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North Korea's nuclear tests weigh on risk sentiment
Investors shelter in safe-haven assets amid North Korea concerns
Once again investors started the week on the back foot as geopolitical tensions escalate over the week-end. With the exception of Chinese equities, which enjoyed a smooth session on Monday, global equities slid in negative territory. The Nikkei was off 0.93%, while the broader Topix index fell 0.99%. European equities followed Japanese ones lower. The Euro Stoxx 50 was down 0.50%, while S&P 500 futures tumbled 0.47%.
North Korea announced it conducted sixth nuclear test on Sunday, triggering another rush for safe haven investments. As usual gold, the Swiss franc and the Japanese yen were better bid, rising 1%, 0.80% and 0.75% respectively. Other precious metals were also in demand with silver climbing 0.80% and palladium rising 0.90%.
Volatility indexes such as the Euro Stoxx volatility index gapped at opening, jumping from 14.7% on Friday to 16.4% on Monday morning. Demand for bonds also surged sending rates lower. German Bunds yields continued to move lower with the 10-year sliding to 0.36%, while on the short-end of the curve the 2-yeat yield reached -0.73%.
EUR/USD edged up in early European session and erased partially Friday’s losses. The single currency rose to $1.1915. The pair is still trading within its multi-month range of 1.1662-1.2070. We do not expect a significant change of behaviour before Thursday’s ECB meeting.
Fundamentals build on GBP reversal
The GBP fall against the Euro continued today reversing last week’s marginal bullish reversal. The sterling verse the euro is now close to its historical low in trade related term. A reality that is not lost on the Bank of England. The MPC has indicated that a 20% decline in the GBP could equal as much as 1.5% increase in inflation depending on the issue. BoE Governor Carney in the past has suggested that exchange rates considerations must be a part of central bank’s policy setting. Should the cause be a decline in relative growth verse global competitors rather than Brexit connected fears then the BoE is more likely to act with higher policy rates. We suspect the current GBP deprecation is a blend of the two increasing the likelihood the BoE will be forced to act.
Economic data from the UK has been on the soft side causing the market to discount potential tighten. However should the domestic inflation and activity suddenly pick up the BoE will quickly shift policy stance. The market is clearly underpricing this potential scenario, yet the probably of a 4Q jump in activity has increase significantly partially due to the weaker sterling. Our bullish GBP call has been under heavy pressure but conditions are pointing to a December move in banks rate will catch the GBP bears short.