The news headlines rang out today that Russia’s leader Vladimir Putin gave the orders to send “peacekeeping” troops into two breakaway regions of Ukraine. Stock market futures reacted instantly. Yahoo had a particularly dramatic headline declaring that futures “tanked.” Reflexively, I checked CNBC to review the preliminary damage: S&P futures down 1.8% and the NASDAQ futures down 2.5% at the time of writing. These declines hardly register in the “tank” category, but they are losses nonetheless. However, when geo-political drama appears to impact stocks, I strongly prefer to watch currencies as a more accurate reflection of sentiment. The story in currency markets is much different…so far.
In fact, according to the currency markets, nothing dramatically new has happened yet. The Australian dollar versus the Japanese yen (AUD/JPY) dipped slightly and then rebounded higher than its price at the time of the news. The euro traded ever so slightly lower against the dollar. EUR/USD continues to cling to the 1.13 level and is not even trading below its intraday low from last week.
Watch Currencies
So why watch currencies over stocks in this scenario? First of all, stock futures are not liquid and are thus subject to over-reaction to the news of the moment. More importantly, currency markets reflect global opinion much better than the U.S. stock market which is dominated by U.S.-based traders. Currency markets are highly liquid during almost all hours of the day for the major currencies. If something happens that will impact global financial markets, currencies will immediately reflect trader’s short-term opinions.
I write often about why AUD/JPY matters to traders. AUD/JPY tends to reflect short-term risk sentiment. The current message from AUD/JPY: hold steady everyone. AUD/JPY remains mired in the churn that has dominated almost two weeks of trading. EUR/USD is a supplementary measure in the case of the tensions over Ukraine. The euro zone, and Europe in general, will feel the most direct impact of fallout from war in its eastern reaches. Both the yen and the U.S. dollar should serve as havens for flight to “safety” trades. The current message from EUR/USD: hold steady everyone.
The Trade
These observations are of course all short-term in nature. The long-term implications of the invasion of Ukraine is impossible to know until all the parties implement counter-measures and subsequent counters. Certainly, it is tragic that once again the lives of potentially millions of people will be negatively impacted by the decisions of a select few who deign to dictate their will over others. For financial markets, I prefer to follow rather than predict. In this case, I will likely buy into a large gap down open on Monday if AUD/JPY and/or EUR/USD do not trade substantially lower in parallel. In that case, I will assume that the typical gap fill trade will be in play. I will post in the comment section what I decide to do.
Note that I am long AUD/JPY in anticipation of a short-term rebound toward the recent highs of the churn. I am short EUR/USD as a longer-term bet on a widening divergence of monetary policy between the U.S. and the eurozone. (Speaking of which, imagine the Fed’s new conundrum. Typically, geo-political tensions can give the Fed the excuse it needs to keep easy monetary policies in place. Yet, inflationary pressures demand the end of the emergency monetary measures that remain in place almost two years since the start of the pandemic).
More than ever, be careful out there!
Full disclosure: long AUD/JPY, short EUR/USD, long QQQ and SPY call and calendar call spreads
Thanks for commentary. Not sure what tensions is Ukraine will do to markets overall, however should continue to further boost commodity stocks.
Question on Gap fill? I have been watching this for a while just to see how this takes place, as often times Gaps are filled, but certainly at times they are not….or can take weeks to months to “fill”. How do you typically decide to play that trade or not?
I was reviewing your churns zones this weekend and the way things were looking on charts, I was going to go with a Call debit spread on SPY or QQQ if they got near the bottom of churn zone. Looks like that might happen at the open.
The expected buying started before the open, so there is no real “fill the gap” trade. That is, the gap is not big enough to make a buy at the open worth the risk. The S&P 500 opened down around 0.4% and the NASDAQ down about 0.7%. Both AUD/JPY and EUR/USD rallied into the U.S. open.
My trade idea for this post was to buy into a large gap down at the open. I didn’t have a specific trade in mind and was going to let the pricing determine it. Preferably, I would have loaded up on straight SPY and/or QQQ call options. I suspect the pricing would have been so high that I would have either SOLD put spreads and/or bought call spreads (including calendar calls).
I definitely want to buy at the bottom of the churn zone assuming the VIX is surging at that point and we are back to or “close enough” to oversold.