Markets switch to risk-off mode as G7 meeting kicks off
Global equities took a hit on the last trading day of the week as investors reallocates their portfolio toward less risky assets. The move was similar in the FX market with the US dollar extending gains against most of its peers, with the exception of the Japanese yen (up 0.25%) and the Swiss franc (range bound). The Eurostoxx 600 gave up 0.65%, the DAX slid 1.40%, while the SMI fell 0.85%. EUR/USD was unable to break the 1.1854 resistance to the upside and eased below 1.1770. After tumbling on its 200dam, USD/JPY fell to 109.35. The currency pair is heading towards its 50dma, which currently stands at 108.84. A break of the latter resistance would open the door towards 108.11 (low from May 29th).
Against such a backdrop, emerging market are bearing the brunt of the sell-off. The South African rand lost another 2% this morning and reached its weakest level against the greenback since December last year amid disappointing economic data. The Brazilian real gave up 1.44% yesterday as USD/BRL hit 3.9657 amid mounting concerns over upcoming elections. INR, KRW, PHP and IDR were no exception as they fell 0.70%, 0.65%, 0.58% and 0.45% against the greenback, respectively.
Trade tariffs discussions will be at centre stage at today G7 meeting in Canada. The US will find themselves isolated as Donald Trump managed to make enemy of most of its allies.
Strategic long EUR/USD
The European Central Bank meeting next Thursday will indicate the end of asset purchases. Council members say that if inflation remains stable, bond buying should be taper. We think that markets are focused on the pure economic data. However, the ECB decision is more practical than fundamental, because Quantitative Easing has expanded its balance sheet to destabilizing heights. ‘Moral hazard’ has increased, as highlighted by the recent Italian political chaos. The ECB wants to avoid owning more than one-third of any nation’s sovereign debt, which after years of buying is coming dangerously close. Stealth ‘debt mutualisation’ in the Eurozone is really happening. Moreover, the ECB wants to reclaim its tools. With a bloated balance sheet and negative rates, the bank has few policy options, should Europe hit a shock. Just as the US Federal Reserve in 2013 saw normalization not just as a function of economic data, so now does the ECB.
Ending QE does not necessary mean higher interest rates, which are expected to come 6-8 months after ECB completely tapers. We remain constructive on EUR/USD as the US rate hike cycle is nearing the end while ECB is nearing the start. We see the current 1.1765 as a good position to reload strategic longs.
