A vulnerable time for risk assets and currencies

Since the re-election of President Obama ten days ago, observable has been the deterioration in risk assets and currencies. Two major explanations can be advanced to explain this response; first, a belief that the fiscal cliff negotiations will likely descend into extended partisan acrimony quite quickly, and second, a hurried financial reappraisal by American high net worth individuals and high income-earners ahead of the likely implementation of increased taxation of income, capital gains and dividends. At the same time, there has been a recognition by real money that risk premiums had become too narrow, which has triggered some further reduction in high-beta assets.

Against this backdrop of painful political pinball in Washington, this process of risk reduction in the major asset classes probably has further to run. For the major currencies, the dollar will likely retain a healthy bid, at least in the short term, while other majors like the euro and the pound may struggle. How the Japanese yen performs is more difficult to anticipate. On the one hand, the Japanese currency is usually a principal beneficiary whenever the impulse for a safe haven predominates. However, the BoJ may be forced down the road of unlimited asset purchases by the LDP should it win next month’s election. Also, the Japanese economy desperately needs a weaker currency, with the corporate sector cratering and GDP contracting.

Like the yen, it is not as easy to be definitive on the Aussie in terms of how it responds if this risk-off period continues. As a very highly-rated AAA sovereign with advantageous interest rate differentials and fiscal settings that other advanced economies would die for, Australia has much to offer those looking for a safe harbour during any new global financial storm. Sovereign wealth funds seem especially attracted, although the RBA now seems prepared to provide them with new Aussie notes in what amounts to clever currency intervention. We have observed in recent weeks that the traditional correlations between risk appetite and major currencies have broken down in some instances, with local macro forces increasing in prominence. That said, if there is a sudden big hiccup in risk assets, it would be remarkable if the AUD was not dragged down below parity for a period.

Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these securities. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Forex involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility.