Bank of America’s quantitative indicators suggest that investors have been positioning for a reduction in geopolitical tensions, resulting in a weaker U.S. dollar and relative strength in the euro, the Australian dollar and emerging-market assets, according to a report released on April 10.
The report notes that talks in Islamabad did not reach an agreement, yet the DXY - the U.S. dollar index - is trading near levels seen in the early days of the conflict. BofA interprets that placement of the DXY as evidence that market participants are pricing in at least some progress toward de-escalation, despite the failed talks.
Option flow and skew metrics enhance this picture, pointing to a market bias that favors de-escalation trades. Those order-flow and risk-premia patterns are particularly supportive of gains in the euro and in emerging-market assets, the bank said.
According to BofA’s technical matrix, momentum readings are turning positive for the euro, the Australian dollar and emerging markets. By contrast, technical signals for the U.S. dollar are characterized as more neutral than decisively negative.
Nonetheless, the bank counsels caution on the prospect of an extended period of dollar weakness. It stresses that, absent a durable ceasefire agreement, the probability of renewed escalation - or the emergence of fears about a global growth shock - could trigger dollar rallies. That risk profile leaves scope for the dollar to strengthen again if conditions deteriorate.
BofA also highlights a specific cross-rate trade: the bank is constructive on EURJPY regardless of how de-escalation developments unfold. The Japanese yen last week stood out among G10 currencies by neither receiving a spot boost nor benefiting from skew versus the dollar, the report notes. The yen’s downtrend versus the euro is supported, in the bank’s view, by positioning and investor sentiment.
Demand for EURJPY appears broad-based, with buying observed across time zones since the end of March. BofA adds that higher oil prices are likely to weigh on Japanese economic data going forward, which could render the yen more exposed to a persistent energy shock than the euro.
The primary countervailing risk to a higher EURJPY is intervention by Japan’s Ministry of Finance. However, BofA argues that with the dollar having moved lower since last week, the near-term likelihood of official intervention has diminished.
Key takeaways
- Quantitative signals point to a market bias toward de-escalation trades, benefitting the euro, Australian dollar and emerging markets.
- The U.S. dollar is trading lower but technicals for the dollar are more neutral and the bank warns of the potential for dollar rallies if conflict re-escalates or global growth worries surface.
- BofA is bullish on EURJPY irrespective of de-escalation outcomes, while noting intervention risk is the main constraint on further upside.
Impacted sectors
- Foreign exchange markets, particularly major currency pairs and the U.S. dollar index.
- Emerging-market assets, which are indicated as likely beneficiaries of de-escalation positioning.
- Japan’s economy and energy-sensitive data, given the bank’s view on oil price risk to the yen.