Morning Commentary: Tug of War

Foreign Exchange - Morning Commentary
Tug of War
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Markets are nothing if not fickle.  In many of our past commentaries, we noted that the global economy faced many significant headwinds.  Despite a long list of material concerns, equity prices have continued to rise and the USD has weakened due to optimism surrounding the re-opening of economies around the world.  It has been a surreal past couple of weeks.  The market’s willingness to shrug off bad news and fully extrapolate out good news could only be described as relentless optimism.

However, this optimism has finally started to show some signs of vulnerability.  At last week’s FOMC meeting, the Fed projected out a near zero policy rate through at least 2022 which forced markets to deal with the somber reality that it has been ignoring for so long.  The combination of fears over a second wave of COVID infections and a downbeat FOMC sparked a steep market selloff last Thursday.  

On the positive side, this sell-off did abate on Friday.  Additionally, policy support should continue to expand as several central banks meet this week and should either add more stimulus or reaffirm dovish forward guidance.  The BoJ is expected to keep its policy unchanged but should continue support through QE and yield curve control.  The BoE also meets and is likely to expand the pace of its QE program and could touch on the possibility of negative rates. 

On the negative side, risk assets remain overbought and are down sharply on the day.  Moreover, nearly half of the re-opened US states have reported an increase in the number of day-to-day infections with a similar dynamic playing out in several other countries.  If this trend continues, it would pose a significant risk to the market’s current “buy the dip” mentality.  

On net, overall market dynamics have put the FX markets into what seems to be a tug of war as it alternates between risk on and risk off and searches for direction. 
  • This week will be a fairly busy week for Fed speakers.  Jay Powell alone is scheduled to speak at least 3 times but is expected to reiterate what the FOMC stated last week.  
  • UK PM Boris Johnson and European Commission President Ursula Von der Leyen start negotiations today.  The EU has reportedly accepted the UK’s position that it will not seek an extension meaning the risks for a hard Brexit rise each day that passes.  With the impending deadline in mind, both sides have agreed to intensify talks, which could be argued as a bullish sign.  Conversely, both sides remain far apart, which is clearly bearish for the GBP.  Keep an eye on headlines as both sides have much to lose on top of already mounting COVID-19 concerns and that could be the catalyst for some compromise.  
  • Beijing is undergoing limited shutdowns in response to a new outbreak and this has weighed on market sentiment.  The more recent virus resurgence is tied to a wholesale market that was visited by a large number of people. 
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