While it may be argued that there is still residual demand to be found once the US and China can ink a trade deal, the price action this week is quite revealing about a potential permutation in the rhetoric that has dominated flows.
Are we getting to a point where the market has priced in all there was to be discounted from the Sino-US story (assumption if a deal is almost baked in the cake) and the attention is swiftly shifting towards economic fundamental divergences?
Risk on risk off fluctuations, the growing influence of capital flows derived off yield spreads (US at the forefront of the recent divergences spotted) must simultaneously coexist with the immediate risk of politics in Europe (Brexit) as we enter a key period.
In the last week or so, the typical risk-on, risk-off gyration have started to decouple due to fundamentally-charged triggers in Canada, Australia to name a few. That’s why it’s been a fairly disjointed affair finding the connections between risk and sensitive currencies to deleveraging episodes in financial markets. This decoupling also applies to the USD, which by default tends to debilitate when risk thrives; it has not been the case as the currency keeps its appeal intact.
What we are seeing is a market that is increasing its correlations toward bond yield spreads, and that is evidence that more attention is being paid towards the prospects of growth and economic divergences on an individual merit basis. At the center of this new re-adjustment towards yield differentials we find the sell-off in US bonds, which keeps stubbornly high demand towards the US Dollar in a world with ultra-low interest rates.
If you are looking for that extra layer of conviction on your Forex trades, this is the time to factor in the bond yield spread to gauge the next flows while keeping an open mind about what currencies may or may not benefit from risk-on or risk-off as fundamentals and politics (EUR, GBP) play an increasing role.
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