New York Open: Risk sentiment continues to fray at the seams

Market Analysis /
14 May 2020

Risk sentiment continues to fray at the seams with global stocks in deep red for the second day in a row. Powell reiterated negative rates were not on the table as expected, and the Greenback had a mild relief rally on the back of that after trading soft ahead of his comments. Rates have not shifted one-bit as fixed income remains bid in line with general negative risk sentiment, and hence currency markets vs. the USD topside could be capped near term as traders continue to sell into rallies for now.
But G-10 traders will never feel comfortable backing a single pony or currency trend in this environment. So, we could expect investors to spread dollar risk across the table and even sell the Greenback selectively against countries whose economies have a healthy outlook and are emerging from lockdowns quicker than others.
Japan is easing restrictions on about half the economy, which has the makings for a good spread the risk trade (sell USD). Besides abnormally large Japanese capital outflows were supporting USDJPY even though US interest rates have plunged close to Japan's levels. The yen now has a favorable balance between a currency that is cheap on most metrics but does not have a cost of carrying disadvantage acting as an anvil on its back.
The closer we get to 105, which is widely seen as the low end of the current range, the higher the chance for Japanese hedge ratios to increase on USD assets. This will drive the USDJPY lower, as in this complex chain of events will result in a virtuous circle for the yen.
Equities appear to have given up the ghost for the time being with the SP500 finishing the day down 1.75%, which led to further weakness in global markets.
 The US equity market has been one of if not the key drivers of the recovery in risk assets, and as such, remains vulnerable to profit-taking. The big question for investors now is what protection I need to own and how much gold should I buy if the sell-off picks up speed and is not just another wobble.
President Trump is looking for scapegoats for the recent weakness in equity markets. Trump blamed the "so-called rich guys," which was a barb aimed at a few prominent investors who had warned on equity market valuations. While Fed Chair escaped the wrath of Trump last night, but that might be coming down the pipe if stocks continue to sell down, and the Fed does not make hints of shifting to negative territory.
Brexit continues to bubble away in the background, and I think a hard Brexit remains the likely outcome. According to reports, tension is already rising between government ministers after reports that the government plans to slash tariffs on US agricultural imports to advance a deal.

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