FYI | Jun 17 2014
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
After last week’s volatility, we are starting to wonder if “sell in May and go away” could be turned on its head and instead things could get more interesting this summer. A couple of themes appear to be developing, which could determine the direction of markets in the coming months:
1, Crude concerns: While the market has been able to shrug off geopolitical risks for most of this year, a continuous drip-feed of concern could wear the market’s patience thin, which may explain the harsh reaction to the news of the insurgency in Iraq at the end of last week. Iraq’s oil producing region has, so far, avoided a descent into violence, and the West is not planning on sending in any troops at this stage, however, a wave of risk aversion continues to hit market sentiment and global stock markets are lower. Reports suggest that Iraq could descend into civil war, and now the Russia/ Ukraine conflict could add to the markets’/ woes. Russia cut off its supply of oil to Ukraine today after officials failed to find a solution to Ukraine’s unpaid bill. Russia was at pains to state that it would continue to pump oil to Europe, which may ease fears of a sharp increase in European demand for oil, and Brent crude oil has backed away from earlier highs. However, the price of a barrel of Brent crude remains above the average of the last 3 years, which is $110.16, and if it continues to move north then we could see investors take flight.
For now geopolitical risks appear contained, which is why volatility indices continue to moderate, but with dual hot spots in Eastern Europe and the Middle East, headline risk is more elevated now than it has been all year.
2, The Carney effect: The head of the UK central bank let the cat out of the bag last week when he said that the market may be under-pricing the risk of a UK rate hike sooner than expected. The market has tried to play catch up, and has moved its expectations of a rate hike from Q2 2015 to the start of next year. Speculative long positions in the pound rose last week, and GBPUSD reached a fresh 5-year high, above the key 1.70 level earlier.
The big question for markets is did Carney’s comments indicate a global shift in central bank thinking? On Friday the BOJ failed to add more stimulus as some had expected, it also did not hint that any further stimulus is in the pipeline, which, along with safe haven flows, boosted the yen, which was one of the top performing currencies in the G10 on Monday.
And we could find out if the Fed is also impacted by this hawkish tilt at this week’s FOMC meeting. A $10 bn reduction in the Fed’s asset programme is expected this Wednesday, which would bring the total amount it buys to $35bn per month. But it is Yellen’s press conference and the latest growth, inflation, and rate forecasts that really matter for markets. While growth is expected to be revised lower because of the disastrous start to the year, inflation could be revised higher, which may give Yellen more room to point to a slightly earlier tightening than currently expected. Right now forward swaps curves are expecting the first rate hike from the Fed in May 2015, a full five months after the BOE, we will be watching to see if Yellen can close this gap.
The market appears to be expecting a hawkish Fed and speculative USD longs increased last week. Thus, if Yellen fails to deliver, and sticks to her uber-dovish mantra, we could see downward pressure in the USD, which could boost cable and hurt USDJPY.
Investors should also watch out for US, European and UK data this week, including the all-important CPI data for May [confirmed at 0.5% subsequent to writing – Ed] and the latest German ZEW survey [due tonight]. While the ECB may take a back seat this week, it can still rattle the market’s feathers. This time it was the job of the Bundesbank’s Weidmann. He publicly disagreed with his ECB colleagues by refuting the notion that weakening the EUR would answer the region’s difficulties. Thus, it seems clear that Germany does not want a EUR devaluation, and what Germany wants, it has been known to get…
So, here’s hoping that volatility does pick up this week. I believe that if the Fed does adopt Carney’s hawkishness this could turn out to the main theme of the year and earlier expectations for Fed rate hikes could trigger a major reversal in USDJPY. Good luck trading.
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