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Volatility breeds opportunity, so why is everyone stuffing their cash under the mattress?

Volatility breeds opportunity, so why is everyone stuffing their cash under the mattress?

The financial markets appear to be going to hell in a handbasket, but the Euro is performing well. Why? The EUR is being supported by safe haven inflows as the selloff in the Eurozone bank stocks and peripheral bond markets is intensifying. The rise in Italian and Spanish bond yields has eroded the value of the bonds held by foreign investors recently. In turn, the drop in their Euro-exposure necessitated the reduction of the short-Euro hedges, with foreign investors forced to buy back the single currency in the FX spot market.

Rising concerns about the health of the Eurozone financial sectors remind us of the 2012 debt crisis when banks were repatriating money from abroad, supporting the single currency. The Euro could remain supported so long as the selloff in the periphery and in the banking stocks continues. However, if the bond yields continue to rise it could lead to a portfolio outflow from Europe, which would in effect be a mass selloff of Euros dragging the single currency down with it. Indeed, this was the experience during the selloff in the Eurozone stock markets last summer.

Fed chair Janet Yellen returns to the spotlight today as she testifies before Congress. Her speech will be keenly watched as other economic data is minimal for the week, and the Dollar has seen some big shifts both upwards and downwards in the recent weeks. If Yellen gives a bullish view, focussing on progress in several areas such as the employment market, this should push the value of the Dollar higher again. However, if Yellen presents a concerned tone focussed on the global markets’ volatility this would suggest no immediate rate hikes and is likely to cause the Dollar to lose further ground. Yellen is likely to leave the door open for a March hike without providing a strong signal in either direction, while indicating that the committee will assess all relevant data to determine the appropriate stance of policy at the time of the March meeting.

Yesterday, the UK trade deficit reduced more than expected at GBP9.9bn for December. However, November’s figure was revised higher to GBP11.5bn from GBP10.6bn and exports dipped lower over the month while there was a sharp widening in the deficit for 2015 as a whole (where GBPEUR averaged 1.3779). Britain is very good at exporting services but struggles with exporting manufacturing output, especially outside the EU and a strong Pound doesn’t help. If you are exporting, the Pound is cheaper now and so this is a good time to discuss hedging with your account manager.

UK industrial production data presents further risk to Sterling after the very weak data reported last month. Sterling will also continue to be influenced strongly by global risk conditions with fear tending to be a negative factor given current account pressures. The Bank of England is currently monitoring credit growth and would act to restrict lending if the rate of credit expansion accelerates.
Data to watch: 9.30 UK Industrial & Manufacturing Production (MoM & YoY). 3pm Fed Yellen testifies. 3pm UK NIESR GDP estimate.

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