The headlines in the media might have suggested that ‘chicken lickin’ was running for cover as the sky came falling in, but the reality in markets was not quite as dramatic. Moves in equities and bonds were certainly aggressive to welcome in the week but despite the countless pictures online and in newspapers of traders holding their heads in their hands or screaming over crowds in a panic, there wasn’t any air of catastrophe. Yes the correction in equities was large and aggressive, and we may not have seen the end of it yet either but to put things into perspective, markets wiped out about two months’ worth of gains, not 10 years. The buildup has been coming and almost every market participant has claimed stocks are stretched and probably have been for several years, even the most bullish would admit to a correction being overdue and this might well be the time. The risk has always been there and regularly highlighted and when the selling starts and goes past a certain point, there is very little to halt the decline.
Measures of volatility spiked through the roof and a combination of fear and algorithms accelerated the declines. Markets will need to face the reality that normality will be returning and central bank liquidity will not be there forever. Interestingly while bond trading volumes were up anywhere between 80% to 130% of their normal volumes, major FX pairs were almost unchanged, the USD index closed the day more or less flat despite pressing two week highs earlier in the session. The USD was actually higher vs the safe haven JPY, GBPUSD and EURUSD were both slightly firmer while EURGBP was more or less unchanged as well. Broadly things have stabilised, there was a recovery in US equites yesterday, the Nikkei and ASX/S&P were both firmer overnight and this morning’s European open shows major bourses trading higher with the exception of Italy.
We are light on fundamental data for the European session this morning but we will be very focused on ECB speakers through the morning as well as the European Commission’s economic forecasts. The euro has already exceeded most analysts 2018 predictions as EURUSD pressed back above 1.2500 however for now the stronger USD is keeping a lid on euro strength. The EURUSD range is 1.2330 where there is downside support, with any rally higher running into sellers ahead of 1.2450 area, while any press above 1.2500 is where larger euro sell orders are lined up. EURGBP is trading back to the top end of its 3 month range, .8930 holding moves highs for now while moves lower will run into support at .8730 and .8685.
At the risk of sounding like a broken record, the outlook for GBP is shaped almost completely on the expectations of how Brexit will proceed. I have several conversations a day with clients wondering what’s next for GBP and while it’s the great unknown, we only have to follow the headlines for short term guidance. Hope of a fairer Brexit transition and a softer Brexit for all saw EURGBP drop to 9 month lows, while GBPUSD traded to levels not seen since the actual Brexit vote. As headlines have soured around the Brexit process so too have GBP, with GBPUSD trading back below 1.4000 while the pound has weakened some 2.2% vs the euro. This will not change and the pounds direction will continue to be set by the winds of change around Brexit talks.