Market Data 
- The US Dollar trades flat with markets returing to carry trades.
- France’s political uncertainty continues to weigh on the country’s bonds and stocks.
- The US Dollar index trades above 105.50 ahead of a soft Monday opening.
The US Dollar (USD) trades flat ahead of the US session on Monday as risk aversion takes over markets amid the French political uncertainty. President Emmanuel Macron’s decision to call for snap legislative elections and the possibility of a far-right-dominated parliament spooked investors, who sold French assets on concerns about how Macron would cope with such a scenario. Sovereign bond spreads in Europe are widening even more, signalling a bond market in distress. Should the bond market continue its rout, the possibility of an intervention by the European Central Bank (ECB) shouldn’t be ruled out in order to keep the European bond market cohesive and in sync with its monetary policy.
On the economic data front, a very quiet start for this week from the US perspective with some lighter data ahead. Pivotal elements to look forward to are the Retail Sales on Tuesday and the Purchasing Managers Index (PMI) numbers on Friday. Traders will need to assess what will get priority: softer US data which would see an easing US Dollar, or will it be again the European political turmoil which would rather see US Dollar strength.
Daily digest market movers: It’s all about EU bonds
- At the start of the European trading session on Monday, European sovereign bond spreads are widening even further than Friday (80 basis points at the time of writing between French and German 10-year benchmark bond yields). A dispersion in sovereign bond yields per country is causing issues for the European Central Bank (ECB) as it has only one overall monetary policy rate that it can use to control inflation in the Eurozone. When bond spreads between countries are getting too wide and too dispersed, the ECB has more difficulties controlling local price forces, which might lead to local flare-ups in inflation or even sudden deflation. The second element is that those countries might start having issues to fund their sovereign debt on international markets and might trigger a bank run or having the ECB stepping in to offer a lifeline to that country so that it doesn’t default on its debt. The best example of that was Greece in 2010 during the sovereign debt crisis.
- At 12:30 GMT, the NY Empire State Manufacturing Index for June got released. The index came in at contraction of 6, which is better than the -15.6 from previous time.
- Near 17:00 GMT, Federal Reserve Bank of Philadelphia President Patrick Harker participates at the Global Interdependence Centre’s 42nd Annual Monetary and Trade Conference.
- Equity markets are looking for direction. European equities are trying to snap the losing streak, even with the bond market turmoil. US Futures are mildly in the green.
- The CME FedWatch Tool shows a 33.3% chance of the Fed interest rate remaining at the current level in September. Odds for a 25-basis-points rate cut stand at 59.0%, while a very slim 7.7% chance is priced in for a 50-basis-points rate cut.
- The benchmark 10-year US Treasury Note slides to the lowest level for this month, near 4.27%, ticking up a bit.
US Dollar Index Technical Analysis: DXY to choose sides
The US Dollar Index (DXY) would likely not be where it is this Monday if it were not for the current European political turmoil. With a higher DXY, there is the risk of a quick correction if European headline risk start to abate and US data comes on the soft side. A fair warning thus that this US Dollar strength might be short-lived.
On the upside, no big changes to the levels traders need to watch out for. The first is 105.52, where the DXY is trading around, a barrier that held during most of April. The next level to watch is 105.88, which triggered a rejection at the start of May and will likely play its role as resistance again. Further up, the biggest challenge remains at 106.51, the year-to-date high from April 16.
On the downside, the trifecta of Simple Moving Averages (SMA) is still playing support. First is the 55-day SMA at 105.10. A touch lower, near 104.55 and 104.47, both the 100-day and the 200-day SMA are forming a double layer of protection to support any declines. Should this area be broken, look for 104.00 to salvage the situation.
Risk sentiment FAQs
In the world of financial jargon the two widely used terms “risk-on” and “risk off” refer to the level of risk that investors are willing to stomach during the period referenced. In a “risk-on” market, investors are optimistic about the future and more willing to buy risky assets. In a “risk-off” market investors start to ‘play it safe’ because they are worried about the future, and therefore buy less risky assets that are more certain of bringing a return, even if it is relatively modest.
Typically, during periods of “risk-on”, stock markets will rise, most commodities – except Gold – will also gain in value, since they benefit from a positive growth outlook. The currencies of nations that are heavy commodity exporters strengthen because of increased demand, and Cryptocurrencies rise. In a “risk-off” market, Bonds go up – especially major government Bonds – Gold shines, and safe-haven currencies such as the Japanese Yen, Swiss Franc and US Dollar all benefit.
The Australian Dollar (AUD), the Canadian Dollar (CAD), the New Zealand Dollar (NZD) and minor FX like the Ruble (RUB) and the South African Rand (ZAR), all tend to rise in markets that are “risk-on”. This is because the economies of these currencies are heavily reliant on commodity exports for growth, and commodities tend to rise in price during risk-on periods. This is because investors foresee greater demand for raw materials in the future due to heightened economic activity.
The major currencies that tend to rise during periods of “risk-off” are the US Dollar (USD), the Japanese Yen (JPY) and the Swiss Franc (CHF). The US Dollar, because it is the world’s reserve currency, and because in times of crisis investors buy US government debt, which is seen as safe because the largest economy in the world is unlikely to default. The Yen, from increased demand for Japanese government bonds, because a high proportion are held by domestic investors who are unlikely to dump them – even in a crisis. The Swiss Franc, because strict Swiss banking laws offer investors enhanced capital protection.
