Geopolitics may have flagged the fragile nature of 'global recovery' trades, but the lead up to Jackson Hole means that it could be time for global tightening to cause a market shakedown
Rising geopolitical tensions last week may well have given investors a wake-up call when it comes to the fragile nature of 'global recovery' trades. Tail risks such as geopolitics, protectionism and the unwind of easy central bank money all provide valid reasons to remain cautious in chasing risk. This is especially true given that not all the foundations to what many have dubbed a 'synchronised' global recovery are actually in place; missing global inflation - and uncertainty over near-term growth in US and China - means that there are two-way risks to global growth.
As investors countdown to Jackson Hole, the Fed and ECB minutes this week may shed light on the proximity of global tightening. It has been a strange environment to see markets relatively calm despite two of the world's biggest central banks both on the verge of making significant changes to their respective balance sheet policies. With global tightening around the corner, one would have expected carry trades to come under some pressure. We still think that August may be the month in which the 'penny (or cent) will drop' and see the dollar bloc currencies as being particularly vulnerable.
The key question for EUR markets this week is whether the ECB minutes will express any concerns about the impact of the strong exchange rate on the economy or inflation. Back at the July ECB press conference, President Draghi talked about the exchange rate in terms of its impact on the financial conditions. Unless the ECB conveys serious concerns about the strength of EUR, any meaningful fallout in the single currency looks unlikely this week.
Both the Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand (RBNZ) have been quick out of the blocks to talk down their respective currencies, with concerns over the negative domestic macro implications met with some tentative - albeit non-credible - threats of FX intervention. Unjustified currency strength - or one driven by a weaker USD and a "global risk bubble" - is like kryptonite for the Antipodean economies and expect to hear more of the same from these central banks over the coming weeks.
There are signs the CHF is coming back in from the cold and a sense of normality is returning. As we noted in our latest CHF update, we expect EUR/CHF to rekindle its correlation with risk. A return to more normal trading conditions, arguably for the first time since 2008, makes a case for EUR/CHF to move up to more normal levels - potentially even 1.30. Fading geopolitical risks means that the bearish CHF story could come back into the mix for markets this week.