Video: Risk Slip at Cliff Edge, How Will VIX and Dollar Align?
- There is little doubt the financial system felt a throb of risk aversion last week, but is it temporary or just the start?
- Correlation and intensity across 'risk' sensitive assets can speak to conviction while volatility signals sensitivity
- How the EUR/USD and Dollar itself responds to the next phase of sentiment - whether better or worse - is crucial for FX
A clear and strong jolt of risk aversion has shaken the markets this past week, leaving traders much more aware of their exposure should this prove to be the start of something my tectonic. Speculative commitment should be our primary concern heading into the new trading week. It has taken a lot to lift the capital markets to the heights that we've reached - extreme monetary policy, years of steadfast growth, the rise of new financial assets and more. But the critical ingredient underlying it all has been complacency. A deep and distracted trust in the markets holding buoyant and stable to the point that traditional value is less important. This is a temporary peace that is present to some degree in all cycles from boom to bust in the financial system. It will be here that we see the fundamental shift occur. It will be on this elemental front that the most profound risks to our funds and equally our greatest opportunities in years will be found.
For provocation, the current focus is on the escalating tension between the United States and North Korea. The involvement of nuclear missiles makes this a civilization-level concern, but the movement of capital is not often tuned to the humanitarian scope. The threat of an abrupt launch of nuclear weapons would lead to a jolt of sharp and wide risk aversion, but after years of buildup in speculative assets, it will take an extended engagement to fully reroute capital. If this remains a 'cold' engagement (one of words and not arms), the impact will still be felt but in a different way. Political risk is one of the broad themes that we have seen weigh the market in previous months and years - the drop from US equities on May 17 to the James Comey scandal is an example. Uncertainty and the practical distraction from growth-oriented policy objectives that have already generated considerable premium for the S&P 500 and other US assets would start to unwind. And, given the state of complacency, any serious momentum registered by the masses can turn into a self-consuming fire.
Heading into the new trading week, we will need to watch both the headlines and key markets' technical levels. Those assets on the extreme end of the risk curve and were blindly pursued for any possible return in a low yield environment (like emerging markets and high yield fixed income) will be the most at risk. That said, benchmarks like the S&P 500, other US and global equity indexes will likely carry greater weight in defining the ultimate state of financial conditions. In FX markets, Yen crosses have already shown some degree of the risk aversion that has already swept the markets. There is more premium to burn through those pairs. The more nuanced - and potentially important - barometer will be the EUR/USD. The most liquid of the pairs, this stalwart isn't often considered a measure of risk trends; but we have seen that measure gain crucial traction these past few years as the Dollar drew on its early monetary policy shift and just this year the Euro rising rapidly on a forward-looking speculative wind. We weigh the stakes of fluid risk trends on the broader market along with the risks and opportunities that will follow in this weekend Trading Video.
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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.