The FX Trader: Choppy ride on headline risks. AUD dips.

The latest

Headline risk reminder: US President Trump dropped a bomb on the market yesterday with a social media post claiming strong diplomacy was under way with Iran and heading toward a total resolution of the conflict and the situation in the Hormuz Strait. Iran later denied Trump’s claims. Sources close to the situation probably are the closes to hinting at the truth: that Trump’s 48-hour ultimatum and threat to bomb power infrastructure could create a disastrous situation and a failed Iranian state with unpredictable consequences. The negative view is that, while Trump’s move avoids disaster, the reality remains unchanged and as worrisome as ever. The more hopeful view is that Trump wants out of this conflict ASAP and wants to talk, which might prompt Iran to begin discussions through intermediaries elsewhere in the region if not directly. Let’s see.

Of course, the immediate impact of Trump’s move yesterday was profound and “stickiest” in terms of its persistent impact in oil markets, somewhat less profound in equity markets, and even less profound if still sharp in FX markets (especially EURNOK!). The US dollar was sold off heavily from its recent attempt to strengthen into Monday morning’s pre-Trump post peak. It’s worth noting that before Trump’s post, the US dollar was not providing as much of a safe haven as it had previously during the very weak risk sentiment episode on Friday and early Monday. This may reflect some near-term positioning exhaustion and a difficulty in finding fresh buyers in a market that had already become quite well positioned since the war broke out more than three weeks ago. As US treasury yields were also spiking during the risk-off episode, this provides further support for the notion that USD liquidity might be important during stressed market conditions, but US treasuries are no longer a safe haven instrument of choice.

For now, market participants are traumatized by new headline risks that can move the market either way sharply. The war continues and the Hormuz Strait is not yet open, although some ships are slipping through.

Looking ahead – we have a shortening timeline to be able to move toward more positive outcomes. While it is impossible to know is what comes next – Trump’s impatience to wind down the war is a positive, but could also be weaponized by Iranian manipulation (feign agreement and then continue low level harassment in area once US forces have left, for example), or something entirely unanticipated can materialize like a regime change. But a significant opening of the Hormuz Strait is needed more and more urgently with each day that passes as millions of barrels a day of production are not only making it through the Ho. Failing a restart of oil flows soon, the situation will weigh increasingly on risk currencies first, then perhaps Europe and Japan next most severely, with the USD and CAD as relative safe havens purely from an absolute energy supply perspective.

Chart focus: EURUSD
EURUSD posted its 1.1411 low a full week before the worst bout of weak global risk sentiment into Monday morning. One support for EURUSD not capitulating lower is the relative EU-US rate differentials at the front end of the yield curve as anticipated ECB rate hikes have accelerated more quickly than the markets removed FOMC rate cuts and begun to ponder whether the Fed’s next move might just be a hike. (Markets are now leaning slightly in favor of an eventual Fed rate hikes despite Trump hatchet man and Fed Governor Stephen Miran saying just yesterday that he thinks the Fed now needs to cut four times this year rather than three.) The US 2-year rate advantage as been volatile since the end of February before the war in Iran was started – trading near 140 basis point on February 27 then to as little as 120 basis points this past Friday and 128 basis points today. But ECB hikes will do nothing to offset real economic damage if these oil and gas supply disruptions from the Gulf are sustained for much longer, and the relative damage to the US will be far smaller as the latter enjoys cheaper oil and vastly cheaper natural gas powering much of its electricity grid. In any case, the headline risk is extreme day to day, while technically, the bulls will need the 1.1700-1800 zone to be vaulted to suggest the bear market risk has been averted, while bears will look for a close back below perhaps 1.1500 to greenlight a possible test of new lows for the cycle and maybe even toward that ultimate support zone into 1.1200-1.1250.