Traders have been furiously unwinding risky FX positions amid the conflict in Syria, causing the US dollar to strengthen, gold to reach a three-month high, and oil—the biggest beneficiary—to hit a two-year high.
The biggest story in the financial markets and the media in general is still the conflict in Syria. Both the US and UK are moving closer to calling for military action, but the latest conversation suggest that the Obama administration prefers a limited strike on military units that carried out the chemical attacks, one that would "deter and degrade" the government's ability to use chemical weaponry again.
The fear over potential backlash in the Middle East means that, most likely, the strikes won't be aimed at ousting Syrian President Bashar al Assad, which is critical for the financial markets because a swift and limited attack could pave the way for a relief rally in currencies and equities.
Unfortunately, the duration and scope of a military response in Syria is not the only risk that investors should be worried about. If there is a strong response from the country's allies (namely, Russia and Iran), Syria will remain a driving force for the financial markets.
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While the selloff in the currency market gained traction over the past 24 hours, equities are stabilizing with European indices moving only slightly lower and US stocks opening higher. In the FX market, there continues to be a flight to quality, with the US dollar (USD) strengthening against all major currencies and gold rising to fresh three-month highs.
The biggest beneficiary of the uncertainty in Syria continues to be oil, which climbed to a two-year high. This helped the Canadian dollar (CAD) avoid losses, although the Australian dollar (AUD) and New Zealand dollar (NZD) were not so fortunate.
Emerging market currencies such as the Indian rupee (INR), Turkish lira (TRY), and Indonesian rupiah (IDR) have been hit the hardest by the uncertainty in Syria, which adds to existing concerns about domestic policies. Traders were cutting back risky positions in emerging market currencies before the chemical attack, and the liquidation only gained momentum since then.
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G-10 currencies, on the other hand, have seen modest losses in comparison. The biggest declines were seen in the AUD and NZD, both of which have fallen 1.3%. The euro (EUR) and British pound (GBP) are virtually unchanged against the dollar from the start of the week, although the selloff in the euro appears to be gaining traction today. These currencies are vulnerable to additional losses if the situation in Syria escalates, but their losses won't be as steep as those in emerging market currencies.
Carney’s Comments Spark GBP/USD Rally
Meanwhile, the British pound rallied on the back of optimism from Bank of England (BoE) Governor Mark Carney, who delivered his first major policy speech today. While the new BoE leader said forward guidance doesn't prevent the central bank from adding stimulus and easing further if market rates hurt the recovery, his comment that the recovery is broad-based and set to continue was enough to rally the pound.
Carney also said that UK growth prospects are solid, but not stellar, and that comment was good enough for GBPUSD bulls, who were looking for any acknowledgement of a firmer outlook from the BoE.
By Kathy Lien of BK Asset Management