Head of FX Strategy
Summary: The market is doing its best to overcome the exogenous shock of the Saudi oil facility attack, and if this factor fades quickly, the focus will shift to the status of the tremendous backup in bond yields and the FOMC meeting on Wednesday, which may contain few surprises.
Trading Interest
The bombing of Saudi oil facilities at the weekend has been felt most intensely in energy markets, of course, with rather mild feed-through into foreign exchange and other markets. One of the reasons that FX absorbs this kind of news in an odd way is that it pulls on conflicting themes: the threat to global growth if the oil price spike is sustained for more than a few weeks is growth and risk negative and works against any smaller currency, even a currency positively correlated with oil prices even if the nominal immediate boost to oil prices boosts the prospects for oil income massively.
The chief worry here is that this attack on Saudi facilities triggers for more overt military confrontation that brings the threat of an even larger disruption to supplies on further attacks. For now, CAD and NOK are up a fraction of a percent and JPY is firmer this morning, but off the modest “spike” lows overnight. The markets look hopeful that Saudi strategic reserves will limit the disruption of supplies and that they are able to make good on assessments that the repairs require on the order of “a few weeks” to carry out.
The chief focus for the week ahead is the Wednesday FOMC meeting, though the narrative has suffered a twist at the weekend that could raise the uncertainty of what will unfold if oil prices don’t calm further by Wednesday. Given that the oil market disruption is so fresh, the Fed can hardly be expected to do more than point out that they are monitoring it for implications and before the events at the weekend, the Fed was seen as a lock to cut 25 basis points, given strong risk appetite and hopes that the US-China trade tensions have thawed.
While we have a bonanza of central bank meetings this week, including four on Thursday (SNB, BoE, Norges Bank and BoJ) G10 currencies, our suspicion is that central banks are increasingly losing the ability to move the needle – with last week’s ECB meeting Exhibit A for that notion. Norges Bank is the only of those four where there is some suspense on the decision, given fairly evenly divided opinion on whether they will hike again.
Let’s recall how Friday closed last week for the bond markets, which suffered a brutal correction all last week that accelerated dramatically on Friday and almost entirely erased the massive downdraft in yields in August. The move has come with little fanfare and points to dysfunctional liquidity conditions in the bond market, but also points to the risk that the complacency driving high-flying stock is on an increasingly uneasy foundation if the move higher in yields continues.
Chart: EURJPY vs Bunds
The key question for markets if we assume that the oil market volatility calms back to a non-factor in coming days is the recent dramatic rise in interest rates from the cycle lows – if this move is not quickly halted, it could quickly become a factor leaning against recent developments like the strength in EM and riskier currencies and weakness in the JPY. Here we show the EURJPY versus the Bund future for a sense of how JPY crosses are sensitive and correlated with bond yields – this is likely to remain the case.
The G-10 rundown
USD – given that so much of the Fed’s uncertainty centers on trade issues, we're unlikely to see the FOMC rate decision and guidance making any strong statements this time around as we await trade relationship developments between the US and China in October.
EUR – the euro firmed late last week on the sense that the ECB is done for the cycle and the next policy direction is fiscal, which tends to be FX supportive – EURUSD still needs another leg higher (last week’s rally stopped at the first key Fibo) if it is to show promise in neutralizing the long slide and showing a turn back higher.
JPY – as we discuss above, the yen outlook rooted in the direction of bond yields and risk appetite, which is beginning to reach extreme levels of complacency by our measures.
GBP – sterling longs getting ambitious into the 1.2500 area in GBPUSD and below 0.8900 in EURGBP recently, but we need real developments pointing to a path out of the Brexit morass for sterling to deserve the strength.
CHF – EURCHF looked like it wanted to go higher before the weekend’s disruptions – likely to inversely track global bond yields.
AUD – almost no trading range in major AUD crosses as we await the direction in the USD and the pivotal area overhead in AUDUSD – a few AU data points this week, but broader market themes likely to dominate.
CAD – USDCAD looked as if it were busy trying to reverse higher before the weekend’s oil price earthquake. Stay tuned, as reattaining the 1.3300+ area would neutralize the recent sell-off (and we are sceptical on the market’s expectations for BoC policy).
NZD – a solid follow through higher in our AUDNZD long on Friday- important test this week on relative data releases as Australian employment data is up on Thursday together with NZ Q3 GDP data.
SEK – EURSEK looking heavy post-ECB but needs to punch through the 10.60 level to merit attention. As we pointed out on our Technical Chart highlights on Friday, the longer term momentum of the long-standing rally is flagging.
NOK – a quite modest NOK rally overnight given the scale of the oil move as the concerns immediately center on longer term demand if oil prices remain elevated. EURNOK in a limbo ahead of Thursday’s Norges Bank meeting, where expectations are divided on whether the bank stands pat or hikes 25 bps.
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