that has capped its stimulus effort and a risk drive that is facing low returns, these crosses are far more exposed.
British Pound Rate Expectations Confronting Global Stability, 2Q GDP
Rate expectations were already receding heading into this past session despite otherwise strong UK data. As global sentiment dimmed, the market was even further drawn from its rate hike focus. Hawkish forecasts are difficult to sustain when financial uncertainty builds – especially when there isn’t a robust backdrop for inflation pressures. Both Gilt yields and swaps showed a further pullback in forecasts of a near-term BoE hike. Moving forward, we will see whether the attitude will change the interpretation of data. Next week, we have BoE minutes and 2Q GDP figures due. A pessimistic lean to this data could significantly change the sterling’s bearings.
Euro Another Currency Exposed to Escalating Fear
In the echelons of risk the Euro is deceivingly exposed. Much of the optimism and low volatility developed over the past months and years was founded on a carefully crafted sense of complacency. For the Eurozone, calm seas are particularly important to maintain the capital inflow as economic conditions are not very encouraging for most members and the discount in local assets has more than been offset over previous years. ECB monetary policy and economic concerns considered, ‘risk trends’ are arguably the Euro’s greatest concern.
US Oil Posts Biggest Rally in 5 Weeks on Middle East Conflict
Following the unexpectedly sharp drop in weekly US Crude Oil inventories and record print in implied demand reported with Wednesday’s DoE figures, crude worked to extend a larger reversal of its month-long decline though this week’s open. The commodity rallied 2 percent on the heaviest futures volume (over a million contracts) since March 12. Middle East supply concerns will stand off against a speculative risk take.
Emerging Markets Tumble Led by Collapse in Russian Ruble
Not surprising for one of the market’s riskier asset classes, emerging markets tumbled this past session. The MSCI’s capital market ETF dropped 1.9 percent while JPMorgan’s EM volatility index rose 4.6 percent from its consolidation at record lows. It was not surprising that the Russian Ruble was the worst performer on the session with a 2.1 percent drop versus the dollar and 2.2 percent against the Euro.
Gold Catches Safe Haven Bid but Not as Intense as Risk Unwind
Amid geopolitical tension and concerns over the stability of the financial system, gold naturally gains a luster. The metal rose $20 (1.5 percent) this past session on news of Ukraine and Gaza. Yet, in that move, we have returned to range rather than forged a new bull wave. Derivative volume was notable, but not exceptional. Meanwhile, SSI shows gold interest plunged and ETF holdings continue to pull back.