- Though the majors can all find fundamental pressure, capital inevitable filters to one key currency - Dollar, Euro, Pound, Yen
- The Dollar is an ultimate haven in a crisis; but short of that panic, what does trade wars, Fed exposure and elections present?
- Sterling has the BoE but also Brexit, Yen is a carry flight with systemic issues, Euro balances ECB with a rise of anti-EU views
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A 'Closed' System between the Dollar, Euro, Pound and Yen
There are dozens of liquid currency across the globe. However, when it comes to actual capital flows, there are really only four such currencies that account for the bulk of actual trading on a regular basis: Dollar, Euro, Pound and Yen. Combined these four currencies account for the vast majority of trading down in the FX market. Naturally, when one of these majors in in systemic retreat, the funds that flee the targeted risk finds harbor disproportionately with these counterparts. Further, unless there is an overwhelming risk diverting flows, the flight to safety usually seeks out the greater liquidity or the closest possible counterpart. This is a rather neat equation, but there are also times when all four currencies face their own unique fundamental issues or the circumstances otherwise undermine the group at large. Where there is a counterpart in gold under the unusual situation where markets are motivated to avoid all major currencies, that will not turn capital away forever. There will always be a currency favored over others - that is the nature of a relative market. And so, even when we may not like any of the majors, we should have always think in terms of preferences.
The Dollar: Liquidity and Yield Isn't Everything
When we consider the liquidity factor, it is natural to think first and foremost that the Greenback is a natural benefactor of uncertainty and pain for its counterparts. This position is in part why we consider the US currency an absolute safe haven when financial markets are in turmoil. In the event that the world's markets are seeking absolute stability amid a panicked flight to safety, this currency will undoubtedly absorb those fleeing the maelstrom. That said, the standard safe haven setting for the currency has been seriously distorted by the Fed's rate hikes which have made the Dollar more of a carry currency while President Trump's promotion of a multi-front trade war raises the risk of a collaborative redirection of funds away from US markets. Meanwhile, political risks in the US are particularly acute as the mid-term elections approach with heavy debate over possible upheaval in the Legislative branch and what it would mean for the government and its policies moving forward. There are far more risks than there is directed promise for this currency.
Sterling has a Constant Fundamental Distraction in Brexit
The British Pound - once the preeminent currency of the global FX market - now accounts for between 5 and 6 percent of global reserves. As modest as that is relative to the US Dollar, that still makes it the third most heavily used currency in the world. What's more, the Bank of England (BoE) is one of the few 'hawkish' policy authorities that has actually raised its benchmark rate. This past session, the group held its benchmark rate unchanged at 0.75 percent (not a surprise given they just recently raised the key rate), but they would keep open the door to future hikes. There are still few that can lay claim to even this bearing. Yet, as much value as could be garnered from this position, there is something far more profound in fundamental terms that constantly plagues the Pound: Brexit. Despite the detrimental economic impact to both the UK and the EU from a 'no deal' outcome, the risk of just such a resolution continues to grow. This may not set the Sterling to a constant retreat, but it does keep it sidetracked from earning more meaningful gains.
Yen's Systemic Issues are Long-Term, Its Safety Role a Constant
In the event of a safe haven move in the broader financial markets, the Japanese Yen is one of the more appealing outlets for FX flows. That is not because of an inherent interest to park capital in Japan, but rather because there is a carry trade that market participants build up over time which see the Japanese currency on the short end of the yield-seeking speculators. Naturally, there is a need to unwind risky exposure in the event of unfavorable fundamental winds which in turn sees a defacto bid for the Yen. Risk aversion is one of the more elemental of forces in the financial system which gives the Japanese currency a remarkable amount of weight - enough to offset other systemic issues such as the Bank of Japan's (BoJ) floundering monetary policy and the risk of trade wars casting its gaze upon the vulnerable country.
Euro Nebulous Risks Crowded Out by Complacency, Rate Forecasts and Anti-Dollar
Perhaps the most appealing of the majors through the medium-term (two weeks to two months) in fundamental terms, is the Euro. This currency is not without its issues. There is a notable protectionist shift in in member economies with is putting unmistakable pressure on the perception of stability for this dominant currency. However, monetary policy hasstartedto shift again in favor of the benchmark with the ECB this past session holding rates but announcing its intention to end its QE policy by year's end and hiking rates after the summer of 2019. We have seen what rate speculation has afforded the Euro back in 2017. Add to that the structural reality that the Euro is the world's second most liquid currency and thereby stands to benefit from the top player's (Dollar) troubles, and start to attract a unique appeal. Further, in contrast to the trade wars being pursued by the US, Europe has remained staunchly 'open for business' which encourages capital into its borders. We do a high level overview of the four most liquid majors to set fundamental trading perspective in this Quick Take video.