Morning Brief – Five-eyes

Five-eyes
 

An exogenous threat always has the capacity to make us reconsider what really matters. In lockdown the things that frustrated us as individuals may now seem to no longer matter or, on the contrary, they may have grown in importance. Whatever the issue and no matter the change in importance, the important thing to note is that few things escape the shift in our perception and sentiment. The same is absolutely true with financial markets. Buyers and sellers including us and you influence the relative value with which currencies trade against each other. In a perfect world the matching of supply and demand at the global level would perfectly reflect the aggregate feeling of every single risk and reward in each currency. But it simply doesn’t. Markets too reflect the human condition and as such they seem incapable of holding too many things in their sight at once.

In the first month of the Coronavirus saga, when the potential damage of the virus and the evolution of a pandemic first became apparent, the things that were in primary focus disappeared. Financial markets in 2019 were concerned by two major macro events: 1) the US-China trade war and the Phase-one deal and 2) Brexit. Sure, the usual influences of economic performance and monetary conditions continued to dictate the path currencies were on but they were the two major risks that pervaded market participants’ minds. With the expansion of the virus these were largely forgotten. After all, why care about trade deals when trade is struggling to take place right now?

As conditions normalise and lockdowns end we will be reminded of the importance of these underlying vulnerabilities in the geopolitical backdrop. With the resumption of virtual second round Brexit negotiations last month the impending UK’s 31st December deadline reared its head as a risk once again. Limited progress was made and there is a degree of pessimism standing over talks due to resume next week.

The US-China trade war looks set to derail markets from their recovery too. Despite a dramatic improvement in risk sentiment at the end of last week with the US Dollar moving dramatically lower across the board, this week has had a rocky start. The VIX, a traded instrument measuring equity market volatility spiked. It remained below levels first seen during the outbreak of the pandemic but demonstrated vulnerable conditions in the economy. The cause for this eruption of risk includes Secretary of State Mike Pompeo’s warning that followed Donald Trump’s admonition of China’s role in creating the virus in a lab in Wuhan. The accusations stopped short of calling the virus man-made but the accusations were severe.

The accusations levied at China were reportedly backed up by Five-eyes the intelligence sharing committee consisting of Australia, Canada, New Zealand, the United Kingdom and the United States. The reports were not confirmed but the accusations have been heard and met in China with state run newspapers accusing these actors of bluffing. In an election year we should not discount the propensity for the US-China trade war to resurface. After all, consider, what was the overarching slogan of Trump’s initial campaign? With the exception perhaps of ‘make America great again’ the phrase that has stuck with most of us is ‘we’re gonna build a wall’. Trump’s campaigns are built upon the exploitation of division and populist politics will only damage already fragile economic growth forecasts. If the blame game is not brought under control there could be further man made stresses in the financial system and foreign exchange market. If these build up below the surface due to the shroud of the virus then any potential V-shaped recovery could be off the cards.

Discussion and Analysis by Charles Porter

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