Daily Comment

Thks to “Heat” for his thoughts…

Q1 is behind us and we can confirm that it has been one of the least volatile quarters ever in foreign exchange markets (February and March arguably boring), after a surprising initial USD selloff in January based on US deficit expansion and most likely reserves portfolio reallocation from Central Banks, Dollar index DXY has been trading sideways in a narrow range (88.50-90.50). Conversely EurUsd traded between 1.2250-1.25, UsdJpy 107.5-105, sterling 1.39-1.42 on the wide…  even Latam currencies remained pretty stable despite USD yields going higher (10Y UST reached 2.94%) and stocks drifting lower which both are good drivers for EM currencies, however we are seeing historic correlations performing poorly in recent months.

Does this lack of volatility makes sense? I´m prone to think that yes it does, seems that we´ve reached an equilibrium point where the synchronized growth is on track with low inflation levels so in everyone’s interest we´ve been in “don´t hurt ourserlves” mode and Central Bankers messages have been neutral. Looking at the Euro,  there is a quite positive sentiment in markets regarding Eurozone economy and the structural CA Eurozone surplus should support the common currency over the medium term, however total absence of inflation pressures (lower inflation set of data in recent weeks) will make any eurusd rally short lived (disinflationary effect of strong currency). Everyday I find it more difficult to believe that Draghi will be able to make any rate hike before he leaves the office by December 2019.

Do I expect to have similar level of volatility in Q2? I don´t think so (being honest I hope not either) thanks to the US stocks market which in my opinion will be the main market driver in coming months. There are several factors which are spooking investors and could lead to a deeper selloff:

·         Trade Wars between Trump and China, at the time of writing China has imposed tariffs on 106 new products including cars or tobacco (Trump´s twitter account followers will love his next entries). The total sum of tariffs imposed to each other is close to 50bn usd, still modest figure given the size of trade between the two but if conflict worsened this would massively erode both economies.

·         Tech companies valuations seems “high” (Amazon P/E ratio >300) and reputational risks are arising (Facebook & Tesla). Don´t forget that top5 US companies by Market Cap belong to IT sector.

·         Pure technical levels. Monday´s close below DMA200 level has taken market attention, additionally S&P is struggling to keep the long term uptrend, clear break of 2550 in s&p500 would leave an ugly scenario ahead of us for risk assets.

It´s true that there never was a clear bear market without the economy entering in a recession (not likely now), however it´s true also that there never was a bull market (almost ten years now) driven by such an extraordinary expansion of Central Banks balance sheet. Said that it´s reasonable to think that once that free liquidity start to vanish risk assets should retrace somewhat.

If that scenario materialized I would expect safe haven currencies such jpy or chf perform well, Latam currencies would suffer and US dollar should be supported, however protectionist rhetoric from US administration could offset buying forces, being honest I think eurusd will trade range bound for the remainder of the year. Treasuries would rally on first place as usual but we are waiting for lower levels for entry short again (2.55%-2.60% target). New Fed Chair Powell showed strong confidence in the US economy  on his first appearance in the March FOMC, Fed members projections were revised up also, makes me think that unless a strong correction in stocks starts to erode consumer confidence and consumption rapidly; the gradual path of rate hikes will continue, so given current market pricing of less than 3hikes until Dec2020 there isn´t too much room for US yields to go lower.

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria