USD traded sharply higher against all of the major
currencies on Tuesday as Treasury yields surged and stocks plummeted. With
several factors driving investors out of risk assets, FX traders need to beware
of the possibility of risk aversion intensifying over the next few days. From
surging commodity prices, the prospect of tighter monetary policies, risk of the
US government shutdown and even a credit default, there are plenty of reasons
to be worried.
The cost of natural gas is skyrocketing and the increase is
spilling over to oil. In the last 2 days, natural gas prices rose more than 10%
and in the past year, it is up 180%. Heading into the cooler fall and winter
months, households will be hit by significantly more expensive heating bills.
The energy crisis is so severe that in countries like the UK and China, there
have been forced blackouts and factory shutdowns. In some Chinese
provinces, traffic lights have been turned off.
Aside from having a direct impact on pocketbooks, higher
natural gas and oil prices is also a problem for inflation. In comments
made today, Federal Reserve Chairman Jerome Powell admitted that “it’s fair to
say that” inflation is broader, more structural and more concerning than
earlier this year. More specifically he said supply chain constraints like
shortages of chips “have not only not gotten better – they’ve actually gotten
worse.” Stickier inflation increases the need for less accommodation, which is
positive for rates, negative for stocks and risk currencies. Considering
that no one expects the energy crisis or supply chain bottlenecks to be
resolved quickly, risk aversion could intensify, leading to demand for USD, JPY
and Swiss Franc.
Treasury Secretary Janet Yellen warned that the government
would not be able to make all of their payments if the debt ceiling is not
raised by October 18th. Companies like JPMorgan said they have begun
preparing for a potential US credit default. Although it is very unlikely,
if that happens the consequences for the markets would be brief but
significant. Equities and currencies would fall sharply.
The government’s current funding expires on October 1st and
lawmakers are rushing to pass legislation that would avoid a partial shutdown.
There’s a lot going on in Washington this week and the battle on Capitol Hill
is hurting and not helping risk appetite. Consumer confidence weakened in
September and given recent developments, we expect further deterioration this
month.
With no major economic reports on the calendar on Wednesday,
equities and Treasuries will drive currency flows. The Bank of England and
Reserve Bank of New Zealand may be two of the least dovish central banks but
their currencies have been hit the hardest by risk aversion.
The UK is dealing with its own petrol crisis worsened by
driver shortage. EUR remains the most resilient, experiencing only modest
losses due to euro’s low yield. Risk aversion is normally negative for
USD/JPY but 10 year Treasury yields which rose to its highest level since June
is having greater influence on USD flows.
