FX Analysis:
- S&P jitters may signal greater volatility ahead as Russia, US situation on a knife-edge
- AUD/USD and USD/ZAR pairs highlighted as USD often favored during uncertainty
- This article makes use of fundamental FX themes and topics. Take a look at our comprehensive Education section for more info
Yesterday’s rare and unusual move in the S&P500 resulted in a trading day only ever witnessed twice before, both in October 2018. The index dropped by nearly 4% before recovering later in the session. The ‘buy the dip” mentality has been synonymous with US equities ever since the easing of lockdowns and admittedly, has had great success. This ‘dip’ however looks a bit more concerning when considering the hawkish shift in monetary policy and geopolitical tensions surrounding Ukraine.
The S&P has witnessed a number of pullbacks but no single day price fluctuations quite like what played out yesterday. Considering the move against a backdrop of soaring inflation, aggressive rate hike expectations (negative for equities), excessive P/E valuations and the threat of war in eastern Ukraine, it may be reasonable to re-evaluate risky assets in the event risk appetite sours. This article takes a look at two currency pairs to watch.
High Beta, Risk Correlated Currencies
In times of uncertainty there is typically a flight to safety. That usually means a shift towards safe haven assets like the US dollar, Japanese Yen, Swiss Franc and US treasuries among others. Typically, investors and traders will reduce exposure to assets that exhibit a high correlation to risk assets - in this case the S&P500 – in favor of ‘safer’ alternatives.
Learn more about safe haven currencies and how to trade them
One such currency exhibiting a strong correlation to risky assets is the Australian dollar. The Aussie dollar tends to benefits from increasing Chinese imports, as was the case once the global lockdowns eased. As such it tends to rise and fall with the ups and downs of the stock market. If yesterday’s fluctuation in the S&P signals a propensity for further drastic intra-day declines, this could be detrimental to the Aussie dollar’s value.
The chart below shows the Aussie dollar rather close to the bottom of the list when measured against USD as it trades around 1.7% down year-to-date.
Source: Reuters
On the other hand, the liquidity associated with the US dollar is often sought after during times of uncertainty – presenting a possible bearish AUD/USD scenario. Such thinking may also be relevant for AUD/JPY and AUD/CHF should the chart setups become favorable.
Read up about China’s influence on Aussie dollar – Core-Perimeter Model
AUD/USD Daily Chart
Source: IG, prepared by Richard Snow
Emerging Market Currencies amid Risk Aversion
Times of uncertainty more often than not, result in weaker emerging market currencies as capital flows move from the riskier asset/currency towards traditional safe haven assets. Emerging market currencies like the Turkish Lira and South African Rand witness extremely volatile moves on a daily basis but even more so during times of uncertainty, underscoring the importance of risk management.
Learn more about emerging market currencies and how to trade them
The South African Reserve Bank (SARB) is due meet on Thursday this week with analyst forecasts suggesting a 25 basis point rate hike, which may see the ZAR claw back recent losses. Nevertheless, USD/ZAR and USD/TRY remain vulnerable to a shift in risk sentiment.
The Rand is one of the top performing currencies against the dollar this year so far however, it boasted a similar stat at the start of 2021 only to depreciate against the dollar come year end – highlighting its volatile nature once more.
USD/ZAR Daily Chart
Source: IG, prepared by Richard Snow
--- Written by Richard Snow for DailyFX.com
Contact and follow Richard on Twitter: @RichardSnowFX
