Risk-on, risk-off tops the agenda again

Forex

John Hardy

Head of FX Strategy

Summary:  After yesterday’s ugly session on Wall Street, global FX has switched back to risk-on, risk-off mode, with the strong USD and JPY firming across the board and pushing back on the EM currency resilience of late.


The equity market’s fresh weakness has traders on edge again, especially as the bounce from last week’s ugly sell-off hasn’t taken the market back into a more technically neutral territory. The 200-day moving average in the S&P 500 looms large again after another touch yesterday and the pivot low from last week’s sell-off needs to hold on today’s close to keep the bears at bay here. We’ll rinse and repeat last week’s warning about closing on an ugly low on a Friday potentially making for very rocky market conditions early next week.

Let’s recall the February sell-off in equities for comparison, as it was a very different animal than this latest weakness in risk appetite. Back then, the correction came only after a parabolic acceleration to the upside. The selling was even more brutal, but quickly found a low that was revisited only several weeks later after a powerful initial bounce and a volatile consolidation period. This time around, the first multi-day bounce attempt has been weaker and suddenly we find ourselves testing lower once again. 

In FX, the reaction to all of the above still feels muted, and we credit a large degree of that to the two things. First, the equity market weakness may be linked to a decline in the negative correlation in equity and bond markets as we note that the latter are providing no real haven status on this selling down of risky assets. Second, all eyes remain on the USDCNY rate and whether China will choose to defend the floor in the renminbi, possibly keeping volatility suppressed until we see the price action veer strongly in either direction.

Still, yesterday’s fresh equity market volatility did show the patterns we normally expect when risk appetite sours, with the JPY and USD catching a bid and emerging market currencies finally wilting as a group. 

The euro is under fresh pressure from Italy’s budget setting process as the EU has roundly rejected the proposed budget and says the deficit must come in below 2.4%. Italian BTPs were heavily offered again, with the 10-year yield closing at a high for the cycle north of 350 basis points yesterday. The EU approach seems to be one of forcing. For perspective, a weighted average of the yields for BTPs that need to be rolled over in 2019 is around 2.7% (this does not count the new issuance necessary to fund the deficit), and sovereign funding at these levels and even higher is possible, but as yields rise, the focus will intensify on Italian banks.

The situation is untenable – which side will blink? I would have thought at some point Italy’s populists would compromise just enough to ram some half-measures through this year and then pick up the fight again next year, post-EU parliament elections that the Lega’s Salvini will cement a rising populist wave. Either way, max pressure on the euro for now as long as Italian yields continue to rise and maximum two-way headline risk.

Chart: EURUSD - weekly

EURUSD is finding more separation from the 1.1500 area and momentum is building for a retest of the 1.1300 area, which is unlikely to hold if we continue to see a stand-off over the Italian budget situation and an ugly intensification of that crisis could see the pair testing into the 1.1200-1.1000 area. Note the important 61.8% Fibo retracement level at 1.1187.
EURUSD. Source: Saxo Bank

The G-10 rundown

USD – the US dollar is firming on a safe-haven bid and we watch today’s close with trepidation. A close at new lows would be ominous for potentially chaotic markets early next week.

JPY – is keeping up with the greenback when risk-off behaviour intensifies. 

EUR – the euro is weaker versus the USD, JPY and CHF on the fresh existential pain from Italy’s budget as the risk of downside picks up here. Headline risk is intensifying.

GBP – sterling is wilting again as despite the friendly noises from the EU on the prospects for an extended transition period for the entire UK through 2021, Tory rebels don’t like the idea of continuing to “pay without say” and may vote with the opposition to force a second referendum. Long-term options are the only way to keep a position through the ugly back and forth likely to mark the next two months of Brexit developments.

CHF – the EU existential risks are forcing EURCHF back lower, though that pair looks inferior to EURJPY for expressing euro risks.

AUD – AUD rally attempt is wilting, but feels dampened relative to risk-off behaviour, perhaps on crowded short positioning and China continuing to prop up the CNY above the floor.

CAD – USDCAD free of local resistance as oil weakness and risk off weigh – could look toward 1.3200 next if the break above 1.3050 holds. Watch out for Canada CPI and Retail Sales data later.

NZD – AUDNZD test higher rejected and could open for test lower below the 1.0850-00 pivot area.

SEK – SEK doesn’t like risk off and likes EU existential pain even less.

NOK – ditto SEK comments with the Brent crossing back below 80 a warning sign for NOK longs.

Upcoming Economic Calendar Highlights (all times GMT)

1230 – Canada Aug. Retail Sales
1230 – Canada Sep. CPI
1400 – US Sep. Existing Home Sales
1600 – US Fed’s Bostic (Voter) to speak on economic outlook

Disclaimer

Saxo Capital Markets (Australia) Pty Ltd prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Combined Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Pty Ltd.
Level 25, 2 Park Street
NSW 2000
Sydney
Australia

Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Pty Ltd ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Combined Financial Services Guide & Product Disclosure Statement to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as CFDs and Margin FX products may result in your losses surpassing your initial deposits. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.
Please click here to view our full disclaimer.