Investors getting jittery

USD traded sharply higher against all of the major currencies on Tuesday as Treasury yields surged and stocks plummeted. With several factors driving investors out of risk assets, FX traders need to beware of the possibility of risk aversion intensifying over the next few days.

From surging commodity prices, the prospect of tighter monetary policies, risk of the US government shutdown and even a credit default, there are plenty of reasons to be worried.

The cost of natural gas is skyrocketing and the increase is spilling over to oil. In the last 2 days, natural gas prices rose more than 10% and in the past year, it is up 180%. Heading into the cooler fall and winter months, households will be hit by significantly more expensive heating bills. The energy crisis is so severe that in countries like the UK and China, there have been forced blackouts and factory shutdowns.  In some Chinese provinces, traffic lights have been turned off.

Aside from having a direct impact on pocketbooks, higher natural gas and oil prices is also a problem for inflation. In comments made today, Federal Reserve Chairman Jerome Powell admitted that “it’s fair to say that” inflation is broader, more structural and more concerning than earlier this year. More specifically he said supply chain constraints like shortages of chips “have not only not gotten better – they’ve actually gotten worse.” Stickier inflation increases the need for less accommodation, which is positive for rates, negative for stocks and risk currencies. Considering that no one expects the energy crisis or supply chain bottlenecks to be resolved quickly, risk aversion could intensify, leading to demand for USD, JPY and Swiss Franc.

Treasury Secretary Janet Yellen warned that the government would not be able to make all of their payments if the debt ceiling is not raised by October 18th.  Companies like JPMorgan said they have begun preparing for a potential US credit default. Although it is very unlikely, if that happens the consequences for the markets would be brief but significant. Equities and currencies would fall sharply.

The government’s current funding expires on October 1st and lawmakers are rushing to pass legislation that would avoid a partial shutdown. There’s a lot going on in Washington this week and the battle on Capitol Hill is hurting and not helping risk appetite.  Consumer confidence weakened in September and given recent developments, we expect further deterioration this month.

With no major economic reports on the calendar on Wednesday, equities and Treasuries will drive currency flows. The Bank of England and Reserve Bank of New Zealand may be two of the least dovish central banks but their currencies have been hit the hardest by risk aversion.

The UK is dealing with its own petrol crisis worsened by driver shortage. EUR remains the most resilient, experiencing only modest losses due to euro’s low yield. Risk aversion is normally negative for USD/JPY but 10 year Treasury yields which rose to its highest level since June is having greater influence on USD flows.

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