For all the blood and thunder in the markets over the last few weeks, when you look at the monthly chart of the S&P 500 index, the moves we’ve seen barely register as even a correction. It’s important to remember this as we live in a central bank mandated world at the moment, and they don’t look at hourly charts and probably not even daily ones. Even so, some of the price action has been extraordinary with record volumes in Chicago just a few days ago. Speaking to some of my colleagues in the banking fraternity it wasn’t unusual to hear comments about difficulties handling the activity, and systems being pushed to extremes. This was primarily in the futures markets, which is not surprising given the multiple standard deviation events that was the move in the treasury future. But let’s put all this into context.. as we speak the S&P 500 is down about 7% from its peak, the dollar is barely 2% weaker relative to its recent high, yes US 10yr yields are 50bps lower as the probability of 2015 Fed hikes is unwound, but oil prices are significantly lower (25% lower roughly speaking over the last 6 months). This is not terrible news, sure the macro data has been disappointing, but all in all growth in the US and UK continues to trend albeit slower than the ideal while Europe and China are concerning. There hasn’t been a meteor strike people.. the global economy is sick but not dying.

Put that way, there are reasons for optimism, but there are also reasons for concern. The optimism is the tremendous boost to consumer disposable incomes from lower commodity prices, the easier monetary conditions implied by lower long term rates is also a positive. But a slight negative would be the fact that the moves, at least in the equity market, have not been substantial enough yet to cause any policy maker action. That could all change of course if the S&P 500 and other major indices were to fall another 10 – 15%, but that’s certainly not my base case view, the fear is that the market might try to force the hands of policy makers. Personally I think we may already have seen a near term bottom, although I wouldn’t be at all surprised if we had one final dip down before the markets start to snap back. One thing that may well have changed though, is that up until this turmoil there were reasons for the dollar to rally and for the euro to fall, making the bearish EUR/USD trade a one way bet. At the margin this still remains the case, but it’s just a weaker proposition now, because the Eurozone economy still sucks, but there is less imminence to the Fed hike paradigm. Don’t get me wrong as soon as wage growth starts to pick up Fed hikes will happen, but when will that be? No one knows and when it does happen we will need several months of data to confirm. For now the Federal Reserve will view continued dollar strength as a de facto tightening in any case.

So what does this mean for currencies? I still maintain that the path of least resistance will be dollar strength, particularly versus the euro and the Japanese yen. We will need to monitor the aftermath of this turmoil for other currencies, but for the life of me I can’t see why sterling should not make at least an attempt to claw back some of its recent losses, after all, there now appears a greater chance than before that rate hikes will happen in the UK first… better wage growth permitting of course! That means EUR/GBP should restart its downward trend in the near future as pound sterling starts to appreciate versus the euro again. How sterling does against the dollar is somewhat dependent on the pace of further euro weakness against the dollar, as always the cleaner trade is betting on EUR/GBP lower. Funding for emerging markets have received a tremendous boost in the last few days with the fall in treasury yields, this should make currencies a bit more attractive, but on the other hand the higher volatility regime we’re in now, is a negative for risky currencies. Still.. if I had to give a view right now, I would think that there’s room for some select emerging market currencies to stabilise here.

The next few weeks will be critical to this stabilisation view. Moves like this can often do tremendous damage to specific banks or investment funds. As long as no one is forced to liquidate positions we should see calm start to return to the market place, let fear recede and some good old fashioned greed back in to the house..