Potential sanctions on Russia dominate in front of Yellen's first FOMC press conference

Macro Outlook

Two significant issues are increasingly dominating investor sentiment in recent sessions. One global macroeconomic and one geopolitical, but both are resulting in a flight to safe haven assets. The first issue is a looming credit crisis in China and the second is the on-going geopolitical tensions that surround Russia and the Ukraine. China underwent its first domestic bond default a couple of weeks ago, but this has since been followed by a second, as steel producer Haixin Steel defaulted on its bank loans. The default was the reason behind a slump in iron ore prices late last week and there is fear how far the contagion could go. Chinese 5 year Credit Default Swaps are now more expensive than those of Ireland, and double the price of France and Japan. This comes as Russian forces reportedly mass on the Ukrainian border and Crimea has held a referendum that could lead to its annexation by Russia. With the G7 threatening economic sanctions and Russia threatening “symmetrical” sanctions, it could be a significant week as the EU Economic Summit on Thursday and Friday could have a crucial impact, as could the stance of China. While we wait to see, the flight to safety continues.

Must watch out for: FOMC asset purchases decision + Janet Yellen’s first press conference

Impact: A strong Non-farm Payrolls report has taken the pressure off the Fed after a slew of weather impacted economic data caused some to question a decrease in the pace of tapering. Janet Yellen noted in her testimony to Congress that it would take a substantial deterioration of the outlook for the Fed to change course. This clears the way for the FOMC to continue the taper of asset purchases by another $10tn to $55bn per month. An intriguing addendum is that Yellen also holds her first press conference as Fed chair. Expect clarification on forward guidance.

Foreign Exchange

After shunning the opportunity to talk the Euro down in his ECB press conference, Mario Draghi was the cause for further volatility in the Euro towards the end of last week. His comments suggested that the exchange rate was increasingly relevant to the ECB’s assessment of price stability, so there will be added interest in today’s second reading for February inflation. Risk appetite continues to play a significant role in how forex markets are moving. The Japanese Yen has been a significant beneficiary of the rising geopolitical tensions over Crimea, dragging both Dollar/Yen and Euro/Yen sharply lower. If tensions continue to escalate, the yen could continue to strengthen which is that last thing that Bank of Japan Governor Kuroda wants. He may use his speech on Thursday as a chance to talk the Yen down once more. There again, if Janet Yellen clarifies the Fed’s forward guidance adequately, the improvement in risk might do Kuroda’s job for him.

WATCH FOR: After a quiet week of data last week, forex traders will quickly need to focus on crucial inflation data, firstly from the Eurozone on Monday and then US on Tuesday. Wednesday could be volatile, especially for Cable with UK employment, MPC minutes, the annual UK Budget and the FOMC statement and press conference all in one day. The EU Economic Summit will focus on banking union and the Ukraine.

Indices

Equity markets have had to bare the brunt of the selling pressure as investor concerns over defaults and a slowing economy in China and events in the Ukraine have seen a flight out of equities for the preference of the safe haven in sovereign debt. The FTSE 100, is heavily laden with resources companies that are intrinsically tied to commodity prices and subsequently to China, resulting in selling pressure. Germany has close economic ties to Russia, being a large trading partner, so any economic sanctions placed on Russia have the potential to take a bite out of the German economy. The S&P 500 is by no means sheltered (Russia accounts for just over 1% of total US trade) but the booming tech giants in the US have helped to hold up the index. However with very little corporate announcements for investors to focus on, China and Russia will continue to pull markets this week. The FOMC and Janet Yellen has the potential to add risk appetite back to the market though with clarification on forward guidance.

WATCH FOR: Equity markets will be very much at the mercy of how events unfold in Crimea and any economic news out of China this week. The FOMC meeting on Wednesday and Janet Yellen’s press conference will be the major economic driver for global equity markets, while UK traders will be focused on Wednesday’s Budget speech by Chancellor Osborne.

Commodities

It was a mixed week for commodities, with further weakness in base metals, further strength in precious metals and oil largely flat. Concerns continue that copper prices trading around 4 year lows on whether this is being seen as a barometer for weakness in the Chinese economy. A second corporate bond default has also put pressure on iron ore prices, while there are concerns of contagion and something more systemic which could signal considerable economic stress. This would be incredibly bad for base metals with China consuming around 40% of global copper production. However, precious metals continue to benefit form the increased tensions in the Ukraine which drive the “insurance” trade. Gold is now trading at the highest since September and whilst the geopolitical issues remain on the table the price looks set for further gains.

WATCH FOR: The main driver behind gold has been the geopolitical tensions in the Ukraine so gold traders will continue to monitor events closely this week. Subsequently the geopolitical fallout from the referendum in Crimea should continue to support Gold, although traders will be watching the EU Economic Summit for news of any potential sanctions on Russia which could impact on risk appetite.