A dramatic week so far and on Monday signs were already there that sentiment in the market was shifting with equities falling across the board. This, following 2 major events last week both with their own implications, the Eurozone continuing its struggle with deflationary pressure and the US in contrast producing some impressive jobs numbers.
There are , however , major factors that can affect not only the fragile economies of the world, of which there are a growing number, but also the hope of US recovery which last week was even starting to look robust. The biggest of those factors right now is the sinking oil price.
Forex Risk Events of the Week
Oil in Free-fall
Wednesday the price of oil fell by 4.5% (that’s huge) to hold just above $60 per barrel.
Logic tells us that exporters will be hurt and indeed we know that many oil producing countries are relying onreserves to keep their industries running.
We have already looked at the Opec decision not to cut production whatever their motives and the effect cannot be described as anything but a rout.
This week Opec have further compounded the losses by lowering demand forecasts. Some commentators have gone as far as to say Opec is not a cartel anymore, it has stepped aside and on the pretext of allowing market forces ( a strange motive for a cartel) attempted to manipulate the US out of its increasingly strong oil production.
Logic may also suggest that importers and non-oil industry would benefit from lower prices which could stimulate growth. However as we have seen with the Eurozone and Japan as the most perilously close to the deflationary spiral, inflation targets are increasingly hard to attain in a world where commodity prices are falling, some of them rapidly.
Shifting Sentiment
Traders have until this week shown an appetite for risk; we are all aware of the all time highs in global equity markets. On Monday we saw the signs of risk aversion. Selling in equity markets began on Monday and continue with the US indexes losing around 1.5%, yesterday, the Dow dropped nearly 300 points and that after two significant selling days. The FTSE, the European bourses and the Nikkei saw the same, as did the the Shanghai index in China losing a stunning 5% on Monday alone. The VIX, the volatility and thus sentiment barometer almost doubled in three days from 12 to 19. That in the context of its movement this year is also dramatic although 19 is still a low number for volatility. This is one to watch.
ECB
Also this week Draghi will attempt another round of what is known as TLTRO’s making funds available via bank loans to bring some liquidity and growth into the zone.
If the launch is unsuccessful and the banks do not choose to borrow the funds on offer then pressure will increase for QE to be implemented.
Draghi , openly in favour was unable to proceed last week at the ECB meeting as, for the first time, he did not have a majority. The opposition is growing against his efforts backed mostly by Germany but if the attempts today fail it may help him to find the votes he needs. Inflation otherwise may prove impossible to attain especially now with an unknown bottom for oil prices.
A Cautionary Note
The USD index has been a high flyer in recent months and has seen a pull back this week which may take some time. Despite last week’s strength in the data, we are approaching year end and the expectation therefore of some profit taking after what has been a strong half year for the USD. Add to this the ‘confusion’ of traders as to the medium to long term effect of the oil situation, and a change in sentiment , and any kind of prediction becomes second guessing the market . The fundamentals have not changed however inasmuch as the US maybe the only economy in the world showing any real signs of recovery .
Keep sentiment in view as, if this is shifting to risk aversion, the rules change. It will favour the JPY, not because of the state of the Japanese economy as we know the fragility well but because of short covering and unwinding of carry trades. This makes the Yen unpredictable and probably wise to stay away from trading it.
It would also favour the USD, regarded as a safe haven. As always make no assumptions and stay aware of the possibility of year end profit taking and short covering in the weaker currencies that can give a false sense of strength. All this without losing the big picture!
Judith Waker
Forex Risk Alert
0 Comments