Talking Points:
- Uncertainty for the future of the US political landscape threatens tax reform, infrastructure spending and Fed hikes
- The S&P 500 posted its largest bearish gap on the open since the Great Financial Crisis Wednesday morning
- A four-day Dollar slide is the largest since February 2016, will the H&S break offer clean technical trades?
See how the DailyFX Analysts' 2Q forecasts for the Dollar, Euro, Pound, Equities and Gold are shaping up in the DailyFX Trading Guides.
Strong risk winds originating with political uncertainty is not exactly a rare occurrence for the markets over the past year. The Brexit fallout, US presidential election, round after round of Eurozone disruption all fall into this category and have generated significant volatility in the financial system. We may have come upon the next bout of political-derived market instability with escalating concern over the progress behind the Trump administration's agenda. However, as this situation develops, we must remember not to apply our personal political views on any assumptions of market value. Markets are largely amoral when it comes to the social considerations most people focus on with such developments. The market will judge this situation for what it means to the time and probability of implementing tax reform, infrastructure spending and the Fed's comfort level with pursuing further withdrawal of monetary accommodation.
Clearly, this is a more immediate and direct threat to US-based assets. US equities, high quality fixed income and certainly riskier assets face deeper questions of cost-value than their European and Asian equivalents. It is in part this 'localization' that can encourage a further outflow of capital from the US which weighs the Dollar even lower. However, that isn't the only trouble facing the Greenback. There is a 'Fed premium' built into the currency's premium as of late that has seen capital chase the expectations of higher returns in the future - not even a significant advantage in current returns. That additional yield has come at a high cost and translates into a faster decline for the currency should its potential evaporate alongside the appetite for thin premium. On this basis, a very stark head-and-shoulders neckline break for the ICE Index (DXY) looks like it is the source of considerable potential. Yet, it is a very particular fundamental line that needs to be walked in order to keep the Dollar diving - technicals are conversely less important to determining this move. In a restrained but persistent risk slide, the Greenback will continue to decline. Alternatively if sentiment stabilizes, recovers or fully collapses; the Dollar is likely to recover. Consider that for technical developments like those on EUR/USD. Arguable the most sensitive pair to express this skew of scenarios on is USD/JPY.
While the US currency and the local assets it prices are in the direct line of fire, the full potential of this uncertainty is general a 'risk' theme. If we finally shake off complacency, full-scale deleveraging will leave few corners of the market untouched. And, there is plenty of pent of leverage that will be quickly and possibly violently worked off. Progress on the investigation in the US will likely take time, but don't write off the influence of speculation. Aside from this overbearing theme, there is more discrete event risk to account for in the coming session. The Pound's response to the employment statistics didn't settle BoE and Brexit concerns with data that shows underlying issues with real wages shrinking. Japanese GDP is a noteworthy indicator but the Yen is more preoccupied with its funding currency status. Australian jobs figures have a history of generating volatility but that will more likely be a consideration for the likes of AUD/NZD and AUD/CAD rather than AUD/USD and AUD/JPY. Watch for ECB President Draghi's and Fed member Mester's remarks on monetary policy views given recent developments. We discuss the ominous swell in uncertainty in the markets and the risk/opportunities it can lead to in today's Trading Video.
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