Why FX Conditions Can Deteriorate in the Months Ahead?

The market sentiment is now “risk-on”, which pretty obvious considering the US dollar continues to lose ground, while currencies like Euro or the Pound continue to gain. However, this market had never been so fragile, raising concerns for a deteriorating environment in the months ahead. In case you are too euphoric about the market outperformance, here are four of the reasons why you should keep your feet on the ground, and remain rational in a shaky environment.

risk sentiment in FX
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# Liquidity issues followed by solvency issues

All that central banks had done in the past few months is extending loans to solvent entities. Solvency is the key issue here because economic activity is far from the 2019 peak, which means most of the companies have lower revenues. Combined with higher debt, it is not beneficial in the long run, since it will further dampen the economic recovery. The market is not pricing insolvency issues in the months ahead, but it should be a variable to be taken into account.

# US election

November 3rd is the date for the US election, a high stakes event which could influence how global politics will be run in the next four years. Also, the domestic situation is not to be excluded, considering the US is still the most powerful country in the world. Based on the pools, a change of power is likely to take place, with Donald Trump projected to lose against Joe Biden. However, as the last election had thoughts us, we should remain cautious, and that will be the market mood until the final result will come out.

# Poor economic output

The COVID-19 pandemic had generated the sharpest economic decline since WWII. Despite massive interventions from central banks and governments, consequences will be felt for years to come. Currency debasement seems like a done deal, but what will be the winning names and the losing ones? Are exotic pairs favored, or the investing community will continue to buy the traditional safe havens like the Yen, US Dollar, or Swiss Franc?

# Rising conflicts between and inside countries

Social unrest and political conflicts are on the rise, accelerating now that the pandemic continues to spread. Unexpected negative events will dampen markets in the short-term and generate flights to safety. We can speculate on when that will happen, but we can be certain the world is changing and change comes with negative implications in the short run.

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