The major FX rates have remained relatively stable at the start of this week in contrast to the deepening sell-off in the equity markets. One of the biggest movers yesterday was the Nasdaq composite index which fell sharply by 4.0% and extended its decline since the high in December to almost 14%.
At the same time, the VIX measure of US equity market volatility has risen to its highest level since early last summer when carry trades unwound abruptly after the BoJ hiked rates in late July.
The heavy sell-off for US tech stocks overnight and broad-based equity market weakness reflects building fears over the outlook for global growth. Comments from President Trump stating that there’s going to be transition period for the US economy and signalling that he still plans to implement further tariff hikes in the coming months have added to market concerns. Worsening conditions for risk appetite amongst investors have reinforced demand for US government bonds putting further downward pressure on US yields.
It has resulted in the 2-year Treasury yield falling to fresh year to date low yesterday of 3.83% while the 10-year US Treasury yield fell back below support from the 200-day moving average which comes in at just above 4.20%. US rate market participants have moved to price in more Fed rate cuts in the coming years in response to building growth fears. However, the spill-overs into the FX market from the deepening sell-off in the US equity market have been limited so far.
The commodity currencies of the Australian, New Zealand and Canadian dollars have all underperformed modestly at the start of this week while the Norwegian krone, yen and euro have outperformed. If the period of risk aversion continues to intensify it remains to be seen whether the US dollar will weaken further alongside the decline in US yields and US equities which has been the relationship that has been in place since the start of this year, or whether the US dollar begins to drive more support from a pick-up in safe haven demand. Heightened US policy uncertainty created by President Trump is raising doubts over the US dollar’s safe haven role alongside the unwinding of popular US tech trades.
The euro has benefitted at the start of the today’s European trading session from reports that the Green party in Germany are now ready to negotiate with Friedrich Merz over his plans to significantly boost government spending on defence on infrastructure, and are hoping to reach an agreement by the end of this week. The Green party’s co- head Franziska Brantner told Bloomberg news that “of course we are ready to negotiate” and added that “the situation is dire in Ukraine and we really need Europe to step up its defence spending”.
While the Greens won’t be part of the next coalition government in Germany, their support is needed to pass legislation through parliament to unlock funds for a significant increase in government spending. The Greens have proposed raising the threshold for defence spending exemptions to 1.5% of GDP compared to Chancellor-in-waiting Merz’s plans to set at 1.0%. Market participants remain optimistic that a deal will be reached with the Greens to pass legislation before the newly elected Bundestag convenes by 25th March at the latest. The prospect of a significant fiscal support is helping to ease concerns over downside risks to the growth outlook for Europe.
