It All Comes Down To Pain | Morning Express 9/26/2022

Posted: Sept. 26, 2022, 8:50 a.m.

The currency chaos continues. Currency and rate markets are the plumbing of the global financial system. In essence, stock and commodity markets do not function without those working properly. As we have always said here with rates; rising rates are not the biggest headwind for risk assets, it’s the velocity in which they move. Excessively sharp drops or rises create stress and dysfunction, equating to risk-off tailwinds. The same goes for currencies. In August, the Euro hit parity against the U.S. Dollar for the first time since December 2002. It traded to a low of 0.9609 last night, down as much as 4.5% on the month and 16% on the year. The Yen has been falling precipitously since the start of last year, when inflation in the U.S. began to show. The worst came with an 11% drop from March through April. There has still been no reprieve, and the Yen has fallen as much as another 9.5% through last week. The Bank of Japan has kept rates at -0.10%, diverging from the global central bank tightening trend, especially from that of the Federal Reserve. This forced the BoJ to intervene last Thursday for the first time since the Asian Financial Crisis in 1998. However, interventions rarely work, and the Yen has surrendered most of its knee-jerk rebound. This brings us to last night’s flash crash in the British Pound. On Friday, the U.K. government announced sweeping tax cuts and increased fiscal spending to boost the economy in the face of exorbitant energy costs. The market punished this behavior, sending the already vulnerable Cable -3.57% on Friday before cratering another 4.2% Sunday night, in less than five minutes. This was a record low for the GBPUSD, painfully breaching the February 1985 level for a moment, before rebounding. Talk about velocity, the yield of U.K.’s 2-year Gilt has risen by 150bps this month, from 3.00% to 4.50%, with the bulk of the move coming in the last two sessions, and five sessions in total. Furthermore, this comes after a 130bps rise in August. Given the currency move, rate markets are begging for the Bank of England to step in and alleviate this pain (or causing more elsewhere), pricing in as much as 200bps worth of hikes through November. The BoE is expected to make a statement today.

Pain is the key word amid this chaos. Markets tend to bring the most pain, to the greatest number of people. Whether it be poor energy policy around the world creating a crisis of survival, extreme market whipsaws knocking out risk parameters of participants, or the pain in which the Fed Chair Powell discusses in bringing down inflation. It all comes down to pain, and the U.S. Dollar being a safe haven to avoid pain elsewhere. We have said for the last couple of months, pain in stocks and commodities will not dissipate until the U.S. Dollar has a blow off top. What we are getting at is a stew of peak Federal Reserve hawkishness, the Euro deeply below parity against the U.S. Dollar, the need for the Bank of Japan to intervene Thursday, and the flash crash in the Cable last night (which it has now gone positive), together all have the makings of a capitulatory blow off top in the U.S. Dollar.