Geopolitical concerns have financial markets behaving in a cautious manner to start the new trading week, as flare-ups in Iraq and Ukraine are causing investors to rotate into perceived safe-haven asset classes.  Combat between the Iraqi military and the Sunni insurgents continues in Northern Iraq, though their progress has been stalled with counter-strikes from the Shiite government. It has also been reported that Iran is preparing to send troops to Iraq to help with the insurgency, and that under certain circumstances the White House could open direct talks with Iran on how to coordinate support for the Iraqi government. At this point oil production has not been greatly affected by the conflict as it has taken place mainly in the north, though if oil supplies do see a large disruption, a spike in Brent north of $120/barrel would not be out of the question; currently the global benchmark is sitting roughly unchanged at $112/barrel.
Also adding to the nervousness in global markets, the talks between Ukraine and Gazprom have broken down, with the Russian energy giant saying it will only provide enough gas to Ukraine’s pipeline network to cover demand from other European countries. This was after an agreement could not be reached for ongoing prices of natural gas supplies to Ukraine, along with the payments in arrears currently owed to Russia.  The Russians had agreed to drop the price to $385 per 1000 cubic meters, yet Kiev decided to play hardball and not budge above its interim offer of $326 per 100 cubic meters. With less usage in the summer and its current stockpiles, Kiev said it expects to be able to meet demand until the fall, so it’s likely the negotiations will continue until it is absolutely necessary for Ukraine to get the gas flowing again.
The combination of the two geopolitical events has safe-havens like the Japanese Yen and fixed income garnering trade flows this morning, while global equities having trouble coming out of the starting blocks as S&P futures are pointing to a lower open to kick of the new week.  USDJPY has lost the 102 handle to the downside, with the yield on the 10-year US treasury dipping below 2.6% as bonds outperform. The Loonie is weaker against the USD this morning, hurt on the flight-to-safety trade that dominates market action. USDCAD has picked up from the bottom end of it’s recent range and is heading into the high-1.08s, despite an encouraging sign in April that foreigners added $10.1bn of exposure to Canadian securities during the month. The inflow into corporate debt and equity markets is a positive sign for the Canadian economy, and should continue throughout the year as the energy industry in the West records record levels of revenue which will spur cap-ex, and should help keep the Loonie from experiencing another drastic drop even if the export sector fails to pick-up over the coming months.  Â
The Week Ahead…
Although the macro-economic data points to be released throughout the upcoming week will likely be insufficient to greatly alter the global economic landscape, there are a number of key reports and central bank action for participants to decipher.
After Mark Carney’s comments from last week highlighted the divergence in monetary policy stances between the Bank of England and the European Central Bank, the UK will see CPI for the month of May drop early on Tuesday, followed up by the monetary policy minutes from the last BoE rate decision a few weeks ago.  The pace of consumer price increases within the UK economy has consolidated after peaking in June of last year, and has given Carney more leeway to keep rates low while the economy chews through some of the excess slack. Now with prices with forecast to stabilize around the 1.7% level on a y/o/y basis, a bottoming for the CPI index could have Carney beginning to think about the optimal time to begin the gradual normalization of rates. While Carney’s hawkish comments that a rate hike might unfold sooner than the market anticipates has sent the Pound within spitting distance of the 1.70 handle against the USD, a dissent showing up on the voting card of the MPC would spark further speculation the rate hike could come as soon as the end of 2014, keeping the Sterling rally alive and well. It’s no far stretch to think GBPUSD could be trading comfortably in the low 1.70s later this week should a strong CPI report and hawkish MPC minutes materialize, though another failure to overtake the 1.70 handle would be a negative technical development for long-GBP participants.
Another central bank that is getting close to tightening policy will also be in the spotlight this week, as the Federal Reserve holds their two-day policy meeting that will concludeon Wednesday. While growth has experienced a welcome pickup from the sharp contraction in Q1, the resulting rebound has been less than stellar, as consumer demand was shown to have moderated in the first few months of the second quarter. That being said, the labour market has remained resilient year-to-date, with the ancillary data like average workweek hours and earnings picking up, showing some of the notable slack in the labour market may be tightening. While the autopilot of a $10bn/month taper program is unlikely to be in jeopardy of seeing a change, the risk heading into the report is one of a hawkish nature, and that of further upside for the USD. Even with the Fed acknowledging the contraction in Q1 was greater than originally anticipated, the likely downward revision to the end of year unemployment forecast and potential for an upward revision to PCE forecasts may flow through to the FOMC’s dot plot of interest rate projections, and thus warn a tightening could be expected earlier than the mid-to-late 2015 market mindset. In addition, this will be the first meeting of the new Vice Chairman Stanley Fischer, the former Bank of Israel head, and could skew the spectrum of the board to one that is slightly hawkish than before his appointment.
While the early part of the week will be quiet from a domestic economic standpoint, CPI figures for the month of May to be released on Friday should liven things up for the Loonie. Expectations are for the temporary effects of higher energy prices to continue, with the headline print breaking above the 2.0% handle on a y/o/y basis, while the core print remains slightly more subdued at 1.5%.  We would caution the CAD bears that the larger, fat-tail risk for the CPI numbers on Friday is one that surprises to the upside, and has market participants questioning Poloz’s dovish stance on inflation; though, subdued retail sales, an uncertain labour market, and less than stellar external demand should keep inflation from getting out of hand, so the greater likelihood is to see prices remain close to the 2.0% level.
Further reading:
CPI figures
AUDUSD Could Rally To 0.9600 Before Turning Down
CPI figures
