Are FX Markets Pausing Or Turning?
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Markets are stabilising after the brutal (and according to some market observers excessive) moves in the immediate aftermath of Brexit. Investors are starting to ask whether the summer lull associated with tighter trading ranges and subsiding FX volatility is about to start.
We still think that the markets are pausing rather than turning and that downside risks for GBP, as well as some European and commodity G10 currencies could intensify before long.
That said, it is important to note that the markets will not correct in a linear fashion and we can well see intermittent periods of abating FX volatility and intensifying demand for risk. This brings us to the question about the potential triggers of additional market volatility. Clearly, Brexit should remain a worry for now. The political vacuum in the UK persists but we believe that at least some of the associated risks seem to be priced in so that investors will want to wait for the more clarity about the new leaders of the Conservatives (and, potentially, the Labour party) before positioning for the next chapter of the Brexit saga.
We suspect that a more potent source of market volatility will be the UK data releases in coming weeks as well as the BoE. Given that markets are already pricing in aggressive easing as soon as August, however, it would take very disappointing data or aggressive policy action to send GBP and risk assets below recent lows. Another risk that we are monitoring is the impact of Brexit on the global economy. Weaker data from around the world could undermine market risk sentiment. If anything, we would highlight next week’s US NFP report as key for the near-term outlook of risk sentiment.
In addition, sentiment indicators out of China could attract attention especially if these point at persistent headwinds. The upcoming central banks could move the markets and we think that the July BoJ meeting in particular could trigger a stronger market response especially if the bank surprises by announcing aggressive monetary stimulus yet again.
Last but not least, the upcoming US presidential election should attract increasing attention with the Democrat and the Republican party conventions likely to feature prominently on investors’ radar screens in coming weeks. Of particular interest will be the details of the programs of the presidential nominees. Any evidence that Clinton is trying to corroborate its lead by ‘borrowing’ some of Trump’s protectionist rhetoric could fuel concerns about the outlook for global trade and growth from here and hence weigh on market risk sentiment
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