FX Market Shrugs Off Risk – But Is EUR/USD Vulnerable?

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Market Drivers for July 18 2014

Risk FX off the lows as markets stabilize

Nikkei -1.01% Europe -0.16%

Oil $103/bbl

Gold $1319/oz.

Europe and Asia:

EUR CA 19.5B vs.24.3B

North America:

CAD CPI 8:30

USD U of M 09:55

USD LEI 10:00

Risk FX sold off sharply in early Asian session trade but the follow through was minimal and currency markets stabilized with high beta FX like Aussie and kiwi posting short covering rallies in morning European dealing.

Sentiment was very tense at the start of Asian trade as markets were hit with two major geopolitical shocks – the downing of civilian MH17 flight over Ukraine by some type of missile and Israel’s incursion into Gaza that escalated the already combustible situation in the Middle East.

Safe haven currencies continued to attract flows with USD/JPY dropping to 101.07 at the start of Asian trade while AUD/USD fell to 9330. But as trading progressed there was very little follow through and markets eventually turned around with USD/JPY erasing it losses while all the high beta currencies hit fresh session highs.

Despite the terrible human tragedy the markets remain generally confident that yesterday’s events will have minimal impact on economic activity. There appears to be very little political will to punish Russia seriously for this incident and with situation on the ground in Ukraine in general chaos there is enough confusion to allow all sides credible deniability. Unless there is definitive proof that MH17 was brought down by Russian weapons systems the story may not have lasting impact on business in the region.

Indeed what was remarkable about yesterday’s reaction in the currency markets was not the high level of fear, but rather the complete absence of it. The EUR/USD barely budged in North American dealing remaining above the 1.3500 level throughout the day. There is clearly a non market sensitive bid in the euro as reserve diversification flows continue to prop the pair at these levels.

However, the combination of increased sanctions and yesterday’s tragic events have certainly chilled diplomatic relations between Russia and the west and ultimately this dynamic could translate into slower growth in Europe especially for region’s leader Germany. German economic data is already starting to reflect the slowdown in activity with Russia and could impact growth for EZ largest economy in H2 of this year.

For now the low US yields and reserve diversification continue to prop up the euro, but the pair remains vulnerable to further downside risk especially if growth rate differentials between US and EZ continue to diverge. With no meaningful economic data on the docket except U of M sentiment survey later in the day, currency traders will continue to follow the geopolitical events but with the weekend looming the shorts may press their case and try to push EUR/USD below the key 1.3500 level as the day proceeds.

Boris Schlossberg
Managing Director

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