By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Has Euro Become the Favorite Safe Haven Currency?
The last 24 hours has been marked by heightened volatility in the foreign-exchange market with the U.S. dollar falling to a 3-month low versus the Japanese yen and a 2-year low against the euro. The rollercoaster ride continued in the North American trading session with USD/JPY recovering all of its losses to trade above 109.50, but the EUR/USD held onto its gains and settled the day right around 1.20. This is the first time that the euro has traded above 1.20 since January 2015 and it remains one of the market’s favorite safe-haven currencies. The euro has not always been a safe haven and in fact struggles with this status as it is also viewed as a high-beta currency. However the central bank’s positive economic outlook, its hawkish monetary policy bias and apparent tolerance for current euro levels makes it more attractive than other currencies whose central banks are less hawkish or more vocal about their exchange-rate concerns. On Monday we talked about how the EUR/USD could hit 1.22 and possibly even 1.25 because historically, the pair is less than halfway between its 2008 1.6038 high and last year’s 1.0352 low. The 5-year average value of EUR/USD is around 1.21 and that may explain why the ECB is not overly concerned about the euro’s level. German consumer prices and Eurozone confidence numbers are due for release Wednesday. If the EUR/USD dips below 1.1950, we expect buyers to sweep in quickly as fundamentals still support a stronger currency.
It's important to realize that the primary reason why euro is strong is because the U.S. dollar is weak but on Tuesday, USD's intraday recovery caught many investors by surprise. North Korea’s actions Monday night should have caused USD/JPY to trade much lower. The U.N. has called a closed-door emergency meeting and President Trump responded by saying “all options are on the table.” Outside of a stronger-than-expected U.S. consumer-confidence report, there is little reason for investors to buy dollars. Hurricane Harvey and North Korea make it harder for the Federal Reserve to raise interest rates at the end of the year. They’ll have to maintain a cautious economic outlook as they wait and see how the Hurricane affects the economy and how stocks respond to North Korea’s threat.
Minimally, from the Hurricane, consumer spending, manufacturing and economic activity in that part of the country will take a hit and on North Korea, some of the world’s largest hedge funds are taking steps to protect their portfolios because they realize how severe the consequences can be. However even with all of these risks, stocks turned positive Tuesday, Treasury yields recovered half of their earlier losses and USD/JPY ended the day in positive territory. This reversal in U.S. assets is remarkable and we can only find two explanations – either the market is hoping that Trump will make a strong, convincing announcement on tax reform Wednesday (even though the nation’s focus should be on Houston and Hurricane rescue efforts) or they are happy that for the time being, Trump’s focus is on Houston and not on mobilizing military action against North Korea because lets not forget that he said the military is “locked and loaded” and their threats will be met with “fire and fury.” ADP and revisions to second-quarter GDP are scheduled for release on Wednesday.
Sterling and the Canadian dollar ended the day lower against the greenback. Although nationwide house prices fell, the report had very little impact on the pound, which had been trading strongly until the U.S. dollar came roaring back. The big story was EUR/GBP, which hit its strongest level in 8 years. Mortgage approvals are due for release Wednesday but sterling’s performance should be driven by the market’s appetite for U.S. dollars and euros, not the latest housing-market report. USD/CAD, on the other hand, ended the day well above 1.25 on the back of lower oil prices, softer data and a stronger U.S. dollar. Industrial product and raw material prices fell 2 times more than expected, a sign that price pressures are easing. Wednesday’s current account balance isn’t expected to lend any support to the currency as trade activity deteriorated in the second quarter. So with USD/CAD ending the day near its highs, the next stop should be 1.26, especially if U.S. crude stockpiles surge. In contrast, the Australian and New Zealand dollars ended the day in positive territory but well off their highs. Both currencies seem to have benefitted from the initial decline in the greenback but are now giving up those gains as the dollar bounces. What’s interesting about the latest price action is that the market interpreted North Korea’s threat as just negative for the dollar and not for risk appetite so AUD and NZD were bought and not sold on the news by European traders.