FX Update: Muted FX reaction to oil shock. FOMC dead ahead

Trading Interest

• Maintaining long AUDNZD with stops raised further to 1.0680 for 1.0950
• Maintaining long EURUSD position with stops 1.0980.

The bombing of Saudi oil facilities at the weekend has been felt most intensely in energy markets, of course, with rather mild feed-through into foreign exchange and other markets. One of the reasons that FX absorbs this kind of news in an odd way is that it pulls on conflicting themes: the threat to global growth if the oil price spike is sustained for more than a few weeks is growth and risk negative and works against any smaller currency, even a currency positively correlated with oil prices even if the nominal immediate boost to oil prices boosts the prospects for oil income massively.

The chief worry here is that this attack on Saudi facilities triggers for more overt military confrontation that brings the threat of an even larger disruption to supplies on further attacks. For now, CAD and NOK are up a fraction of a percent and JPY is firmer this morning, but off the modest “spike” lows overnight. The markets look hopeful that Saudi strategic reserves will limit the disruption of supplies and that they are able to make good on assessments that the repairs require on the order of “a few weeks” to carry out.

The chief focus for the week ahead is the Wednesday FOMC meeting, though the narrative has suffered a twist at the weekend that could raise the uncertainty of what will unfold if oil prices don’t calm further by Wednesday. Given that the oil market disruption is so fresh, the Fed can hardly be expected to do more than point out that they are monitoring it for implications and before the events at the weekend, the Fed was seen as a lock to cut 25 basis points, given strong risk appetite and hopes that the US-China trade tensions have thawed.

While we have a bonanza of central bank meetings this week, including four on Thursday (SNB, BoE, Norges Bank and BoJ) G10 currencies, our suspicion is that central banks are increasingly losing the ability to move the needle – with last week’s ECB meeting Exhibit A for that notion. Norges Bank is the only of those four where there is some suspense on the decision, given fairly evenly divided opinion on whether they will hike again.

Let’s recall how Friday closed last week for the bond markets, which suffered a brutal correction all last week that accelerated dramatically on Friday and almost entirely erased the massive downdraft in yields in August. The move has come with little fanfare and points to dysfunctional liquidity conditions in the bond market, but also points to the risk that the complacency driving high-flying stock is on an increasingly uneasy foundation if the move higher in yields continues.

Chart: EURJPY vs Bunds
The key question for markets if we assume that the oil market volatility calms back to a non-factor in coming days is the recent dramatic rise in interest rates from the cycle lows – if this move is not quickly halted, it could quickly become a factor leaning against recent developments like the strength in EM and riskier currencies and weakness in the JPY. Here we show the EURJPY versus the Bund future for a sense of how JPY crosses are sensitive and correlated with bond yields – this is likely to remain the case.