Risk sentiment returns, NFPs in focus, while pound flounders
The gold price sums up how financial markets have performed this week. After surging to its highest level since March 2013 on the back of heightened geopolitical risk and the US/Iranian tensions, the yellow metal has given back nearly 75% of its gains and is now trading around $1,545, down from the $1,610 peak from earlier this week. Risk is back on and economics has taken over from geopolitics as the key driver of markets.
The problem with trading geopolitics
We would caution too much optimism, however, as the situation between Iran and the US remains unresolved. Just this morning Iranian officials said that they would take “harsher revenge soon”, after striking US air bases in Iraq with missiles on Tuesday evening. While it appears that the prospect of World War Three has receded, both sides remain volatile, and rogue action from either side could shatter market confidence once more. Thus, proceed with caution when trading risky positions, and remember to always be disciplined and use risk management techniques.
When geopolitics becomes a key driver of markets this poses a problem for traders: financial markets have no idea what will happen next and thus need to react to situations as they arise. This is why we try to avoid trading geopolitical events, if possible. In our experience, markets always tend to mean revert, and after a bout of risk aversion they return to normal. However, you never know how long it will take to return to normal after a geopolitical event, in this case a few days. While there could be another flare up of tensions between the US and Iran in the near future, we prefer to concentrate on the economic picture this week, which is starting to pick up.
The global economic recovery of 2020 looks to be taking shape
On the economic front, UK service sector PMI, European PMIs, US service sector ISMs, UK and European retail sales and the US ADP report all beat expectations when they were released this week, which has also helped risk sentiment to recover. The larger than expected drop in German exports reported this morning was a shock for the markets, however, it was somewhat mollified by the stronger than expected pick up in German industrial production for November, which rose by 1.1%, beating the 0.7% expected. The German Dax index is playing a blinder this morning and is up nearly 1.5%, as better than expected industrial production, which should boost exports down the line, along with the easing of geopolitical tensions, all help this index to recoup earlier losses. The German index is close to making a record high, suggesting that investors are willing to forget about US/Iranian tensions and carry on pricing in a pick-up in global growth and global trade for 2020.
FX: Pound under pressure as trade deal concerns come into focus
In the FX space, the euro remains weak, although it has managed to climb back above $1.11 vs. the USD this morning. Some of the pressure has eased on the euro as the yen and CHF give back gains as safe havens become less desirable. However, euro gains could be short lived, as the dollar is also rising on a broad basis. The dollar index has risen sharply this morning as USD/JPY claws back gains after the sharp drop after US forces killed the Iranian general Soleimani. The DXY is up some 50 pips as the markets turn their attention to the NFP report due tomorrow. USD/JPY has risen nearly 150 pips as risk sentiment has returned to the market, and this has also weighed on the pound. GBP/USD has fallen below $1.31 on Thursday as the market waits for a speech by outgoing BOE Governor Mark Carney. Personally, we do not think that this speech will move financial markets as he is leaving the Bank, instead a speech by incoming Governor Andrew Bailey would be much more important for UK asset prices. We believe that comments from the EU’s chief negotiator Michel Barnier, that the timeframe for reaching a new trade relationship with the UK is hugely challenging and that a deal won’t be reached in the next 11 months, are more damaging for the pound in the short term. $1.3050 is key short-term support, and as long as cable remains above $1.30, then it has a chance to remain within its most recent $1.30-$1.32 range.
Could a better than expected NFP add to positive risk sentiment?
Looking ahead, US payrolls for December are released on Friday. The market expects a 166k reading after a reading of 266k for November. However, a stronger than expected ADP report for December is boosting expectations that the NFP report could beat forecasts. The ADP report came in at 202k, vs. 160k expected. A stronger than expected reading may further boost the dollar’s attractiveness and make life tougher for the pound, it could also help the S&P 500 continue on its uptrend.