Saxo

FX Update: Whiplash is not a sign of a healthy market

SAXO:GBPUSD   British Pound / U.S. Dollar
Summary: The sudden meltdown in risk sentiment yesterday, followed by an impressive reversal that wiped away much of the damage, is not a sign of a healthy market, at least tactically. Markets could remain a bit edgy after this episode and at least into early January, especially around the two run-off elections in the US state of Georgia that could yet grant more policymaking control to the incoming Biden administration.

Today’s FX Trading focus:

Yesterday’s episode underlines that the USD is the safest of safe havens.

Yesterday’s sudden meltdown in risk sentiment, apparently on the Covid-19 mutation news, saw a highly correlated move across asset classes, as poor liquidity saw the USD sharply higher, US treasuries likewise (prices up, yields down), equities down, etc., before everything reversed in unison and nearly managed to get back to where it came from. The comeback looks like a win for the optimists, but the whole episode suggests markets are rather frazzled and fragile here and could suffer further setbacks after revealing how easily significant air pockets in confidence can suddenly appear.

Two noteworthy developments were on display yesterday as volatility rocked exchange rates. The first of these was that the US dollar is clearly the top dog in FX-land when these moves unfold, as the JPY was only modestly resilient in the crosses while lower versus the US dollar . By the way – an interesting signal from new Japanese PM Suga , who appears to want to defend the 100 level in USDJPY at all costs. Likewise, CHF made now waves either and hasn’t really through all of the recent Brexit concerns, either. Second, CAD was very sensitive to the oil move lower, with the latter market showing some refreshing independence from jumpy contagion across asset markets.

Eventually, other exporting countries (Europe first, but others eventually too) will join Japan in the competitive devaluation game if the USD comes under further heavy pressure in 2021. So, barring extremely high inflationary pressures and/or galloping growth optimism, the path lower for the USD could prove rather fitful. Again, the key is whether everything is coming up roses post-Q1 on a successful and rapid vaccine roll-out (max USD pressure) or a less positive growth path and more caution.

And in the nearest term, we have the residual uncertainty on the US political situation through the January 5 Senate run-offs in Georgia, with polls very tight in these races. Remember that both would have to go to the Democrats to change the voting balance in the US Senate to a hair-fine 50-50 (with VP Harris then able to cast the deciding vote.)

Today will be the last update until next Monday. Have a wonderful holiday if you are taking one!

Chart: GBPUSD
Buffeted by USD strength yesterday and Brexit concerns rising and falling and rising again (today, the EU has rejected the latest UK concession on fisheries), GBPUSD has proven very volatile and will likely remain so until we finally know what shape the Brexit situation takes into year-end – if the fisheries issue is the last one standing, I have a hard time seeing both sides willing to go to the wall over that, but the only two things I have conviction on at the moment are 1) that trading spot is futile and traders should take a two-week or longer directional long option trade as the way to maintain a position in sterling, whether versus the USD or EUR, and 2) that the ceiling for sterling even in the best of scenarios could prove rather low, once a decent rally is in the rear-view mirror. Sterling is beset with the same structural issues as the US dollar (external deficit), with only its still somewhat cheap valuation working in its favour – a valuation that was even cheaper for a very long time but still didn’t provide much improvement in external imbalances. The 1.3500 level is the fulcrum here but we’re likely to be in a very different place in a month’s time, whether higher or lower.

John Hardy
Head of FX Strategy

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