Safe-haven repatriation flow seen in Yen post military action in middle east

Outlook:

We see doubt and fear everywhere. The month and quarter are coming to an end, which can make traders jumpier than usual and certainly prone to profit-taking. Smoke ‘em if you’ve got ‘em, and in the case of biotech, traders have nice gains to book. This is not necessarily outright risk aversion, although that seems to be what we see in European equities. European data shows some green shoots, especially in the leading economy, Germany. So if traders are dumping equities at the same time notes and bonds are offering negatives, it must be risk aversion. Where is the money going—into cash?

We wonder if the blame can’t be laid at the US’ door. Durables was like a slap in the face with a wet fish. Demand is weak, companies are not making capital investments that lead to the productivity that leads to wage increases, and wages are lagging so far behind housing price gains that we honestly cannot expect a boomy real estate revival, low rates or not. Some Fed officials may speak of needing to get rates up ASAP, like Mr. Bullard, but off on the side, big institutional economists are busy revising Q1 GDP estimates downward. That surely stays the Fed’s hand.

The wonderful, resilient US economy of yore—maybe not. Last year we had a Q1 contraction and many see it coming again this year. Q1 2014 was -2.1% with Q2 up 4.6% and Q3 at 5%, with a slowdown to 2.2% in Q4. The Atlanta Fed cut its Q1 “GDPNow” model forecast from 0.3% on March 17 to 0.2% on March 25 on the disappointing durables. Morgan Stanley cut from 1.2% to 0.9%, naming a bunch of things, including weather and the ports shutdown. Barclays cut by 0.1% to 1.2%, Macroeconomic Advisors from 1.5$ to 1.2%, and JP MorganChase, from 2% to 1.5%. But JP MorganChase is not too worried, saying “Overall, given the usual noise in the data, as well as a melange of other special factors, we do not view the 1.5% [First-quarter] tracking as so far below the 2.4% average of the current expansion to raise more serious worries.”

Reassurances notwithstanding, negative sentiment is high and rising. Today we get the usual Thursday jobless claims and the Markit services PMI, but these are not likely to reverse the doom-and-gloom feeling in the air.

Today’s oil price action and to a certain extent, the FX response, is a case of geopolitical events pushing to the top of the factor heap. Traders in all asset classes really dislike it when that happens, because even if you can see the ending, that doesn’t necessarily tell you how to position. As we noted yesterday, we can see the train wreck of Greece coming down the tracks but we don’t know if the most likely outcome-default without Grexit but with capital controls (the Cyprus method)--is good or bad for the euro.

The new military action in the Middle East arouses the same kind of uncertainty. Yemen is not a big oil player, except maybe in terms of coastal transportation. It’s a failed state like so many others, but because the Saudis suddenly want to defend a king who has already absconded, traders are worried in a vague but big way. Some analysts see something sinister in the Saudis bombing rebels in Yemen that are being supported by Iran. It’s a “proxy war” between Iranian Shiites and Saudi Sunnis. Separately, the US is bombing rebels in Iraq in cahoots with ground troops from Iran. Realistically, the Saudis and other Gulf allies have shown no appetite for putting boots on the ground in their own region.

The only way this turns into a real war is if the US and European allies decide to make it one. Some fear that Iran has imperial ambitions; it will clean out the barbarian pests and then take over (Iraq and Syria). Heaven only knows where this would leave the Kurds, who get betrayed by every ally, every time, especially the US.

We like what the King of Jordan said—it’s their war, not ours. In fact, the only way it can be won is by locals, even if the locals are barely one step above the rebels in terms of civilized behavior, let alone military capability. Aside from a few warmongers, the vast majority of US citizens (and almost certainly European citizens) want our governments to stay the hell out of it this time. Historically, we only make things worse.

What does this have to do with FX? Not much except in two indirect ways—the price of oil and the knee-jerk buy dollars response when the US does something big militarily, as in the Bush One Kuwait adventure and the Bush Two invasion of Iraq. We do not expect the current government to ratchet up the US presence—how could Obama keep the Nobel Peace Prize?—but later, who knows? That leaves oil, and it’s not clear the Saudis are making a connection between military action and market-share maintenance policy.

So anxiety is perhaps not really warranted, but anxiety is what we are getting. So far this is not driving money to Treasuries and the dollar, although it may at some point. Traders say they see a safe-haven repatriation flow in the yen but not the dollar. Maybe it develops into that and maybe not. We lack guidance from history as to which it will be, and if it is a safe-haven inflow to dollars, what catalyst is needed.

Until we get some better ideas about geopolitics, the safe bet is to trade the chart. And the chart shows the euro rally resuming. As noted above, the next Fib level is as good as any other forecast—1.1386 and probably not more than the previous intermediate high around 1.1534—but all forecasts are bad right now and subject to revision at any time.