Global stage is set for a geopolitical drama

The global stage is set for a geopolitical drama that's making Hollywood thrillers look tame. In the Middle East, the US is playing the role of the concerned parent, warning of a potential blockbuster retaliation from Iran or its proxies on Israel. This comes after a dramatic plot twist involving the assassinations of key Hamas and Hezbollah figures. Amidst these tensions, there's a subplot of shaky cease-fire talks between Israel and Hamas, trying to find some semblance of peace in the script.

Meanwhile, over in Europe, Ukraine has launched its boldest foray into Russian territory since the 2022 season premiere of their ongoing conflict is sending European gas prices through the roof—reaching a season-high, no less. Both sides, however, seem keen to keep the gas pipelines, a crucial lifeline, open to Europe, even as the battles rage near key transit points.

As for the commodities market cameo, oil prices are making a modest comeback, hovering around US$82 per barrel, not quite reaching their previous season highs of US$86-90.

Amidst this backdrop of uncertainty, economic surprises continue to roll in from major players like China, Europe, and the US, staying stubbornly negative. We're all eyes on the horizon to see if these trends will flip, setting the stage for the next episode of global financial markets and FX trends. And yes, all this just in time for the next big reveal: the US CPI inflation data. Strap in; it’s going to be a bumpy ride.

The JPY trade

On the JPY front, I've found it to be a superb hedge in scenarios where macroeconomic tremors threaten to rattle the equity markets, particularly those tremors that echo from the U.S., leaving a noticeable dent. However, when it comes to shielding against geopolitical shockwaves—like an oil crisis—JPY doesn't quite cut it. Japan's hefty oil import bill means that the yen doesn’t offer the best cover during oil shocks.

This limitation played out vividly in yesterday’s London session when the USDJPY suddenly perked up, trading above 148.00 USD/JPY.

Looking toward the CPI, the market lean suggests traders will react more sharply to a CPI miss to the downside rather than an overshoot, suggesting a strategy to fade any upward spikes in USDJPY. Why? The market sentiment is tilting, with the Fed increasingly focused on shoring up the labour market as part of its dual mandate. The Fed will likely take a small inflation overshoot in stride.

With an eye on the simmering tensions in Eastern Europe, the backdrop of rising European gas and global oil prices adds a layer of complexity. From 2022, we know that spikes in energy costs tend to prop up the dollar—a historical tidbit that should not escape any dollar traders' purview.