Red lights are flashing for risk

John Hardy

Head of FX Strategy, Saxo Bank Group
John Hardy joined Saxo in 2002 and has been Head of FX Strategy since October 2007. He focuses on delivering strategies and analyses in the currency market as defined by fundamentals, changes in macroeconomic themes, and technical developments.

The pickup in yen volatility, together with other signs of market strain, have us in a very defensive posture on currencies correlated with risk appetite. CAD volatility could accelerate the most among G10 currencies if oil prices come under pressure.

This market presents an odd set of circumstances. The focus of late has been the rising rate expectations from the Fed and the notable breakout in the longer US treasury yields, the purported drivers of the USD rally. With the latest Federal Open Market Committee minutes release this week and even in the couple of sessions prior, these rate moves have eased notably and the status of the major breakout above the 2.95-3.05% zone for the US 10-year benchmark is an open question. And yet the US dollar rally has mostly only faltered against a suddenly surging Japanese yen. Sure, the yen is very sensitive to the direction of global yields, but the pickup in volatility is out of proportion with recent developments and suggests that there is a bit more afoot. 

It is difficult to quantify the fallout for the JPY from the North Korean summit situation, as the recent cancellation coincided with the sudden spike in JPY volatility. Otherwise, perhaps some of the JPY strength may be on the recent wobbles in emerging markets (as the aggravation of the TRY meltdown likewise coincided with the spike in JPY), which are popular destinations for Japanese savers looking for enhanced yield. 

Certainly, in any case, the risk appetite backdrop is far from calm and is throwing off conflicting signals. The normal global risk barometer, the S&P 500 index, has neither followed through higher nor sold off after breaking important Fibonacci and trend-line resistance, and US large caps may have taken on a kind of odd safe haven status. In any case, we suspect that the very quiet moves in that index are odd rather than reassuring and that the VIX trying to establish new lows below 13 since the early February volatility event is a red herring. Looking over at EM equities, in USD terms the MSCI Emerging Market index has slipped below its 200-day moving average and has closed near the lows of the year in recent session.

Elsewhere, the Germany-Italy 10-year yield spread is crossing above 200 basis points as we write this morning, a deterioration that threatens a weaker euro versus the most liquid safe haven currencies like USD and EUR, with CHF potential perhaps frustrated by the Swiss National Bank. Note a story discussing the potential for “pooled” sovereign bond backed securities  circulating yesterday as a novel way to partially address the debt mutualisation issue in the EU.

In EMs, we need to keep an eye on TRY after Erdogan and his AKP leadership shot itself in the foot yesterday, the very day after the central bank’s emergency 300 basis point rate hike, by announcing that “relief from high interest rates” are a priority for the party’s election platform. Oh dear.

One currency that could be on the edge of a further decline on a double whammy of weaker oil prices and a fresh decline in risk appetite is CAD, which has been gyrating in a tight range versus the USD. So far the action has been capped by the 1.2900+ resistance, but if risk appetite shows broader signs of declining and oil prices finally correct lower on the risk that OPEC and Russia agree to step up production to compensate for Venezuela’s declining exports, then the top could come off. Still, the upside potential may be constrained a bit until the other side of next Wednesday’s Bank of Canada meeting, which is likely the chief arbiter on whether the 1.30-1.31 range will fall here.


The G-10 rundown

USD – the greenback rally is very much intact outside of USDJPY, where the JPY may continue to outperform, particularly if US rates take a more decisive dive lower.

EUR – the euro can’t sustain any notable rally and continues to look vulnerable versus the USD, JPY and CHF, but the breadth of its weakness may ease if a risk-on/risk-off theme develops (where smaller currencies that have outpaced the euro recently underperform based on liquidity).

JPY – the yen retains the most potential for volatility and may spike higher still if broad risk indicators continue to deteriorate. An oil sell-off would add further rally potential. USDJPY looks offered as long as it stays below the 110.00-25 area and EURJPY likewise below 129.00-50.

GBP – sterling saw a very strong Retail Sales surge in April, likely linked to very good weather. The resulting sterling rally has entirely faded and today sees the release of the Q1 GDP estimate. Risk for GBPUSD point lower as long as we remain below 1.3450-1.3500.

CHF – the Italian yield spreads worsened again late yesterday and EURCHF pushed back toward 1.1600. The Swiss National Bank may be increasingly active as 1.1500 approaches, but pressure to the downside remains as long as signs of EU existential strain worsen.

AUD – the Aussie is stuck in 0.7550-0.7650 limbo against the US dollar and global risk appetite likely to provide the impetus for the next move as the next Australia event risks are some ways off (June 5 Reserve Bank of Australia meeting).

CAD – there should be plenty of room for CAD volatility over the next week as oil needs to choose a direction, the USDCAD chart needs to resolve a triangle, and we have a Bank of Canada meeting up next week.

NZD – the kiwi looks weak versus the AUD and if risk appetite continues to weaken, the kiwi should underperform broadly.

SEK – supposedly SEK looks more solid if EU existential risks worsen, but then again, Sweden is generally a leverage play on its export economy (most of that to Europe) and is often sensitive to risk appetite, so upside potential may be very limited in this environment. 

NOK – EURNOK can’t engineer a solid downside break and may fail to do so if oil prices correct badly and risk appetite fails to improve. Potentially offsetting this are EU existential risks, though these seem to have weak feed through into EURNOK.

Upcoming Economic Calendar Highlights (all times GMT)
0800 – Germany May IFO
0830 – UK Q1 GDP 
1230 – US Apr. Durable Goods Orders
1315 – ECB’s Coeure to speak
1320 – US Fed’s Powell to Speak at Sweden Conference
1545 – US Fed Speakers Kaplan, Evans, Bostic (Voter)



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