Calm before the…
Markets have begun this week with a somehow threatening sense of normality. Despite the volatility seen over the past week and a half, stable ranges appear to be establishing themselves in FX. Meanwhile equity market volatility is moderating. This is undoubtedly a relative calm in comparison to the volatility of last week, but what comes next?
Receding volatility may counterintuitively be concerning to some given that major dislocations in market pricing are still evident. For example, EURUSD still implies a risk premium of between 5 and 6%, stretching the upper limits of price versus fundamentals. Many will take the drop down in volatility as a good sign. After all, levels of implied volatility approaching 20% in EUR/USD are sustainable only in major global crises.
However, emerging price stability can also be seen as a risk of complacency where dislocations between price and value still exist. In markets there has been continued discussion of the so-called Mar-a-Lago accord. As Treasury Secretary Scott Bessent commences trade negotiations with willing nations, markets will be keen to see whether FX and the Dollar come into the scope of any prospective deal. Negotiating nations currently centre on Japan and Korea both of whom would conveniently fit perfectly into the play book of such an accord.
The target of the Mar-a-Lago accord, if you recall, would be those nations whose own currencies create a perceived upward pressure on the Dollar. That comes by virtue of firstly their own currency being undervalued and is aided by being a material net exporter to the USA. The final necessary condition is being willing to negotiate with the US. Many emerging market economies will satisfy the first condition but are unlikely to draw the attention of negotiators. Therefore, emerging market FX is still likely to underperform in the current environment. The same goes for commodity currencies where despite a minor recovery in oil prices, demand threats will continue to outweigh any effect of USD selling.
Discussion and Analysis by Charles Porter
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