FX market stands still despite global equity rout
The FX market has been only slightly affected by the sell-off in equities. Moreover, even risk-haven currencies, such as the Japanese yen and the Swiss franc, were of limited interest to investors. Overall, the US dollar enjoyed renewed interest from traders. The dollar index hit 90.57 yesterday, up roughly 1.6% on the week. The index’s gains were contained by the appreciation of the Japanese yen.
However, both the Swiss franc and the Japanese yen reversed momentum on Friday with the CHF and JPY down 0.35% and 0.45% against the greenback, respectively. This is somewhat surprising as the US government shut down once again on Friday morning. Investors seem to be not overly fussed about it, which suggests that they remain confident a solution will be find on Friday. Indeed, the lower house is expected to vote early morning.
We see limited risk for further USD weakness as the overall risk-off sentiment is rather dollar supportive for now. However, today will be key as a renewed sell-off in equities ahead of the weekend could trigger a panic reaction. Indeed, investors have always been reluctant to load on risk ahead of weekends. In the FX, this could translate into rising buying pressure in the Japanese yen and Swiss franc. The effect on the greenback is more uncertain.
MXN: recovery to resume
While resurgent volatility suggest that risk asset are still in jeopardy, in general high beta FX have not been materially affected. S&P 500 saw all sectors close down over 300bps as US yields rallied yet FX remained stable. This lack of contagion to us indicates that stock are not going to go much lower as this is a technical correction rather than a structural shift. In the FX EM Mexican Peso is increase becoming attractive. Banxico raised interest rate 25bp while providing a hawkish tone signaling that more hikes are likely. Inflation has come down marginally yet weaker MXN is could change this trend.
It’s unlikely given domestic and global environment that inflation will come down meaningfully. We don’t see any dovish policy communication until 2019 and could see rates peak at 5.75%. Also, we continue to see a soft NAFTA result. Despite Trumps feet stomping US – Mexico trade economy is deeply integrated. Any action would have complex result and most can be easily circumvented. We would see current USDMXN strength as an opportunity to reload shorts.