Daily Brief – One more risk

One more risk

As we wrote yesterday, a New York Times report that the US and Israel may have drawn up plans for military action against Iran following the mid-terms has continued to dominate markets. Energy commodities remain bid thereby sustaining significant headwinds against currencies including, but not limited to: ZAR, EUR, GBP, INR, JPY. On the opposing side, those currencies that enjoy higher energy commodity prices including CAD, USD and NOK remain resilient.

Whilst markets continue to digest that prospect, they must also continue to be wary of the forthcoming risks presented by the UK’s autumn budget and the outcome of the US mid-terms themselves. Fortunately for risk appetite, the impact of the mid-terms themselves might be limited this time around. The argument for this is simple: ordinarily, if the key institutions of law making, the House of Representatives and the Senate, are controlled by a different party than the White House, lawmaking progress may be difficult to achieve. Risks to the Dollar including constrained economic policy, as well as elements such as government shutdown, become more pronounced. However, if you haven’t yet noticed, this President doesn’t always tend to play by conventional rules.

As if that were not enough, there is another risk that has presented itself over the weekend. As you will no doubt recall, the carry trade continues to be prominent in markets. Despite higher realised and implied volatility levels, there remains ample demand for exposure to higher yielding currencies, funded by borrowing/selling low yielding currencies. Arguably the favourite amongst those high-yielders was the Brazilian Real, in particular funded against the Yen. As a result of the upset in the election result at the weekend, BRL dropped around 8% versus Friday’s close. That sharp reversal will push yield-seeking carry trades into other emerging market currencies and also back into funding currencies.

Discussion and Analysis by Charles Porter

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