Tuesday FX Brief: Stand by Your Beds!

by: Interactive Brokers

The words of the North Korean leader commanding his troops to be battle-ready are yet another excuse for markets to recoil once again this morning. Investors’ nerves are already at breaking point as a further wave of selling causes stocks to tank. The heightened geopolitical tensions probably have absolutely nothing to do with why equity indices are plunging around the world. The repeated prospect of a North-South conflict is highly likely a convenient excuse as the weight of European fiscal catastrophe continues to overhang market sentiment.

Japanese yen –The Japanese yen always adds appeal as regional tensions grow. The dollar eased to ¥89.40 with investors clearly eyeing the yen’s maximum strength of last week at ¥89.00 as a viable target. The yen surged once more against a lackluster euro and breached the recent lows to take the euro down to ¥108.75 for a 2.7% loss on the day. The pair has over the years proven to be an excellent barometer of risk appetite as investors play the carry trade. However, it should probably be said that the recent loss of confidence in the euro as investors prod holes in its ability to remain an international reserve currency, means that the relationship is largely broken. Investors will undoubtedly look to the other side of a realignment of equity prices in watching for relative euro strength against the yen before they are willing to reassert such a relationship. The time-lapse required in awaiting this outcome is highly uncertain.

Euro – The Bank of Spain forced four lenders to combine after having seized a fifth regional lender at the weekend. Rather than creating any confidence in the banking system the measure seems to have touched off a heightened sense of awareness that financial systems look vulnerable. The euro once again weakened against the greenback from $1.2382 to a low so far this morning at $1.2178 and within spitting distance of last week’s lowest point at $1.2144.

British pound – External monetary policy-maker Adam Posen warned of the risks to recovery in a speech in London earlier. The pound remains lower regardless of his words given the fact it continues to trade more as a risk unit, just like the Aussie dollar and is inextricably interwoven into the behavior of the euro. The pound declines by a cent to $1.4340 against the greenback while it gained a half penny per euro to 85.24 pence. Mr. Posen used his podium-time at the London School of Economics to contrast the outlook for the recovery in the U.K., U.S. and Europe to the so-called “Lost Decade” in Japan starting around 1995. He blamed repeated policy mistakes there for growth depravation but predicted Western governments wouldn’t fall into the same trap. One fear, however, is that during its recovery, Japan was not deprived of external demand, which is something that recovering economies certainly face today. Mr. Posen noted that “the prospects for strong growth in most of the euro-are are rather dim over the next few years.”

Aussie dollar – The Aussie dollar remains trapped on a helter-skelter trajectory dragged down the slippery-slope by the behavior of commodity prices. With Asian stock markets responding to the drama of a potential Korean clash and the resumption of dollar strength weighing on commodity prices, the Aussie remains under pressure. It has, however, rebounded from weakness at 80.66 U.S. cents and is currently trading at 81.25 cents. Against the Japanese yen the Aussie rebounded from ¥72.06 to trade at ¥72.85.

Canadian dollar – In a similar fashion the Canadian dollar remains under pressure at 92.60 U.S. cents. The slide in the price of oil currently carries more weight than a rising price of gold. While the latter indicates the unhealthy nature of the risk barometer, the price of oil indicates a perception that global growth will falter.

U.S. dollar - The dollar index has jumped to 87.18 or almost 1% as the cacophony of noise forewarning of threats to growth rises.