In light of all the tragedy in France, it is refreshing to see that the terrorists did not successfully terrorize the financial markets. U.S. and European equities ended the day steady or slightly higher and even though investors sold the EUR/USD, the decline could have been a lot steeper. In fact we did not see any unusually large moves in currencies. Some analysts attribute the muted reaction to uncertainty but if that was true, we would see more risk aversion. Other analysts believe the attacks give the Federal Reserve the perfect excuse to forgo a rate hike next month, but today’s rise in the U.S. dollar and the relatively mild drop in Treasury yields signal that investors have not adjusted their positions for this possibility.
Just like people, financial markets typically face down terrorism with resilience.
January Charlie Hebdo Attacks – 2 day market reaction
July 2005 London Bombing – 2 day market reaction
March 2004 Madrid Bombing – 3 day reaction
9/11 NYC Attacks – 8 day reaction
Both euro and French stocks responded negatively after the Charlie Hebdo attacks in early January but the impact lasted only 2 trading days. After the London bombings in July 2005, the low for the FTSE was set on the day of the attack and while sterling dropped 250 pips in 48 hours, 2 days afterwards it was trading 475 pips higher. In 2004 the EUR/USD actually rose on the day of the Madrid bombings and while Spanish stocks dropped nearly 5%, the move was over in 3 trading days. The market’s reaction to the September 11th attacks lasted the longest and even then USD/JPY bottomed 8 trading days later after a 5% decline. These reactions show that historically terror attacks have a short-lived impact on the markets because investors and the general public don’t let terrorists terrorize for long. This time it could be different if there is another high profile attack but security is being stepped up around the world and hopefully this increased vigilance by individual governments will help avoid another tragedy.
With this in mind, we are still looking for EUR/USD to break 1.05 in the next 3 weeks. France is the second largest economy in the Eurozone and the attacks will have a significant impact on economic confidence, trade and tourism activity. In recent months, France’s economy returned to growth as Germany was slowing but now with the two regional powerhouses both experiencing troubles, ECB easing is almost certain. The market may have priced this in but the size and scope of the expansion as well as their willingness to do more in the months ahead has not been discounted. The ECB announced QE 15 days after the Charlie Hebdo attacks – that timing may have been a coincidence but this one will not.
Weaker U.S. data did not deter investors from seeking safety in the U.S. dollar. The greenback moved higher against all of the major currencies and held onto its gains after a worse than expected Empire State manufacturing report. The index was forecasted to rebound from -11.36 to -6.5 but instead it rose only marginally to -10.74 in the month of November. Investors could be relieved the index improved but we doubt the report had much impact on the market’s desire to own dollars. The biggest question on everyone’s minds now is whether the attacks will cause the Federal Reserve to back away from raising interest rates next month. Considering that the market’s reaction has been muted and the Eurozone economy was facing troubles before the attacks, it is too soon to say whether international developments will encourage the central bank to wait. In the Fed’s eyes, the U.S. economy is resilient and if the December non-farm payrolls report is strong, they could still tighten. Many policymakers are scheduled to speak this week and the uncertainty about Fed policy makes it extremely important to listen for any changes in views. Aside from Fed speak, the most important event risk this week will be the FOMC minutes.
Normally the Japanese Yen is also a big beneficiary of risk aversion but this time we have not seen significant demand for the currency. The problem is that Japan has fallen into its fourth recession in five years. Japan’s economy contracted 0.2% in the third quarter as weaker demand from China, slower global growth and a rise in the yen curbed economic activity. The Japanese government refused to provide stimulus in October and according to recent comments from government officials, there’s little desire to respond because the government believes that the economy is still recovering and they see this as nothing more than a temporary technical recession. While we believe the Bank of Japan needs to act to avoid a deeper downturn, the government does not.
USD/CAD rose to a 7 week high after oil prices dropped to a 2-month low intraday. Traditionally oil performs well during times of geopolitical uncertainty but it appears that concerns about oversupply and the rise in the U.S. dollar is offsetting the risks. There is a significant amount of technical support at $40 a barrel and we believe this support will hold. Softer Canadian manufacturing data also contributed to the currency pair’s rise. Manufacturing sales were expected to have increased by 0.2% in the month of September but instead if fell -1.5%. However the housing market appears to be recovering with existing home sales rising 1.8% last month after falling 2.1% in September.
The worst performing currency today was the New Zealand dollar. Fonterra increased its payout to dairy farmers and retail sales rose more than expected in the third quarter but risk aversion and the slowdown in service activity weighed heavily on the currency. There’s also a global dairy trade auction tomorrow and investors are worried that prices could fall for a third time in a row.
The Australian dollar moved lower ahead of tonight’s RBA minutes. Although gold prices increased on risk aversion, A$ traders were much more focused on the fall in copper prices. The Reserve Bank of Australia was surprisingly optimistic at their last meeting but if there is even a hint of concern in the minutes it could accelerate the decline in AUD/USD.
The British pound is in play tomorrow with U.K. inflation data scheduled for release. Consumer prices are expected to rise but considering that the Bank of England cited low inflation as the primary reason for their dovish monetary policy stance earlier this month, the risk is to the downside for the report. Sterling’s strength versus the euro has and will continue to put downward pressure on prices. Even if CPI increases, annualized basis price growth could remain negative for the second month in a row.