Geopolitical Risks Make US Assets Attractive

• Geopolitical Risks Make US Assets Attractive
• EUR Lifted by De-escalation of Russia/Ukraine Tensions
• GBP: Big Week Ahead for Sterling
• USD/CAD Snaps Back on Weak Canadian Employment
• AUD: Weak Home Loans and Investment Lending
• NZD: Chinese Trade Balance Hits Record Highs in July
• USD/JPY Hit by Losses in Nikkei and Drop in Treasury Yields

Geopolitical Risks Make US Assets Attractive

Over the past week investors struggled to understand why the dollar refuses to fall despite the sell-off in U.S. yields and today's price action breaks the dynamic down perfectly. President Obama's decision for airstrikes on Iraq drove ten year Treasury yields to a 14 month low. The dollar also sold off but its losses were nominal compared to the decline in U.S. rates. However when Russia announced its plans to end military exercises near the Ukraine border, both the dollar and Treasury yields moved higher. Geopolitical uncertainty is clearly driving risk appetite and the conflicts abroad has made U.S. assets very attractive. Throughout the North American trading session, stocks had been performing well and for the most part, the greenback is holding strong even with a mild decline against the euro on Friday. The reason why the dollar did not follow yields lower earlier this week is because heightened geopolitical uncertainty makes Treasuries more attractive to investors and central banks looking to park their money in the safest assets and their demand provides support for the greenback. Just this morning Canada reported very weak job numbers, adding to the labor market disappointments seen in Australia and New Zealand and yesterday, the European Central Bank talked about increasing stimulus. There's a subtle buy America mentality out there not because the outlook for the U.S. economy is strong but because there are no better alternatives. Labor market conditions in the U.S. also fell short of expectations last month but the numbers are still healthy enough to make U.S. investments and the dollar attractive especially at a time when there is no immediate threat of Fed tightening. The two burning questions on everyone's minds now is #1 Will Treasury yields continue to fall and #2 Will the dollar remain resilient and shrug off the decline. If demand for Treasuries is caused by geopolitical uncertainty and risk aversion, then the answer is yes because during the Global Financial Crisis and 9/11, the dollar rose as yields fell. Of course, the limited engagement in Iraq and the Russian-Ukraine crisis are not comparable to those to events, but these are all examples of periods when risk aversion boosted demand for Treasuries AND the U.S. dollar. However realistically the recent geopolitical tensions will be contained locally with little spillover to the global economy and for this reason we believe it won't be long before there's re-convergence between currencies, equities and Treasuries. Eventually yields will bottom but the path of least resistance for the time being is still lower which means the more likely catch up move will be in equities and currencies.

EUR Lifted by De-escalation of Russia/Ukraine Tensions

The euro traded higher against the U.S. dollar today on the hope that tensions between the Ukraine, Russia and the rest of the world are easing. The Russian Defense Ministry announced that military drills near the Ukraine border are over, catching many traders by surprise because earlier this week Russia banned food imports from the European Union and there were reports that troops were mobilizing near the Ukraine border raising concerns that Russia would attempt another intervention into Ukraine. 24 hours later it appears that the outlook has improved significantly to many investors. The euro bounced off the 1.3350 level for the third time in a row. Higher highs and higher lows point to a potential bottom but given the dovishness of the ECB, continued disappointments in Eurozone data and a recession in Italy, it is hard to be bullish euros. ECB President Mario Draghi made it clear this week that the central bank is still looking to increase stimulus, worried about geopolitical tensions and expect ECB and Fed rates to diverge for a long period of time. All of this is negative for the euro but as we have seen today, risk appetite can also has a big impact on the currency. The most important Eurozone event risks on next week's calendar are the second quarter GDP reports from Germany, France and the Eurozone along with the German ZEW survey.

GBP: Big Week Ahead for Sterling

Unlike the euro, sterling failed to rally against the U.S. dollar. The U.K. trade deficit widened in the month of June but that alone does not explain the underperformance of the currency since German trade data also surprised to the downside and EUR/USD moved higher. On a technical basis, the downtrend in the British pound remains intact but next week is a busy one in the U.K. and the outcome of the employment and Quarterly Inflation Report could alter the technical picture for the currency. The reason why this report is so important is because any bias that would have been revealed in the BoE minutes due the following week will be foreshadowed in the Inflation Report along with an update on the central bank's economic forecasts. There's been a lot of talk about the division within the Monetary Policy Committee and if the hawkish chatter makes its way into the report or into the forecasts, it could set a bottom for sterling. Some policymakers believe that it would be prudent to raise rates early to ensure that the process is smooth and gradual. Although the manufacturing sector is losing momentum and wage growth has been soft, the service sector is performing well, house prices remain high and spare capacity within companies is declining. As a result, policymakers can argue that rates should rise soon in order to avoid being caught behind the curve and forced to deliver a larger hike in the future that could threaten the recovery.

USD/CAD Snaps Back on Weak Canadian Employment

Surprisingly weak Canadian employment numbers resurrected the rally in USD/CAD. For most of the week it looked like USD/CAD would top out below 1.10 especially with manufacturing activity accelerating and the trade balance turning positive. However, a big miss in this morning's labor market number reminded investors of the challenges within Canada's economy. Only 200 jobs were created in the month of July against expectations for a 24k rise. The June report was already very weak and everyone had been hoping for a rebound but unfortunately due to a loss of 59.7k full-time jobs and a gain of 60k jobs, the labor market saw very little improvement last month. Furthermore, the fact that Canadian companies are dropping their full time workers and adding part time workers is a sign of trouble for the economy. The Canadian government was quick to say that the monthly labor data is volatile but with the falling participation rate explaining the improvement in the unemployment rate, it is clear that the jobs number accurately reflects a slowdown in hiring. In contrast, the Australian and New Zealand dollars received a boost from last night's Chinese trade data. Anyone questioning the pace and sustainability of China's recovery will have to sit back in their seats after the country's trade activity hit a record high in the month July. Exports doubled expectations, rising at a 14.5% year over year pace while imports fell 1.6%. While domestic demand pared back slightly, the pickup in exports will promote stronger growth in China's economy and provide benefits to countries such as Australia and New Zealand who rely on Chinese demand. In the coming week we have more Chinese data such as industrial production, inflation and retail sales scheduled for release.

USD/JPY Hit by Losses in Nikkei and Drop in Treasury Yields

The Japanese Yen is the quintessential safe haven currency and in times like this when investors are nervous about geopolitical risks, it performs extremely well which explains why the Yen traded higher against most of the major currencies today. Overnight, the Nikkei dropped nearly 3% with the intraday low in Japanese stocks set around the same time as the intraday low in USD/JPY. Throughout the week we said based upon the decline in Treasury yields, USD/JPY should be trading on the 101 and not 102 handle. Now that it is has moved in this direction and hit our target of 101.50, we expect the currency pair to remain under pressure until 10 year Treasury yields trade recapture 2.5%. The Bank of Japan left monetary policy unchanged last night and Governor Kuroda expressed confidence in a continued moderate recovery but noted signs of weakness in exports and production due to "sluggish emerging economies," "cold weather in the U.S.," and "structural changes in Japan." Like ECB President Draghi, he sees growing geopolitical risks but doesn't believe they will impact Japan's economy. Although he noted that, "there is no reason for Yen strength now," it is clear that risk aversion is driving the currency higher. Looking ahead, the most important release on the calendar next week is second quarter GDP. Investors are eager to see much damage the sales tax really had on the economy.