Tantrum Tempered:

Financial markets are stabilizing this morning, after last week’s sell off destroyed more than a trillion dollars in wealth. Ostensibly triggered by the Federal Reserve’s plans to end asset purchases at the end of this month, the rout in the foreign exchange markets is now seeing a slight reversal. Depressed Treasury yields are making it less attractive to invest at the centre of the financial system – helping to lift Southeast Asian and Latin American emerging market currencies against the large industrialized units.

The US dollar is marking gains against most of the majors, supported by Friday’ssurprisingly robust  consumer sentiment and housing start numbers, as well as a continued string of positive earnings releases. The yen is slightly weaker to start the week, helping to propel the Nikkei composite equity index to a four percent gain overnight.

Clouds continue to hover over Europe however, with bourses down across the continent. The turbulence that afflicted the zone last week is easing however, with bond yields returning to normalized levels. Greek 10-years have dropped below 8% once again, while comparable bunds are earning 0.85%. Against this interest rate backdrop, the euro is struggling to gain traction against the big dollar, and is weakening as the session unwinds.

After getting decimated last week, benchmark crude prices have rebounded into the mid-80’s – providing some relief for currencies like the Canadian dollar. The unit is tracking slightly higher as the trading cycle progressses, but remains firmly on the defensive as investors reposition for what is widely expected to be a slow and painful death to the commodity cycle.

With supplies rising, cheap liquidity pouring out, and Chinese demand flatlining, raw materials are under pressure across the spectrum. In response, currency traders have turned bearish on the Aussie, kiwi, nokkie and loonie, and we see little evidence that the secular trends underway can be reversed in the short term.

Some optimism is warranted, however. The drop in commodity prices that has occurred over the last three months is poised to deliver the most widely-dispersed, progressive and effective stimulus programme that the global economy has received in many years – by signalling an acceptance of $80 oil,  the Saudi oil ministry has accomplished what the G7 central banks have been unable to. This development should help to boost growth across the planet, and sets the stage for a rebound in exports in the coming year.

A long-awaited rebalancing in the commodity-bloc countries is underway, meaning that pain in the raw materials and construction sectors should eventually give way to more sustainable growth in other areas. Ironically, this cloud has a silver lining…

Further reading:

Forex markets: Fear makes comeback, but for how long?

Why We Remain Euro Bears; Risk & JPY Next Move – CIBC