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Markets end the week on the back foot
Risk-off move accelerates ahead of the weekend
Financial markets are set to end the week on the back foot as US political turmoil takes centre stage with many of Trump’s business counsellors resigning. Wall Street suffered its worst sell-off since May with the Dow Jones Industrial Average falling 1.24% to 21,750 points. The S&P 500 was down 1.54%, while the tech-heavy Nasdaq tumbled 1.94%. The sell-off spreads to European stocks on Friday after a terrorists attack in the streets of Barcelona. The Eurostoxx 50 gave up 0.90%, the Dax was down 0.75%, while the CAC 40 slid 1%.
Against this backdrop, investors have switched to risk-off mode, sending equity indices through the floor and piling into safe haven assets. The yellow metal reversed early week losses and returned to $1,290 an ounce, rising more than 2% since Tuesday. The broad debasement of risky assets sees a strengthening of demand for Treasuries. 10-year German Bund yields dipped to 0.40%, while the 2-year slid to -0.71% amid rising bonds’ price.
In the FX market, the yields hungry investors piled into higher yielding currencies such as the Aussie and the Kiwie. AUD/USD rose 0.45% to 0.7920 while NZD/USD was up 0.50% to 0.7315. The single currency was also edging higher - despite the risk-off move - treading water at around 1.1735. The Japanese yen was up 0.40% with USD/JPY trading at around 109.15.
Overall, today’s risk-off move is amplified by the fact that investors are always reluctant to hold risky position over the week-end. Indeed Trump’s political mess creates a substantial risk for markets overreacting on Monday should the situation worsens when markets are closed.
Japan: strong upside pressures on the yen
The Japanese yen is on a clear bullish momentum. The currency has outperformed major G-10 currencies since last month. In particular, the USDJPY has weakened from 114 in a month. The rally may now seem a bit over extended and we may see some rebound within the short-term. Anyway the pair is riding a downtrend channel and there are definitely some more room for further weakness.
Japanese bond yield keeps on declining. The 10-year bond is back is heading back towards 0. The current rate is the lowest since last October. This indicates that the demand for inflation-linked bonds are actually very low. Markets are then estimating than inflation should remain low over the next decade!
This is a clear pessimistic view and the deflationary environment. The strengthening yen should also weigh on consumer prices. Japan vicious circle is set to continue. And we remember that a month early the BoJ has downgraded its inflation forecast for fiscal years 17/18 and 18/19. The central bank inflation target seems a difficult objective and upside risks on the currency should very likely continue, especially against the greenback with Trump failing to deliver his reforms.