BNY Mellon: A Change in Behavior

15 oktober 2018

By Simon Derrick, Chief Currency Strategist, BNY Mellon

As had just begun to become clear by Thursday morning, last week appears to have seen a marked shift in behavior patterns within the foreign exchange markets.

Probably the clearest expression of this changed pattern can be seen in the performance of EUR/USD. In recent months just about the best indicator for price movement in the EUR been the shifts seen in the yield gap between 10-year Bunds and the equivalent tenor BTPs.

This pattern in turn, had been pretty consistent with the broader behavior seen in the pair over the past two years as politics has come to dominate price movements.

This broke down in a very clear fashion from the middle of last week, despite a number of provocative comments from key Italian politicians regarding Italy’s budget plan (the deadline for Italy to submit its budget to the European Commission).

Most notably, the League’s budget chief, Borghi tells Corriere della Sera that he expected the EU to reject Italy’s budget plan.

However, even with a yield gap that has remained firmly above 300 bps, the EUR did nothing but head up against the USD for most of the rest of the week.

The point at which everything changed appeared to be the opening of the US equity markets on Wednesday.

Looking at the news headlines heading into the US open, the main events had been warnings from Treasury Secretary Mnuchin about CNY devaluation and from the IMF about Chinese growth.

Both, in turn had fed into concerns about a rise in the USD beyond CNY 7 and the potential this might have to feed through into broader market volatility (a topic of discussion throughout the last few months).

The previous 24 hours had also seen President Trump repeat his threat to place tariffs on an additional USD 267 bn of Chinese imports.

In other words, the most likely cause for the sharp change of mood at the US open was concerns about Chinese growth and how this would reverberate out into the global economy rather than anything else.

From this point on, a quite distinct trading pattern began to emerge with many currencies following their local equity market performance.

As just one example of this it is worth noting that the appreciation seen on Friday in the KRW and TWD coincided exactly with the rallies seen in the KOSPI and the TWI of 2.4%.

Moreover, as soon as both markets closed, both currencies began to track sideways against the USD.

This pattern extends to the largest market in the world with USD/JPY tracking particularly closely to on Wednesday, Thursday and Friday to the performance of the S&P 500 when it was trading and e-mini Dow futures when it wasn’t.

Finally, given the topic at hand and just out of curiosity, we thought readers might find the following comparative charts interesting.