Keep calm, there’s less than 24 hours to go in a week wholly dominated by developments in the Middle East. With that in mind, we’re starting with a bang again this morning as a powerful explosion was heard at the Syria-Iraq border. I’m working with no details at the time of writing but, like yesterday's opening narrative, I expect this to be the norm as we’ll be on heightened risk alert around possible rogue or proxy escalations given the increased level of Anti-US sentiment is running thick amid Iran's crescent of influence.
Other than the widely expected announcement that a Chinese trade delegate led by Vice Premier Liu is heading Washington to sign in to affect the P1 trade deal, there hasn't been a great deal else for markets to feed off. So, today's critical payroll data comes as a most welcome distraction and will provide an essential update on the pace of US job gains. With US economic growth mostly dependent on the consumer, a healthy labor market is crucial to any constructive "risk-on" narrative.
With the market backdrop remaining supportive – namely improving macro, central bank easing and receding tail risk around trade, Brexit, and the Middle East – the path of least resistance remains up.
If truth be told, I can't wait for this hectic week to end and I don't think I'm alone in that view. So, traders will be excused if they decided to sit this one out and elect to do little more than their pre-NFP position housekeeping chores.
Oil markets are trying to stage a come back after prices continued to sell off hard in the wake of President Trump's de-escalation White House address. And what seems to happen so often in oil markets, when things turn upside down they head south in a big way. This week's additional piling-on to the crude market was the EIA inventory data showing a surprise build in oil and more substantial than expected builds in gasoline and distillates.
The compounding effects have been pretty gnarly for oil bulls over the past 48 hours. And while it’s challenging to quantify what, if any, residual risk premium is left priced into crude markets for political risk, given prices had retraced back to mid-December levels overnight I think that infers there’s now very little risk premia left to sell-off.
The precedent of the attack on Abqaiq in September was the template the market has chosen to model this week with low 70's on Brent capping out buying appetite and the initial price response reversing, despite the lingering geopolitical effect likely to persist for a few months. So, with Brent at $65, the market is probably not fully pricing in supply risk factors. With this risk skewed to the upside and the chance of proxy or rogue threats of disruption to physical supplies still elevated, we could see a floor start to build around current levels. At the same time, traders will now turn the focus back on the relatively pedestrian views around trade and data, which remain positive for oil.
A key factor driving gold was the turnaround in oil as both commodities remain highly correlated to Middle East geopolitical risk. But for gold, unlike oil markets, a variety of underlying uncertainties around data, trade, the Fed on hold narrative and even the lingering effects of the Middle East fracas has cushioned further losses so far. In addition, with the house in gridlock, President Trump has two areas of policy control under the Commander in Chief powers: trade and military policy. So, it could be wise to assume these areas will remain in the market's focus for some time and the uncertainty around these shifting dynamics, given the President's mercurial nature, will likely support gold for the time being.
That said, it might be worth keeping an eye on the new war powers measures legislation tabled by Pelosi, which would limit Trump's power to take military action against Iran. But with a stronger USD, surging equities and higher US yields greeting Asia market this morning, it makes for a compelling reason to sell not buy gold.
Despite the fast money meltdown to $1541/oz on the back of a considerable “risk-on” cross-asset move, yesterday's net flows were still into buying territory so it seems like the technical levels appear to be good contrarian entry points for gold bulls. On the technical scrim, look for $1550/oz pivot with $1530 the next primary level of support.
Critical to that long gold view, traders are keeping an eye on the US dollar which is currently being viewed as the global barometer of risk. Finally, we could see traders adopt a wait and see approach as the market pivots to tonight’s critical NFP report.
FX flows this week have been characterised by risk-on buying of USD.
One notable exception that I'm a bit puzzled by is CHF which is trading very bid as large flows are going through the market during European hours, despite the risk-on tone. Other than to suggest hedge funds view the franc as fair value at current levels and an excellent hedge against all the ills of the word, I’m a bit perplexed.
The Euro and Swiss Franc
Nonetheless, there’s been a lot of interest in EURCHF topside structures. The feeling here is that since the Swissy benefitted disproportionately from recent tensions in the Middle East, perhaps Japan's dependency on oil imports from the Persian Gulf (c. 85%) made the yen an unreliable haven. So, as the Middle East tensions de-escalated, the EURCHF could fly on a more pronounced long CHF unwind. But it hasn't worked out that way so far.
The Japanese Yen
Long USDJPY has worked out well, and I still don't see any reason not to play it from the long side. The markets should remain in buy on dip mode with stop losses getting moved up to 108.50. On the topside, I expect a lot of two-way interest to come in around 110, but it looks like a matter of time before we test it.
The Australian dollar and the Yuan
If you were looking to get into the global growth for 2020 trade, it could be worth looking at the divergence in CNH and AUD as the Aussie has been hammered over the past four days on bushfires and Iran fears while the Yuan has remained firm. With the CNH likely to bounce after signing of the trade deal positiveity, the AUD shouldn't be that far behind and the correlation could play some significant catch up in the days ahead – even more so with risk on lights flashing green.
The Malaysian Ringgit
With regional risk sentiment improving and the US-China trade deal still on course to be signed January 15, despite softer oil prices the Ringgit will likely coattail the Yuan’s positive skew into the P1 trade deal.
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Ongoing rate curve repricing and risk asset reaction perfectly illustrate how worryingly reliant investors have become on easy money policies