- Lulled by the 'Summer Doldrums' global markets recieved a risk shock Friday as trouble in Turkey spread across the world
- Obscuring safe haven roles and financial exposure to the imminent threat, EURUSD earned a critical break to extend its reversal
- Though full systemic (and lasting) risk aversion is still a high hurdle most markets will revert to their traditional sides
The Summer Quiet is Broken by Fears of Global Fallout from Turkey Pressure
Global financial markets took a troubling tumble to close out this past week. The sudden jolt of volatility came as a surprise for many that had assumed that we had slid into shallow waters of the Summer Doldrums. Up until Friday, the markets were settling into the complacency that returned implied volatility measures (VIX) to lows last seen with 2017's unprecedented extremes and pushed the zombie like climb in risk assets which lifted S&P 500 into striking distance of its record high. What is remarkable both about the climb and the subsequent reversal is the fundamental risks that have accumulated over time. We have faced an overt trade war, general appreciation of over-extended monetary policy and cooling economic growth forecasts; yet none of that would sink capital markets. Yet, the threat of the spillover from Turkey's rapidly deteriorating financial situation seemed to strike a nerve. Further turning the screws on Turkey, US President Donald Trump announced that he was doubling the tariffs on the country's imported steel and aluminum. The Turkish Lira responded with another 15.6 percent drop against the US Dollar to a fresh record low. This time, the impact wouldn't be restricted to the region. Global indices suffered a painful drop that turned into a 0.5 percent gap lower on the open for the S&P 500. The speculative impact was uniform across markets, but where the pain more dramatic than with emerging market currencies. The Lira tallied the most remarkable move on the day; but there were also strong technical moves from the like of high yield, carry trade and risk-leaning commodities among others. This was clearly a true market-wide risk aversion, but the true concern is whether the fire spreads after the weekend.
What's at Stake for the Euro in this Threat to Risk Trends
Each systemic swing in sentiment is unique. The catalysts for the move and the response from the markets differs according to the circumstances. We have yet to establish whether we are at the very beginning of a deep speculative reversal or not, but we can see the implications starting to show through in various currencies. The Euro seems to be one of the most at-risk members of the majors, providing the critical momentum that led EURUSD to a critical technical break of a long-term head-and-shoulders pattern. The connection between the EU and Turkey is made via the heavy investment of the former in the latter. A report from the FT that the ECB has voiced concern over the exposure Europe's banks have to the country helped exacerbate fears. The MSCI's European Financial ETF suffered a painful tumble on the day, spreading up through the regions broader equity indices and into the region's financial markets. Whether or not that was an intentional result by the Trump administration, the President seems to have found a way to pressure Europe despite his recent promise alongside Juncker not to apply additional direct tariffs on the region. Between the indirect effects of Turkey and Iran, the US is exerting remarkable pressure on the European markets and Euro.
Dollar Dons a Questionable Safe Haven Status to Force a Key Technical Break
Is the Dollar a genuine safe haven? Does it still follow the lines of a traditional harbor from turmoil that we have ascribed to the currency in past years and decades? The update from the US CPI data showed price pressures were steadily building behind the Fed's hawkish policy lean, but this adds little to the forecast for the Greenback given the long disconnect we have witness between policy bearings and Dollar bearings lately. Yet, when a risk is explicitly raised against the world's second most liquid currency, there are few alternatives robust enough to stand as a full scale haven alternative other than the most liquid: the Greenback. Considering the fundamental leverage for the EURUSD, the trade-weighted DXY Index naturally drove through its own inverse head-and-shoulders 'neckline'. However, the charge was registered against most of the currency's counterparts - with additional progress for remarkable runs like that from GBPUSD and dramatic technical progress as with AUDUSD's drop to 19-month lows. If we are witnessing the opening phase of a large-scale risk aversion, a grind on liquidity would amplify one of the Dollar's key virtues. However, if the tempo does not hit an extreme pace, we will be left to question the particulars behind this currency. One particularly important consideration: what are the long-term implications of the United States' penchant for pursuing tariffs and sanctions against so many trade partners?
Fundamental Conflict Between the Pound, Yen and Gold
In the depths of a true financial fire, there is little else we need to evaluate beyond the intensity of fear the exact standing of our target asset in the 'risk' spectrum. However, we have seen sentiment swoon many times before over the years only to stabilize soon after. We should keep tabs on the quality of sentiment and account for competing fundamental themes that will survive this job in investor confidence - if indeed it is passing. From the Japanese Yen, we have seen such a strong upswing that its drive led USDJPY to a loss through the day. In an equally-weighted index, we find the Yen standing at a wide range floor with questions over its true standing as a haven muddled with its performance as a funding currency in carry trade that never really gained true traction. For the Pound, a rise in risk aversion translates into closer evaluation of unique shortcomings. For the Sterling, the growing threat of a 'no deal' Brexit is clearly unnerving investors and British citizens alike. Everything considered, EURGBP is a remarkable pair. Finally, if we are due a true and severe collapse in risk trends, keep gold in the back of your mind. Between capital market deleveraging, the distortion of monetary policy that long ago hit its extreme and the added pressure on currencies from global trade wars; there are few outlets for stability aside from the precious metal. We discuss all of this and more in this weekend Trading Video.
If you want to download my Manic-Crisis calendar, you can find the updated file here.