Will Risk off Prevail

Fri 22 Sep 2017

Discussion and Analysis by Charles Porter:


Today holds considerable upside potential and downside risk within major currency pairs. Before our publication of a week in review and week ahead report, this article guides you though this tumultuous Friday and weekend. The events covered include North Korea’s supposed threat and Theresa May’s speech in Florence: from the Peninsula to Tuscany; Dotards to Brexit.


There will be considerable volatility within Sterling currency pairs this afternoon. The volatility will be significant and definite, manifesting as either an appreciation or depreciation of Sterling. The direction of the currency movement will be determined by both the content and rhetoric surrounding Theresa May’s speech in Florence, Italy, this afternoon.


The Florence speech should be a defining moment within the premature-secession negotiations. There are strong expectations for Theresa May to request a formal transitional period, likely for a fixed period of two years. Moreover, there is a strong indication for a budgetary contribution elucidation, or exit fee, in the order of 20 billion Euros. Whilst this figure is unlikely to be cited, it will be implied within the rhetorical guarantees of the UK Prime Minister.


Any offer that the debate surrounding Theresa May’s speech in Florence determines to be sufficient to assure the progression of Brexit negotiations will see the Pound rally. If, for example, Cabinet ministers and negotiator, David Davis, join the Prime Minister on her trip to Italy, then this will signal unity within the government and award credibility to the content of May’s speech. Therefore, the normative rhetoric surrounding May’s speech may prove to be as market-sensitive as its more solid content.


The converse is also true. The strong expectations that have surrounded the speech mean that a certain value has already been priced within the Pound Sterling. A strong consensus over the base case of the speech amongst investors means that falling short of the anticipated guarantees will devalue the pound. For example, citizen’s rights are expected to be partially addressed and safeguarded.


However, the expectation is for a demonstration of attention and care, not meaningful offerings. Any announcements containing a tangible offer will strengthen the Pound, any deviation away from addressing EU citizens’ rights will weaken the Pound. The propensity to affect the Pound Sterling derives from the preclusion of trade negotiations before significant first-round progress. A strong speech will constitute or finalise progression within the first round.


Within the wider, global, economy a risk off strategy and capital flight towards more safe assets may affect major currencies. There is expectation-derived evidence that this has already happened, however, any manifestation of the treats emanating from the Korean Peninsula may develop these movements.


The dangerous rhetoric surrounding the nuclearisation of North Korea intensified during early morning trading. Tensions between North Korea, neighbouring South Korea, Japan, and the United States have mounted. This follows US President Donald Trump’s address to the United National General Assembly this week. Derogatory comments labelling the North Koran leader, ‘rocket man’ and the retaliatory branding of Trump a ‘dotard’ are suggestive of an intensification of North Korea’s intentions.


Rising geopolitical risk, including the threat of nuclear proliferation and deployment, will force capital out of developed markets and into safer assets. Safehaven assets, those whose prices move inversely to developed market normal assets and currencies, primarily include Gold, the Japanese Yen and Swiss Franc, as well as treasuries. The performance of the Japanese Yen, given its inclusion within the threat, may be unpredictable. A rise in geopolitical risk will typically appreciate the Yen because of capital inflow within the safehaven currency. Given that Japan and the Japanese economy may itself be implicated within the risk, the performance of its currency may be uncharacteristic.


For now, the pound awaits the progression of Prime Minister May’s speech in Florence. The US Dollar weakened early this morning whilst gold, the Japanese Yen, and the Swiss Franc all appreciated following the news. Whilst geopolitical risk has remained at the centre of investors’ radar, the movements have been muted either through market ambivalence or a pre-existing pricing in of the risk. However, a tangible manifestation of this rhetoric, including the firing of a hydrogen weapon into the Pacific Ocean, will see extremely severe risk-off movements.

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