Monday was all about the re-pricing of risk. That’s not such a bad thing given that there were signs that markets were getting complacent once again. The VIX measure of equity market volatility is perhaps the best measure of this, in light of its liquidity. This was nudging below the 15.0 level towards the end of last month, a level that has not been seen on a sustained basis since the late 2006 and the early part of 2007 (and less than 0.5% of the time since September 2008). We now know, in part with the benefit of hindsight, that markets were massively under-pricing risk at that time. Therefore, the fact that the VIX is now above 20 and the dollar has regained some of its poise should be broadly welcomed as a sign that investors are being a little more realistic regarding the underlying risks to the global economy and euro zone sovereign risk in particular.

After dropping as low as $1.3970 (its lowest level in two months) versus the dollar yesterday, the euro appears to have stabilised on the back of some short covering demand and bids from Asian central banks. Stable commodities and regional share prices also helped stem any further decline in the euro overnight. Meanwhile, versus the Swiss franc, the euro found some support in comments from the vice chairman of the Swiss National Bank expressing worry about the recent rise in the currency. However, despite moves overnight, market sentiment remains generally bearish on concerns about euro zone sovereign risk.

Data released this morning confirmed that the German economy grew by 1.5% in Q1 of this year, with the detailed data showing that the recovery is broadening further. However, there are some concerns that the pace of recovery will ease in Q2, with the flash manufacturing and services PMIs for May, which were released yesterday, disappointing. Today sees the release of the German Ifo index for this month, which will also be important in terms of providing direction on the current pace of economic activity.

Though currently off yesterday’s two month highs of Stg0.8663, sterling continues to benefit from the euro’s woes. Upside momentum, however, is seen as limited with the GBP sticking close to seven week lows versus the USD as investors cut exposure to risky assets. This morning’s comments from ratings agency Moody’s warning of downgrades of UK banks is also likely to hit sentiment. Today sees the release of the CBI distributive trades survey for May, which is expected to show a fall back after April’s strong reading.

Regards,

Tom Trevorrow
Senior FX Trader
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