Muted FX reaction to market meltdown

Many of the usual correlations in FX were in evidence as equity markets suffered a remarkable meltdown yesterday, but currency market moves feel muted relative to similar incidents in the past.

The US equity market closed yesterday with a chunky loss of over 3% for the broader market and a loss of more than 4% for the high-momentum, tech-weighted Nasdaq 100 containing the largest, most popular names. As was the case back in early February of this year, the violent acceleration of the selling relative to recent quiet volatility and small trading ranges magnified the impression of the size of the move.

The bond market rally one would normally expect as traders head for safety was rather muted, perhaps as rising yields of late, as was the case in 1987, are providing some of the fuel for the intensity of this move. The move continued overnight, with US futures down over 1% at one point and the Japanese Nikkei Index in a brutal session that wiped out the remainder of gains from September and then some. 

Reaction in the currency market was largely along the lines one would expect, with the Japanese yen seizing the initiative and cutting a path of destruction across the landscape. The idea, as ever, is that Japanese savings sloshing around the world in higher-yield and higher-growth areas come sloshing back home when Japan’s savers decide to sell assets and repatriate. Elsewhere, however, volatility felt a bit muted – all of the G10 small currencies were weak, but not remarkably so (AUDUSD not even posting a new low) and EM looks surprisingly stable even if under pressure, with some of the support likely coming from China’s persistence in maintaining the CNY floor.

In Europe, Brexit hopes are confusing the mix and normal reaction patterns, likely keeping a CHF rally at bay and supportive of course of GBP and maybe even the Euro to a degree as Italy’s BTP yields are rather orderly. The US is less of a safe haven than normal because the market was already rather long of USD and falling US rates erode some of the narrative driving the stronger USD of late.

The timing of the move is more than interesting with the US mid-terms just weeks away, as President Trump has egg on his face from all directions at the moment after the bruising Kavanaugh court nomination and his mocking of women claiming sexual assault, a massive sudden hurricane Michael that may be the most intense to ever make landfall in the US, and now a market meltdown that could be set to get even worse.

Trump is already out blaming Fed chair Powell for the stock market sell-off, saying that the Fed has “gone crazy”. Sorry, President Trump, but the crazy came well before Powell. And it would be very convenient for Powell if today’s US CPI release prints higher than expected.

The US Treasury auctions yesterday went off without a hitch, if a bit on the weak side – more interested purchasers when a market meltdown is afoot!

Chart: USDJPY

We return to USDJPY, where the pair has taken out the pivotal 113.00 area and will likely continue to look heavy until this equity market deleveraging has played itself out. Maximum risk until volatility is clearly fading. It feels like something has broken here and that this will take a very long time to recover. If so, we may have seen the high in USDJPY, though a more profound sense that the market has turned could be a full retreat below 111.00-110.00, which contains the Ichimoku cloud, the prior price pivot and the 100- and 200-day moving averages.