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While it may be argued that there is still residual demand to be found once the US and China can ink a trade deal, the price action this week is quite revealing about a potential permutation in the rhetoric that has dominated flows.
Are we getting to a point where the market has priced in all there was to be discounted from the Sino-US story (assumption is a deal is almost baked in the cake) and the attention is swiftly shifting towards economic fundamental divergences?
Risk on risk off fluctuations, the growing influence of capital flows derived off yield spreads (US at the forefront of the recent divergences spotted) must simultaneously coexist with the immediate risk of politics in Europe (Brexit) as we enter a key period.
In the last week or so, the typical risk-on, risk-off gyration have started to decouple due to fundamentally-charged triggers in Canada, Australia to name a few. That’s why it’s been a fairly disjointed affair finding the connections between risk and sensitive currencies to deleveraging episodes in financial markets. This decoupling also applies to the USD, which by default tends to debilitate when risk thrives; it has not been the case as the currency keeps its appeal intact.
What we are seeing is a market that is increasing its correlations toward bond yield spreads, and that is evidence that more attention is being paid towards the prospects of growth and economic divergences on an individual merit basis. At the center of this new re-adjustment towards yield differentials we find the sell-off in US bonds, which keeps stubboly high demand towards the US Dollar in a world with ultra-low interest rates.
If you are looking for that extra layer of conviction on your Forex trades, this is the time to factor in the bond yield spread to gauge the next flows while keeping an open mind about what currencies may or may not benefit from risk-on or risk-off as fundamentals and politics (EUR, GBP) play an increasing role.
In the near term (microflows), the pendulum has swung towards ‘true risk off’ conditions, an environment characterized by a firmer JPY and USD. The recent aggressive setback in the S&P 500, alongside back-to-back corrective days in US yields coupled with a rising USD, qualifies the latest daily fluctuations as a juncture not risk friendly, even if the relatively contained range in the S&P 500 over the last 24h has somehow tamed the selling of risky assets.
Evidence of that, even if more fundamentally driven, is the performance of the Aussie and the Kiwi, on the back of the RBA policy meeting. I must say that in the last week, we are starting to see some disjointed FX moves away from respecting RORO conditions, as divergence in fundamentals take centerstage.
That’s the reason we’ve seen such a depressed CAD since last Friday, as the market prices in a more dovish BOC this week. In terms of the EUR and GBP, as the Brexit deadline approaches, that’s at the epicenter to determine next flows. Meanwhile, the USD and US yields for this matter, have both been rising as the US economy keeps showing signs or a strong comeback after the hiccups of Q4 and post the US govement shutdown.
We are transitioning into a period where fundamental divergences may start to play a greater role to assess the forward-looking performance in currencies, a very important consideration that one must reconcile with when looking to gauge flows beside the RORO-led rotations.
When it comes to the macro picture, the 5-DMA slope in the DXY and US yields is firmly pointing upwards, which when combined with a flat 5-DMA slope in the S&P 500, makes the current context a source of conce to see further deleveraging on risky assets if equities remain fragile. If the risk-off conditions extend, playing risk-sensitive currencies such as the CAD at a time of negative fundamental news, can potentially result, as seen recently, in ample movements.
EUR/USD: In A Bearish Cycle Phase, Divergence W/ Bond Yield Spread
GBP/USD: V-Shaped Tu at Key Horizontal Line
USD/JPY: Retu Of Risk-Off Flows Encapsulates The Pair
AUD/USD: Sellers In Control As Range Breakout Looms
USD/CAD: Clearest Bull Trend In the FX Space
Gold: Follows DXY/US Yields In Locksteps
AUD/JPY: Setting Up For An Outlier Move
EUR/AUD: Follow The Yield Spread To Keep You Safer
NZD/USD: As Negative As It’s Been For Weeks