Markets Today: False Alarm?

A mild risk-off theme quickly emerged around midnight following North Korea’s statement that the US has effectively “declared war” and that North Korea has every right to “make countermeasures”.

By

While the White House has called both statements “absurd”, this does represent a significant escalation in rhetoric and raises the risk of a tactical misstep. Safe havens were consequently bid, with increases in the Yen (+0.3%) and Swiss Franc (+0.2%), Gold rose (+1.2%), Equities fell (S&P500 -0.2%) and Treasury yields were lower (-3.0bps).

How worried should we be? It is clear that over the past few weeks both sides have been upping their rhetoric. Stratfor who has more expertise than most in this area points to the North Korean threat being equivalent to recent US threats – the US has discussed shooting down North Korea’s next missile test and North Korea has responded in kind with the threat of possibly shooting down US bombers. Statfor concludes that the probability of intentional war is still relatively low, but the potential for an accident or miscalculation is rising (see Stratfor worldview for more).

Now to markets! There was US dollar strength overnight with the DXY up 0.5%. Much of that strength appears to have come from weakness in the Euro (-0.9%) with the Euro under pressure as the market digested the results of the German election. Also contributing to US dollar strength was expectations of US tax reform, with the press suggesting tax reform details could be released on Wednesday.

As for the German elections, while Merkel’s conservative bloc gained the most votes at 33%, she needs to negotiate to form government. The two likely partners are a “Jamaican” coalition with the FDP and the Greens who are likely to insist on lower immigration and argue for a less of a push towards Eurozone integration; the alternative is to form a coalition with the Social Democrats though they have not expressed a willingness to do so to date. The other clear winner of the election was the rise of the far right with the Alternative for Germany (AfD) winning 12.6% of the vote, a 7.9% point increase from the last election in 2013. It seems Germany is not immune from global trends and a breakdown of voters reveals half of the support for the AfD came from people who normally do not vote in elections.

It’s no surprise then to see the Euro down 0.9% to $1.1847. Also weighing on the Euro was a softer IFO Business Confidence (107.4 vs 108.0 expected), while remarks by Draghi to the European Parliament did not yield much of a reaction. There is good support for the Euro at this level, though a break below $1.18 could be possible if US dollar strength continues on the back of a possible US tax reform plan. In that case, my colleague Gavin Friend suggests the next range being 1.1675-1.1775.

Other currency pairs showed only modest slippage against the USD: Aussie (-0.3%); Canadian Dollar (-0.3%). The Yen was bid on safe haven concerns (+0.3%), with Japanese markets little affected by the decision for a snap election (it was mooted some weeks ago) and to PM’s Abe’s economic stimulus package (worth ¥2trillion Yen or around US$18bn ).

German Bund yields also fell, down 4.7bps to 0.40%. Some of the fall does relate to risk aversion following the North Korean statements overnight and US Treasury yields are also down similarly by 3.0 bps to 2.22%.

As for Fed Talk, Evans (voter) and Dudley (voter) hit the wires overnight with slightly contrasting views on inflation. Dudley reinforced that weak inflation over the past six months reflected temporary factors that will fade and thus expects “inflation will rise and stabilise around the Fed’s 2% objective”. Evans in contrast wants to see “clear signs of building wage and price pressures before taking the next step in removing accommodation” and that a “gradual and cautious approach” is appropriate. It’s clear that the next few months of CPI prints will be crucial in determining whether the FOMC sees the recent low inflation as transitory, or a more permanent feature.

The other big mover overnight was the oil price. WTI rose 2.9% to $52.13 while Brent was stronger (+4.2% to $59.24). The move higher reflects political tensions between Turkey and the Iraqi area of Kurdistan which held an independence referendum yesterday – counting has begun but no results are available as yet. Turkey also has a sizeable Kurdish population and the fear is that if Kurdistan succeeds it could lead to a fragmentation of Turkey. It’s no surprise then to see Turkey threatening “to close the valves” on Kurdistan’s oil exports.

Coming Up

Domestically it is quiet with only second-tier Weekly Consumer Confidence which rose last week to 114.8 – around its long-run average. There is also one RBA item, with the RBA’s Bullock who heads up financial stability speaking at a panel on “where to from here?”.

Internationally, the clear highlight will be US Fed Chair Yellen (2.45am AEST) who is speaking on “Inflation, Uncertainty, and Monetary Policy” at the NABE conference.

Outside of this, it is very quiet. NZ has the ANZ Business Outlook (10.00am AEST) and the US has the Conference Board Measure of Consumer Confidence (12.00am AEST).

Overnight

On global stock markets, the S&P 500 was -0.22%. Bond markets saw US 10-years -3.01bp to 2.22%. In commodities, Brent crude oil +4.19% to $59.24, gold+1.2% to $1,309, iron ore -0.8% to $63.06, steam coal -0.3% to $96.95, met. coal +0.1% to $204.75. AUD is at 0.7937 and the range since yesterday 5pm Sydney time is 0.7926 to 0.7974.

For full analysis, download the report:

For further FX, Interest rate and Commodities information visit nab.com.au/nabfinancialmarkets