A new year, and a mini-correction in risk sentiment as the S&P 500 is already down 3% from the highs of the penultimate day of 2014. Perhaps more significant though is the price action in the currency and commodity markets. Oil prices are down almost 9% from the opening price of the year, with WTI for February delivery trading below $50 at $49.40, and Brent not too far behind at $52.30. Expect cheaper pump prices! And then we look at the currency markets, and it’s all about the euro and the other European currencies in its orbit. We, at ParityFX, were gratified to see our end year EUR/USD target met, and indeed we’ve seen extensions down to the mid 1.18s and the pound sterling has not been much better with a brief spell below 1.52. The dollar is actually slightly weaker versus the Japanese yen, in a sign that the big moves are very Europe specific. The Greek elections on January 25th have implications for the integrity of the European Union, and the UK elections in the summer appear to have kicked off early. The travails of the euro are obvious to all, but the pound sterling has its own specific issues, despite the UK’s robust economic performance. The concern here is that with the recent electoral success of UKIP – a party that along with Podemos of Spain, Syriza of Greece, Front National in France and AfD in Germany are viewed as anti-European Union – could force a national government in Britain at the next election. For our readers in other parts of the world let me elaborate… if neither of the two largest parties the Conservatives or Labour are able to form a government after the next election, they might be forced to work together in government. This hasn’t happened since the 2nd World War and needless to say this is a far from optimal outcome, but the collapse of the Liberal Democrats as a 3rd force in UK politics is what makes this possible. Would a national government ever get anything done? One thing is certain.. the pound sterling would be the major victim of the resulting uncertainty.
I must confess the price action we’re seeing in the equity market is not a surprise to me, although it does appear to be happening about a week earlier than I would have anticipated. Still.. there are already signs of weakening momentum and I wouldn’t be surprised to see us make a new low sometime later on today before we see a bounce of some sort. It’s at that point that things get interesting from my perspective… what happens next? Either we see a re-test of the highs, or we see a deeper correction, I just don’t know. There are also signs of weakening momentum in EUR/USD in the longer term charts and the narrative that I find most compelling is either a rejection at the last moment of Syriza in Greece, or a coalition strong enough to supplant them, leading to a short term relief rally. I would therefore not be surprised to see EUR/USD trading up around 1.23 at some point closer to the end of this month, but let me clear.. the divergent policies of the ECB and Federal Reserve will drive currencies and volatility this year. The euro will depreciate, and the US dollar will continue to rally. Levels like 1.10 in EUR/USD look all too realistic, at some point this year, in my view and I would go further and say that EUR/USD parity.. 1.00.. is well within range within the next 18 months to 2 years. Some might ask what this will mean for the pound sterling, and I would say… it is difficult for the British currency, effectively a satellite orbiting around the Eurozone currency to diverge significantly from the path of the euro. Yes EUR/GBP is likely to be lower in this scenario, but probably not as low as one would expect, and most certainly cable, GBP/USD, will be significantly lower as well.
This morning we got some decent macro data out of China, with a services PMI measure coming out better than expected, and indeed an uptick from the prior month. Unfortunately I can’t say the same about similar Indian data, which was a bit disappointing, it’s going to be a long road for Prime Minister Modi. In Europe we will also get a wealth of services data this morning. Indeed, I can see that the French, German and Spanish data has been impressive, but the Italian data is terribly disappointing, I guess we should mark all that up in the ‘good’ box! French consumer confidence data is also looking a bit cheerful, perhaps it’s those cheaper pump prices making the sun shine brighter. We can look forward to some ISM data later on in the afternoon from the United States, as well as factory orders. The combination of all this information will be a good start in helping us build up the macro picture for early 2015.
I will talk about emerging market currencies over the days and weeks ahead. I don’t want to bore you with all that today, but I think you all know the message already! This will be a tough tough year for the less liquid currencies. The policy divergence of the major central banks, and more specifically the onset of normalisation from extraordinary measures in the United States represents a substantial and as yet unquantifiable risk to some of these currencies, and we can already see from the price action that exposures to this space are being reduced. I think it will get worse..