“Sell volatility, buy the dip” has been the investor mindset for some time, when it comes to the equity markets. It appears that this mindset is holding firm, after investors brushed away the market uncertainty that was created in the early hours of Tuesday morning, following the news that North Korea fired a missile over Japan.
That said, I can’t remember seeing such a rapid reversal of market fortunes as we saw yesterday, at least since Donald Trump shocked the world by winning the US elections in November 2016. Could yesterday’s reversal have occurred because North Korean risks have been priced into the markets? I am unsure, because any news around North Korea is unpredictable at best; the announcement from North Korea that the firing of a missile over Japan was the first step of military operations in the Pacific, is something that investors simply cannot afford to ignore.
Perhaps the contributing factor for the market recovery, was because the response from President Trump was more measured than his previous “fire and fury” rhetoric that spooked investors earlier in August.
Is the Euro now a safe haven?
Much has been made about the Euro possibly emerging as a safe haven currency following the rapid appreciation to its highest levels since January 2015, but we shouldn’t get carried away before we label the Euro as a new safe haven currency.
We have seen this trend in the past; when there is Dollar weakness, the correlation it encourages in terms of Euro strength is one of the easiest for traders to spot. The Euro did manage to peak at levels not seen since early 2015, at the same time that the Dollar dropped to its lowest levels since January 2015.
At the moment, investors are using any reason possible to buy the Euro, and they are also pricing in as much hawkish news from the European Central Bank (ECB), as can be expected before the next interest rate decision in September. The ECB will not be comfortable with the rapid appreciation in the Euro, but traders also know that the ECB will not be in a hurry to make changes to monetary policy. They want to price in as much in the Euro as they can, before taking profits on a pair that has rallied close to 14% year-to-date.
The likely eventual target for the EURUSD is probably between 1.22 – 1.25, which was roughly where the Eurodollar was trading, before traders priced in the fact that the ECB were set to announce its QE stimulus in January 2015. With expectations increasing that the ECB are going to announce an unwinding of QE as soon as September, we can consider the rally in the Euro over recent months, as “going full circle”.
Dollar Index looking oversold
Traders need to remain mindful before jumping into any more selling positions, because the Dollar short is really starting to look like a crowded trade.
There is no doubt that the Dollar is horribly oversold, but the ongoing uncertainty when it comes to the ability of President Trump to implement his promised legislative reforms, and a reversal of ambition from the Federal Reserve to raise US interest rates are making traders very hesitant to purchase the Dollar from what looks like heavily oversold levels.
Additional anxiety over the debt ceiling, Nafta, geopolitics, and the likelihood that Federal Reserve Chair Janet Yellen could be replaced at the end of her term by someone more encouraged to support financial deregulation, are all seen as possible catalysts that could send the Dollar flying right through psychological support levels.
Investors need to pay very careful attention to where the Dollar concludes this month; if the Dollar Index does manage to conclude trading below 92, it increases the bias towards more sellers flooding the market. This could take the USD to levels not seen since investors began to price in that the Federal Reserve would raise US interest rates two years ago.
Still some time left to purchase the Yuan
After signaling a clear “buy” signal to the markets earlier in August, when the USD/CNH unexpectedly slipped through the psychological 6.70 level, the Chinese currency has exploded into buying pressure. Despite the advance this month, I think there is further room for appreciation.
If you compare the Chinese Yuan to a basket of different currencies, in terms of its performance year-to-date against the Dollar, you will see that the Yuan has only advanced around 5% against the Dollar in 2017. The Euro, Australian Dollar and Japanese Yen have all advanced more strongly against the Dollar; my view is that the Yuan needs to mirror the strength that has been noticed across these developed currencies. This one factor is behind why I am still bullish on the Yuan, while the market remains heavily negative on the Dollar.
6.55 is the likely eventual target for the USDCNH.