Week In FX Europe: Forex Market Seeks Risk/Reward Opportunities

by: Dean Popplewell
    • EUR squeezed on the crosses
    • Geopolitical risks aids commodities
    • The Fed content with low-rate environment

By Dean Popplewell

All any forex trader requires is some kind of market movement. A move either up or down, not the "contained" ranges that end up more often trading sideways. This has been a common occurrence throughout the fist-half of 2014. Unfortunately, this type of market movement limits notable trading opportunities, and certainly calls into question the risk/reward of undertaking various trades.

For those not World Cup tied, this past week has been a trading feast, full of worthwhile prospects backed by a surprising Fed and a massive uptick in geopolitical risks.

In midweek, Ms. Yellen and company at the Fed gave the market the green light to proceed with business as usual by reiterating "lower for longer rate policy." This reassurance has taken many in the market by surprise. Dealers and investors were very much positioned for more hawkish rhetoric from the Fed head.

The fixed-income market had been pricing an aggressive showing by the Fed, especially on the back of this week's surprising U.S. inflation report. The unexpectedly large increase in the May CPI report (+0.4%, m/m and +2.1%, y/y) was suppose to provide fodder for the FOMC "hawks." The market was looking for any indication that the Fed debate would be shifting from "reducing" to "removing" policy accommodation. This favored higher US short-term rates, the dollar in demand and the value of equities being questioned.

However, the dovish outcome had investors scrambling to unwind some dollar longs, squeezed the short EUR positions and breathed some much needed life back into the commodity market (aided by Ukraine and Iraq). Now that noise is over, where does the market go from here? Again the market is back to watching fundamentals, looking for inflation data scraps, just like CAD's surprising CPI data that could change the BoC script. The loonie got a lift early Friday, squeezing the EUR on the cross.

A low-rate environment certainly promotes low volatility and endorses the popular carry trade. Until the markets get sustainable rate divergence by G10 Central Banks, either the Fed hikes or the ECB follows through with an "easing monetary policy," we can expect more of the same, peppered and trumped by geopolitical risk. This risk tends to be priced in by week's end and unwound at the beginning of every week.

The metals markets appear to be increasingly more critical of the Fed's inflation-curbing credentials, however, piling into the "store of value" trade. Aiding commodity prices is the escalating tension in Iraq which continues to lure investors into safer haven assets and reason enough to see gold rally to its biggest intraday gain in nine months ($1,312oz) this week. The yellow metal has managed to climb 5% this month alone. Crude has seen a similar story, with Brent ($115) trading 5.5% during the same time period, supported by distribution and potential supply constraints as the holiday driving season gets underway stateside. The longer the Iraqi insurgency lasts the more difficult it will be for Iraq to fulfill its daily production quota (around +6m bpd) which would have massive implications for oil markets and commodity sensitive currencies in the foreseeable future.

Traders can now be expected to lean more heavily on geopolitical concerns until Central Banks break with "business as usual."

On tap for next week:

The market will be focusing on global manufacturing PMIs, starting with China this weekend. Chinese indices are mixed going into Sunday's flash PMI release. The most recent figure of 49.4 was a five-month high, albeit the fifth consecutive month in contraction. Europe and Germany follow on Monday. In the midst of the first round of the World Cup, traders will get to gauge German business and US consumer sentiment. After US durables, the week finishes off with German preliminary inflation numbers.