FX Week Ahead - Market In Need Of Brain-changer, Not Game-changer
Rajan Dhall | Sep 25, 2017 06:22
After the FOMC meeting last week, it was (yet) again apparent that the Fed are still keen to maintain a normalisation path designed to not only get rates back to neutral levels, but also build up the policy tool kit again as well as staving off excessive leverage which has boosted stock markets to record highs. In the latter part of that, many of us believe we have already gone way past the point of excessive, and therein lies the delicate situation the Fed is faced with. As such, it is steady as she goes, and as we can see with the plans on balance sheet reduction, the reinvestment caps are barely scratching the surface.
On these bases, the market is happy to continue 'taking on' any USD recovery, and alongside this, we also have a persistent bid in the EUR, as the pace of economic expansion shows greater acceleration in Europe - what we call gamma in the options market. Consequently, the prospects of a meaningful pullback in EUR/USD look slim, but over-exhaustion and the constantly communicated concerns from the ECB limit gains to the degree that sellers above 1.2000 are also a little more confident in 'playing the range' for now. As we noted a few weeks back, 1.1800 will prove to be a strong support point given president Draghi revealed this level as the reference point in the last staff projections, and will be seen to be tacit 'acceptance' of fair value - for now.
On Friday, we saw the EU wide PMIs pointing to continued expansion in activity, and looking to the 5 days ahead, we expect the German IFO survey on Monday to do the same. Midweek we get Italian trade and industrial orders which have also been improving at a rapid pace, while in Germany again, we get September inflation data, retail sales and unemployment. At the end of the week however, we also have EU wide inflation, but this will have to dip significantly to derail EUR sentiment.
So from the US perspective, Thursday's final Q2 GDP number will be the focal point, preceded by the volatile durable goods orders reported the day before. This is expected to remain at 3.0%, and traders will naturally pounce on this if we miss on expectations. Any upside surprise will likely have less of an effect given a series of downgrades due to the impact of Hurricanes Harvey, Irma and Maria. On Friday we then core PCE for Aug as well as the personal income and spending components, so we expect a cautious start to the week for all USD pairs, with limited upside likely unless we get some good news on fiscal policy.
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The Trump administration reverts focus back to efforts on tax overhaul, which has slipped up and down the priority list as the GOP look for some form of progress here as well as in health-care reform and the multitude of trade agreements and disputes including China and NAFTA. Working from a low base - i.e., none - one could argue that from this perspective, the USD 'risk' is to the upside, but after so many falls over hurdles, the market confidence is low.
This may well be one of the more supportive factors for USD/JPY, with the pick up in Treasury yields having run their course. 10yr has tested and held first 'target' at 2.30%, and odds for a December Fed move are back up to 70%, so above 112.00 there is and has been little momentum to drive us to the next target area which we see closer to 114.00. That said, we see limited downside from here in the meantime, though this has room to extend into the mid to lower 110.00's.
Barring any fresh developments emanating from North Korea, the JPY pairs should be relatively stable through the week, but as ever, this carry trade relies on stock market performance. AUD, CAD and NZD rates are all off better levels, but will be seen to represent a dip buying opportunity for now.
Lots of Japanese data to look to, chief of which is the inflation number on Friday. Core CPI is expected to rise from 0.5% to 0.7% in August. Later on in the session, industrial production and construction orders also stand out, less so retail sales, but all expected to show market improvement in August.
Friday is also the focal point of UK data watchers as we get the latest estimates of Q2 GDP and also business investment. The BoE believe this is strong enough to weather a rate increase in order to tame inflation first and foremost, but I remain firmly in the camp that a 25bp move - now widely priced into November - would be a case of 'one and done'. Little else to note earlier in the week other than the CBI distributive trades survey - recall last week - industrial trend orders on Friday saw the index weaken from 13 to 7.
On Brexit, the hype over Theresa May's speech in Florence was overdone, but this comes as little surprise for a market hungry for event risk - and Brexit is good source of this. Even so, judging by comments from the EU's Barnier, it was relatively well received in terms of spirit, but including the line that 'no deal is better than a bad deal', there is clearly a line which the UK government will not cross, no matter how conciliatory they have been in recent weeks and months.
GBP gains from here should be limited - indeed, some will have been surprised that we have extended this far, with the present day market hanging on every word of central banks. That said, some of the data has been holding up well under the circumstances, but numbers such as the strong retail sales print last week should be taken in context - in this case seasonality. Cable has hit a wall of selling interest above 1.3600, and with the CofT positioning somewhat lightened, we cannot count on short covering to drive GBP south at this stage, with EUR/GBP losses having taken us back to key levels in and around 0.8800.
Little of note of Australia again, with the AUD tone softened a little after comments from gov. Lowe that even though the next move in rates is likely up, we should not expect any imminent change.
Over in NZ, the election result means another hung parliament and coalition to be formed, so it will be an interesting start to NZD trade when Asian markets get underway, with the Nationals and Labour vying for the support of New Zealand First to form government. As if that is not enough, we also have the RBNZ meeting and announcement Wednesday, but in the current climate, no change and or material change in their statement will be anticipated. Trade data on Monday to note, but likely to be overshadowed.
AUD/NZD will be as volatile as NZD/USD, with both pairs reacting to the polls last week which saw the Nationals back in the lead - the vote count so far matching the 46% touted, but uncertainty from here set to weigh again. AUD/USD levels to watch for lie at .7900 and .8100, and are largely dependent on the USD from here.
This may also be the case for the CAD, though on Friday, we saw core CPI in Canada sticking to 0.9% while the headline rate rose less than expected from 1.2% to 1.4%. Growth and improving economic activity have pushed the BoC to reverse the rate cuts from 2015, so from here we would not be pursuing the steep rate profile the market is now pricing in, so we see further room for CAD correction.
BoC gov Poloz is speaking next week and may well take a more cautious tone in light of the strong CAD appreciation, which the central bank are now monitoring along with the impact of higher rates. July GDP on Friday is the only key data point of note, with a rise of 0.1% expected (seems a little low) vs 0.3% in Jun.
Retail sales data in both Norway and Sweden to look to as well as Norwegian unemployment and Swedish trade. From a policy point of view, both central banks are on the cautious side, more so the Riksbank, but the Norges bank will not have been encouraged the slippage in inflation - a global phenomenon (UK excluded) which the market seems to forget at times. NOK/SEK still well contained.
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