Complex Made Simple

Currencies’ storm ahead: Political risks come back into market focus

Following the lead from April, the second quarter of 2018 is shaping up to be an extremely busy one for the financial markets with volatility across different asset classes continuing to intensify last month.

The month of May saw a large range of different headlines keeping investors on their toes, most notably a return to political risk encouraging risk aversion from investors.

In case you missed it: Bahrain not in a good place financially, as debt soars

A hectic month

Last month was certainly a hectic one with news flow from the United States as President Trump attracted worldwide attention after pulling out of the 2015 Iranian nuclear deal as largely expected, before announcing later in the same month that the planned summit between himself and North Korean leader Kim Jong-un for June would no longer be going ahead.

Negotiations to prevent a potential trade war between China and the United States continues to remain ongoing behind the scenes; while many global markets received another scare late in the month following a sudden escalation of political uncertainty in Italy renewing concerns over populism in Europe and even the potential for Italy to call for its own EU referendum in the future.

One of the major talking points across the UAE and GCC region would, of course, be the news that President Trump pulled the United States out of the 2015 Iranian nuclear deal.

The price of US Crude peaked above $71 for the first time since November 2014 in the aftermath of the decision, as a result of traders pricing in additional risk premium into the Oil markets.

Outside of the price of oil, the market reaction was more limited to what was feared, although we did notice some risk aversion where investors were less inclined to take on added risk into their portfolios.

There hasn’t been a lasting impact on regional markets that by this development, but the news that other members of the nuclear deal would remain in the agreement could be the reason why regional markets were not as negatively impacted by the announcement.

What has been particularly interesting to monitor following the increased buying sentiment in the Oil markets is the recent news that OPEC and Russia could be planning to ease production cuts, which is potentially a consequence of major producers being concerned that the rally for the commodity might lead to another rebound in inventories from the United States. Higher oil prices are seen as a motivator for the U.S to increase its own production output, which was seen as the main catalyst behind why the price of Oil suffered such a severe nosedive from its peak in 2014 above $110 all the way to its milestone lows in early 2016 below $30.

Its today: Apple’s WWDC: iOS 12 is just around the corner

Good news or bad news?

While increased oil prices is seen as good news for all major producers of the commodity as it moves higher in value, the increase in price needs to be on a gradual basis to increase the chance of sustainability in valuations.

The likely reduction in inventories from Iran is not seen as the reason behind the volatility in the oil markets directly.

It is the concerns that such a rebound in the market could lead to increased supply from the likes of Russia, OPEC and eventual larger stockpiles from the United States has combined together to encourage sharp moves for the commodity.

All currencies pegged to the Dollar have strengthened since the expected news that President Trump would exit the Iran agreement, however, it is highly doubtful that this is solely due to the decision from Trump.

We have seen a dramatic turnaround in investor sentiment towards the USD due to a number of different reasons, but not linked to the implications of the United States exiting the Iran nuclear agreement.

The underlying strength of the economy in the United States and a realization that interest rate differentials between the U.S and its developed peers remain largely in favor of the United States.

The persistent buying of the USD from traders has resulted in currencies pegged to the Dollar, such as the UAE Dirham strengthening across the board.

The Greenback has advanced beyond 5% over the past two months, meaning those currencies pegged to the Dollar have enjoyed the same strength in the second quarter of 2018.

Related: Life after oil for the UAE

The UAE Dirham has advanced significantly 

Against the Euro, the Dirham has gained nearly 6% already this quarter; while the Dirham has also strengthened by just below 5.5% against the British Pound so far in the current quarter.

The outlook is that the Dirham should continue to maintain gains against both these currencies unless the United States administration intervenes to talk down the Dollar strength.

Visit FXTM here