Equities: New extremes and a challenging opportunity set
Discover insights on the future of equity markets in Q1 2024 and navigate the potential recession with strategic investment choices.
Head of FX Strategy
Summary: While headline risk for markets continues from the war in Ukraine, the less-severe-than feared US sanctions yesterday could cap aggravation of risk sentiment for the short-term, particularly if energy markets calm further. This could allow smaller currencies to stage a comeback next week, even if longer term visibility remains poor.
FX Trading Focus: US sanctions underwhelm, risk sentiment rebounds
A wild ride for global markets yesterday as markets first swooned on the shock of the invasion of Ukraine, but then rebounded late yesterday as the US chose far less severe sanctions than many had feared against the Russian financial system. Especially encouraging (for global markets) was the clear intent from the US and in Europe to avoid impacting the flow of Russian energy exports via “carve-outs” for transactions related to oil, even from sanctioned banks. This is a key development for avoiding an immediate lurch into a more negative growth outlook. The Brent oil price yesterday spiked above $105 per barrel yesterday, but had dropped to below $98 as of this writing. The most risk-correlated currencies also staged a comeback after selling off.
One very notable exception in currencies to the rebound from the reaction to the situation in Ukraine is the euro, which continues to trade weakly even if it has bounced versus the franc and yen. That is likely in part down to ECB expectations for rate hikes this year easing lower on a number of softer comments from ECB speakers, including Holzmann, who suggested that rate hikes might be delayed just days after he recently called for two rate hikes this year. As well, there has been considerable chatter that the ECB may choose to continue with asset purchases even after it begins hiking rates, unlike other central banks. This has always made sense from the angle of ensuring peripheral EU yield spreads among EU countries remain orderly, but some ECB members have specifically argued in favour of the standard “sequencing” of halting purchases before raising rates. About half of the rise in ECB yield expectations for later this year has been erased since the late January, with the bulk of the reaction to the Feb 3 ECB meeting reversed. ECB Chief Economist Philip Lane today said that the Ukraine conflict could shave 0.3-0.4% of growth from the EU GDP. EURUSD has been under pressure in part from the proximity of the Ukraine conflict to the EU and on the negative impact from higher local energy prices (particularly power and gas), which have worn on ECB expectations, while US Fed expectations have remained more stable.
Comments from Fed members have yielded fewer expressions of concern about the impact from Ukraine. The most recent comment of particular interest came late yesterday from Christopher Waller of the Fed Board of Governors (and therefore also a voter at FOMC meetings), who said that there is a “strong case” for a 50-basis point move in March and 100 basis point of total easing by mid-year. This is identical to the scenario called for by St. Louis Fed president Bullard – is that a coordinated message? One could argue that this scenario offers the Fed the chance to move boldly with its first move, but not to suggest it is set to hike in 50 basis point increments after the initial lift-off. Of course, the “bold” initiative was largely lost at the January FOMC meeting, which failed to see the Fed simply ending QE right away. Markets are priced about 50/50 for a 50 bps move at the March 16 FOMC meeting.
In choosing where to look to take some measured risk (many likely unwilling ahead of the weekend and the market can certainly take an ugly turn again – long options strategies are always one way to limit risk for those familiar with their uses) for next week, the Swedish krona stands out on valuation grounds and technical grounds in the case of EURSEK (see below), but so too does the Aussie, particularly if the AUDUSD closes back above 0.7250 again. Arguably, Australia is well positioned for the complex of commodity risks, not only the usual China-centric ones, but also on its LNG exports and as a massive food producer and exporter – particularly wheat. Ukraine is a significant exporter of wheat, and Russia is the largest and wheat prices have skyrocketed on the outbreak of war in Ukraine.
Elsewhere, CEE currencies are trying to mount a comeback on improved risk sentiment, but are beset with special problems: not only the proximity to the conflict, but also the developing Ukrainian refugee situation, although surely the EU will mount a relief effort to ease the financial burden and hopefully also to distribute refugees to other EU countries.
The Swedish krona should prove one of the most sensitive of currencies to any improvement in sentiment, as it has been sold off on the impact across markets from the war in Ukraine and on the weaker euro. The technical setup looks interesting as well, with a choppy price action at the top and momentum rolling over here. The pair could drop back down as far as 10.25 on the conflict in Ukraine “resolving” in some way that sees a halt to the overt phase of military conflict and no impact on energy deliveries and maybe even a significant drop in natural gas prices into Europe.) Then, an ECB might feel more comfortable with a more significant shift in its guidance at the March 10 meeting, which could in turn encourage the Swedish Riksbank to start second-guessing its own guidance after the recent SEK weakness has aggravated inflation risks. More tactically, simply pushing back down into the 10.50-40 range may merely require that the backdrop doesn’t worsen.
Table: FX Board of G10 and CNH trend evolution and strength.
Watching EUR and GBP next week if risk sentiment improves, as if it does, would expect that USD, JPY and CHF are the weaklings, with the smalls rebounding and EUR and GBP somewhere in the middle.
Table: FX Board Trend Scoreboard for individual pairs.
Watching AUDUSD for a price break to confirm uptrend potential (or not) next week after the pair has once again survived risk-off headwinds. Similar for EURSEK, and the really cheeky risk-takers out there might have a look at CHFSEK and CHFNOK.
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