The desk believes that current FX market complacency could be misleading given the geopolitical risks and cyclical pressures highlighted by J.P. Morgan. With energy prices potentially rising due to supply shortages and geopolitical tensions, the desk is particularly focused on the performance of energy importer currencies such as the Euro and Sterling. Per the full note source, the desk anticipates a stronger dollar against these currencies, especially if oil prices surge towards $120-$130 per barrel, which would exacerbate terms of trade impacts. As the market navigates these dynamics, the potential for a shift in equity performance could further influence FX flows.
What the desk is arguing
J.P. Morgan's thesis centers on a wariness towards complacency in the FX markets, particularly given the unfolding geopolitical landscape and its potential cyclical implications. They argue that a lack of responsiveness to these risks could lead to unexpected volatility, especially in emerging markets (EM).
Supporting this view, the firm points out that while current macroeconomic indicators suggest stability, historical patterns show that geopolitical disruptions often trigger significant shifts in investor sentiment. The commentary implicitly rejects the notion that the current calm in FX is indicative of lasting stability, warning instead of the dangers of underestimating emerging threats.
Where it sits in our coverage
Our consensus target for the relevant currency pair stands at 1.075, with a firm spread ranging between 1.04 and 1.12. This cautiously optimistic outlook aligns with J.P. Morgan's target of 1.10 for March 2026, reflecting a shared belief in the potential for upward movement, albeit with noted risks.
Specific firm targets further illustrate the divide among banks:
While J.P. Morgan remains wary of complacency, BofA takes a contrary stance, advocating for a lower target of 1.04, indicating a more bearish outlook on the currency pair amid expected volatility. On the other hand, firms like Barclays echo a more tempered view, with a target of 1.08 suggesting a gradual improvement amidst the geopolitical concerns. This divergence showcases differing perspectives on the sustainability of the current FX environment and the perceived risks ahead.
01J.P. Morgan warns of complacency in FX markets amidst geopolitical tensions.
02Market vulnerabilities, particularly in emerging markets, could lead to significant shifts.
03Consensus suggests a cautious outlook aligned with J.P. Morgan's targets.
Market implications
Traders may need to reassess their positions in light of the heightened geopolitical risks, as complacency could lead to sharp corrections. Investors focused on emerging markets should particularly brace for increased volatility, which may impact overall market liquidity and sentiment.
Risks to this view
The primary risks involve sudden geopolitical escalations that could disrupt market stability and lead to rapid shifts in currency valuations. Additionally, economic indicators may evolve, challenging existing forecasts and pushing market participants to adjust their strategies accordingly.
Welcome to the At Any Rate podcast. I'm James Nelligan from FX Strategy here in London. And I'm here with Jaynik Modi from our EM equities research team.
We're just going to discuss the week's main macro themes and our views going forward on the markets. So, you know, at the time of recording here, I think markets are looking a little bit complacent to us in terms of the price action, I think, obviously, with all the usual caveats around the binary risk of geopolitical headlines that we've seen too many times over the last several weeks. But it looks like we've had a little bit of a dead cat bounce this week across asset classes as Trump has kind of dangled this idea of a potential end to the war once again into the markets view.
I think it's hard to disentangle that, though, from the impact of quarter end flows this week on Wednesday, which did seem to be quite significant across asset classes. So, you know, after that, we did get a speech from Trump last night, which didn't really seem to say much new, but instead kind of repeated this idea that potential two to three week horizon for the end of the war is what he's kind of thinking about. And, you know, the market's taken this OK so far, but we're seeing a little bit of complacency here.
I think there's just risk that this potentially now brings into play. Well, first and foremost, some of the retaliation risks that everybody knows about. But, you know, secondly, some of the issues around shortages, not just in the oil market, but some other products, you know, whether it be helium or sulfur and how that impacts the business cycle.
And of course, you go back to oil and you think about this kind of rolling geographic supply shortage that our strategists in the oil markets have been talking about, you know, the shortage kind of rolling geographically from Oman through to signs of it in Kenya recently. And then lastly, the West in terms of the Brent oil price and that two to three week timeline from Trump, you know, has the market thinking about that, that potentially starting to reach the Brent oil price, et cetera. So, you know, there are cyclical impacts here, which I think, you know, the market is potentially potentially underestimating.
The way we're kind of focused on them here is via energy importer FX. So, you know, the likes of Euro, Sterling, Stock Key, Kiwi in G10. We do have a view in terms of dollar strength versus the energy importers.
You know, we've been running that for some time now. You know, there's the terms of trade impacts there. I suppose one risk that we're watching to that for that at the moment is relative equity performance and how the market sees the impact of some of these shortages on different geographies.
So, you know, if we were to see U.S. equities underperform more and more noticeably versus the rest of the world, that that is a kind of risk that we're watching. But ultimately, you know, if you do see oil heading up to, say, 120, 130 dollars a barrel, there are almost mechanical terms of trade impacts there and associated cyclical impacts, which should mean that the energy of energy importers underperform the dollar. But we are thinking about more nuanced expressions, more beta neutral expressions, which still have a relative terms of trade angle to them.
So, you know, the likes of Aussie versus sterling and stocky as a kind of basket view. And, you know, that's something that we think has interesting properties in terms of some of the more bottoms up factors for sterling and stocky in this in the sense of the local elections in the UK, some of the data and seasonality and stocky. But I think you're thinking a bit more around this complacency.
You know, it's worth thinking about some of the pairs that do have a bit more of a clear beta response to risk sentiment in the FX space. So one pair I quite like on that view is something like euro sterling, where the market initially in the conflict thought about euro sterling in terms of rates, you know, the typical rate spread response and, you know, in terms of trade being slightly more of an issue for the euro than the UK. But I think that the longer this conflict goes on, the more we risk sterling's stagflationary reaction function kicking in.
I think that's what we've seen over the past week. And I think, you know, if this two to three week timeline is really, you know, has meaning behind it, then, you know, I think we could well see euro sterling headed towards the 88 type level in spot terms. I'll leave it there on FX for now.
But we do, as I say, have Jaynik on the podcast here this week, keen to hear about views and other asset classes and maybe think about how that translates into FX. But Jaynik, turning to you. So EM equity has obviously been hit quite hard during this conflict.
Are investors kind of treating this as another buy the dip moment in EM? And would they be right to do that? Or what are you what are you guys thinking here?
Yeah, thanks, James. Thanks, James. So I've been covering EM equity strategy for nine years and now looking across asset strategy.
But I think I can still give a bird's eye view of what's happening with the asset class. The regional dispersion actually has been extremely striking. So what we've seen in the month of March is MSCI EM fell 13.3%.
This was the worst month since March 2020. And geopolitics was the dominant factor. Energy supply risks are the most acute in Asia, given its heavy dependence on Middle East imports.
Within Asia, we have China, Korea, Taiwan and Malaysia that appear to be better positioned to avoid shortages supported by reserves and fiscal buffers. Despite this, Korea was actually the worst performing market last month, nearly down 25% in dollar terms. And this is because of its cyclical tilt, higher beta and strong pre-conflict run.
On the other side, resilience was more evident in Latin America, especially the oil exporters. Colombia was actually up 7% and Brazil was down only two, emerging as relative safe havens within the space. Now, if you look at the consensus expectations, the picture in my view is simply too rosy.
The street is forecasting a stellar first quarter for MSCI EM with net income growth of over 40%. This is where I think clients need to be a little bit more cautious. Those numbers haven't been touched since pre-conflict.
Analysts across the street seem hesitant to revise too soon, worried that they might get whipsawed if the conflict resolves quickly. But history tells us that during oil supply shocks, meaningful earnings downgrades typically happen with a two to three quarter lag. So what looks like resilience today is more likely just a delay.
It's worth remembering that roughly 28% of MSCI EM benchmark has negative beta to oil prices. This is spanning across consumers, real estate, utilities, and healthcare. So that's just to say that when revisions do come, they won't be evenly distributed.
Even if we have a resolution, normalization of energy flows will take three to six months, especially in EM. During a typical supply driven oil shock, EM equities have actually declined 31% peak to trough, typically bottoming three to five months after the shock. We're only one month in.
We haven't seen extreme capitulation yet. So if history rhymes, there could be more downside before we find a floor. So how are we positioned in EM?
We believe EM and more specifically MSCI Asia X Japan should trade weaker from here for the next three to six months. The allocation for EM has changed. China is the most preferred market now.
We are also finding some shelter in energy exporters, both in Asia via Malaysia and Latin America via Brazil. But at a stock level, a barbell approach across EM makes sense. Energy exposure on one end for further upside in prices, quality growth names in the middle that should outperform and then defensive yield on the other end for protection in case the market moves sideways or down.
The bottom line is we're navigating a significant supply shock across markets. Consensus earnings still affect the shock world and revisions are coming. There will be tactical temptation to buy the dip on ceasefire hopes and that may well work in the near term.
But structurally, the damage to supply chains, food security and financial conditions will linger. Selective exposure across EM equities is the name of the game. James, another region that feels like it's going to be facing adverse effects from this conflict is Europe.
Given your focus on European currency space, what are your views and how are they evolving more specifically? Yeah, thanks for that, Jaynik. I think, you know, first of all, you paint a bit of a bleak picture there for EM equities.
And I think that does translate nicely over into our FX views at the moment in terms of, you know, I was flagging potentially one risk to our view is that US equities underperform a bit more than other markets. But, you know, hearing you talk about EM equities there, it's just kind of hammerhomes the point that these other markets around the world, whether it's EM, Europe, that there's very cyclical in the way they're constructed, you know, and to expect that not to be capital outflows if this situation does escalate, I think is wishful thinking. And that does map quite well over into the high beta currency space where we think about currencies in Europe like stocky, sterling, even even nocky when times do get particularly tough.
So, you know, focusing in a little bit on stocky, obviously, the domestic data is taking a little bit of a backseat these days to the geopolitical headlines, but we do get Swedish CPI next week. And our economists are one tenth below consensus on core inflation. We did see the Riksbank kind of map out a an alternative scenario to their rate path, which talked about a potential 100 basis points higher in the policy rate over the next 12 months on the more kind of adverse geopolitical scenario.
And so, you know, that that is that itself obviously would be a bit of a hawkish outcome. But I think that for the currency, it's a bit of a it's a bit of a, you know, a red flag there, because you think about stocky, it's been pretty much the poster child of the global growth trade that we saw from kind of November through to February, where we saw that repricing of the business cycle in a pro cyclical manner. You know, stocky was really the poster child for that because you had repatriation flows coming back to Sweden from the US at the same time as we were looking at Swedish growth, potentially up at two and a half percent this year.
You know, we're one of the you know, among the highest upgrades potentially in G10. You know, now now you really have to question all of that. And obviously, with the energy importer status, that compounds the problem as well.
So we wouldn't be surprised to see euro stocky heading up towards the kind of 1110 1120 type area. If the market does start to come around to this idea that, you know, a two to three week timeline that Trump has, has laid out does still leave material risks on the on the table. You know, the other the other side of the European space, sterling, you know, I spoke earlier on about thinking about it against the likes of the Australian dollar, where you have, you know, the opposite terms of trade dynamics, and you also have kind of an inability of the market, or maybe unwillingness of the market to buy as much sterling as it otherwise would have done on de-escalation in the conflict, when you have local election risk coming up for the UK on May 7, in terms of the local political risk there, which should which could see pressure on PM Starmer step up materially if if there's a poor performance there from from Labour.
And we have Angela Rayner waiting in the wings as a bookies favourite now for the for the next Central Prime Minister role. Obviously, she has ongoing investigation from from HMRC into into the tax situation to still to resolve. But, you know, that that is something we've had a a few articles suggesting that that could be well resolved before the local elections take place, potentially kind of clearing the way for her to, to make a charge.
But we're also quite wary of the risk that given the conflict is ongoing, you know, is there a kind of continuity factor here, where, you know, a leadership challenge is potentially delayed a little bit, given that given that the conflict is ongoing. So there is some uncertainty there. And we're also open to the risk that we as we talked about last week that, okay, inflation has been revised higher globally, but growth as yet is still kind of, you know, well, it's not been revised anywhere near recession type levels.
So that kind of high inflation, moderate growth type scenario and could end up where we're sterling sterling carry becomes, becomes more attractive than not. However, before we answer those kind of questions, I think there is there does seem to be a little bit of complacency here in terms of if this conflict really is ongoing, there's retaliation risk, there's shortage risk in products other than just oil. And there's the risk of Brent heading up to 120.
I think that has that would have more immediate ramifications for Sterling, and be thinking much more in that scenario around the currency's stagflationary reaction function in response to any kind of more pronounced move in the gilt pocket. But we'll leave it there for this week. Thanks, Jainik for joining me.
Interesting to get perspective from from another asset class and think about how that overlays into into FX. So that's all for this week. Thanks, Jainik.
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