Sweeping unidirectional moves across many asset classes last week saw the most liquid FX market begin to experience liquidity problems and may have triggered a margin call cascade. Early on Monday morning, the pound sterling and the euro struggled to find buyers for several minutes, while the dollar index set a new high (114.50):

Dollar index, EURUSD, GBPUSD, 1M timeframe

The spike in the GPBUSD reached the level of 1.03. Subsequently, the EURUSD and GBPUSD partially pared down the fall, however bullish sentiment in the Pound remains extremely weak and the risk of speculative pressure suggests the pair will likely continue to explore new lows in the near term. FX option markets price in 28% implied one-week volatility in the GBPUSD which is also a strong sign that a sell-off is far from over, especially without verbal or policy intervention from the Bank of England.

European markets trade in green, however gains are limited by half a percent. The US futures trade near opening, indicating that the market has largely factored in recession risks from the Fed’s hawkish position, outlined last week at the FOMC meeting, as well as short-term consequences of a new round of geopolitical tensions. Therefore, barring new shocks, especially from geopolitical front, consolidation in the risk asset market seems to be a more likely scenario this week than extension of the downside.

Nevertheless, bearish pressure persists in sovereign debt markets due to inflation and policy tightening concerns. Yields rise across all maturities, but if in the US this is due to fears of an excessive tightening from the Fed, then in the EU and the UK, yields rise amid expectations of a fiscal stimulus (increasing bond supply from the government) and fears of a sticky energy-driven inflation. The downtrend in European currencies, together with the fact that they are dependent on energy supplies, creates a vicious circle in which the swelling trade deficit puts pressure on the exchange rate, which creates even greater fears of an imbalance in foreign trade in favor of imports. Falling oil somewhat eases the development of this trend.

Bearish sentiment also prevails in Asian FX. The onshore yuan made another jump upwards on Monday, the USDCNY tested 7.15. The PBOC intervened by increasing the reserve ratio for the foreign exchange forward deals to 20%, thus limiting upside pressure on the exchange rate. The weak yuan also explains the negative performance of the currencies of emerging markets, as well as the currencies of China trading partners in G10, where its share in trade is large, such as the AUD and NZD. Both currencies on Monday weakened against the dollar by about half a percent.

The economic calendar this week is quite boring, with the U.S. durable goods orders due on Tuesday, GfK German Consumer Confidence on Wednesday, German September inflation report (preliminary estimate) and the final estimate of the US GDP growth for 2Q on Thursday. On Friday, the report on inflation in the Eurozone is due, core inflation is expected to show acceleration from 4.3 to 4.7%, possibly prompting more policy response from the ECB.