A more measured view of the world

One of the main fears last month was that markets were too complacent on the prevailing risks. Volatility measures were at multi-year lows, stock markets continued ever higher with no real corrective activity, with no signs of concern over geo-political events in Russia and beyond. In many ways, it is comforting to see markets taking a more sanguine view of the world, without having fallen out of bed with it. This can be seen in the continued higher stance of the VIX index after the sharp rise seen late July, together with the continued fall in bond yields, culminating in the German 2 year yield touching zero for the first time in over a year. Stock markets have also taken on a more cautious tone, the S&P having corrected nearly 3% from the year high seen last month.

For FX, there have been several implications. The first is that the dollar’s underlying bid, helped initially by better than expected data, has found further support. We’ve also seen what can best be described as traditional safe-haven currencies outperform in the past few weeks, with this most notable on USDJPY through the first half of August. The CHF has also remained buoyant, but also constrained to a degree by the SNB’s 1.20 floor on EURCHF. Finally, the CVIX measure of FX volatility has also increased to levels last seen early June, but still remains at very low levels historically.

The main risk event for currencies this week comes on Wednesday, with the latest Bank of England Inflation Report. Sterling has waned of late following the surge seen during June and the early part of July, on the growing expectation that the Bank could raise interest rates as early as this year. For sure, some of the recent correction has been down to broad dollar strength, but sterling has also been lacking in data and indications to further push the view that rates are likely to rise this year. Having come out in June and explicitly questioned market pricing (under-estimating chance of rate hike this year), Carney seems unlikely to reverse this stance this week when the Inflation Report is released. We may have to wait until September for a more sustained impetus on sterling, especially if we see some members of the MPC voting for higher rates by then (as seems increasingly likely).