FX Week Ahead: Discretion And Common Sense Not Easy For “The Machines”
Submitted by Shant Movsesian and Rajan Dhall MSTA of fxdailyterminal.com
Coming off the back of a mixed payrolls report which saw the headline number recording a negative balance for the first time in 7 years, the USD initially gained on the rise in wage inflation which recorded a 0.5% increase in average hourly earnings. Into the weekend, we saw these moves tamed to a modest, but varying degree(s), with the market still very much of the mind that this remains a USD correction at best. We still feel this has more to run, but it will be anything but smooth as the larger fund managers are happy to stay short on the greenback for the longer term. As such, no material sign of this positioning being lightened.
Nevertheless, the Fed are signalling their intention to hike in Dec, and Fed chair Yellen continues to communicate this as subtly as she can. The odds for adding another 25bps onto the Fed Funds rate have been over 70% for a few weeks now, and we expect the next significant USD push will come from solidifying expectations for 2-3 hikes next year – 2 is a safe based on the trajectory of data, with the ISM reads last week strong in both manufacturing and non manufacturing industry. Little to get excited over until the end of next week when we get the Sep inflation readings. Many will be looking at the incremental changes with a certain sense of apathy. Core CPI is expected to rise from 1.7% to 1.8% as the oil prices are expected to help lift the headline rate through 2.0%, but for the purposes of monetary policy, we expect current levels are strong enough to keep the Fed on their normalisation path. Once again, equity markets need a reality check, and it will not come from the level of balance sheet reduction now under way.
So where now for the lead USD pairings?. Going on the trade weighted index, EUR/USD is set to continue the fight to find a base and set off for the next trek higher. This is what we saw when the pair dipped under 1.1700 again on Friday, with the retail market excited to see a test on 1.1660 and jumping in aggressively to buy the dip here for a return to 1.2000 and beyond.
We can look at the German industrial production data on Monday, followed by trade stats on Tuesday. EU wide industrial production is due later on the week accompanied by French and German HICPs, but does any of this concern the market which has been fed by a constant stream of forecasts that the EUR is heading back to value levels at 1.2500? I take issue with the fact that so many see value here, as PPP metrics are flawed in many ways given its rigidity against the ever changing dynamics of the global economic structure.
Any aggressive move higher should be capped in the 1.2000-1.2100 in the lead EUR rate, and in that we factor in time-frame on the pace of gains seen. Focus on the the political backdrop is starting to look like ‘old news’ already given the price action, with markets generally desensitised to risk themes that come and go with the familiar transitory shift into safe havens. Consequently, EUR/CHF is also turning higher again, with the dip under 1.1400 here again all too brief. However, Germany’s undercurrent of unrest with immigration is just as unsettling as the fragmentation in Spain, and as many quickly forget, Italy’s contentious elections next year will also jolt EUR gains ahead, but it is all about positioning for the ECB’s unavoidable adjustment to monetary stimulus at present, and I for one am not going to get excited. Range trading in the EUR for me.
In the UK, it was only a matter of time before the Pound was going to come back off its lofty levels, which in the broader context are still pretty low historically. However, at times, I get the sense that the market does not appreciate the full extent of this material sea change in the aftermath of Brexit, and calling for a Cable move to 1.4000 and 1.4500 at this stage is ‘head in the sand’ analysis at its best (worst). We shifted our range from 1.2000-1.3000 to 1.2500-1.3500, and we are not ready to shift it again, well, not higher anyway.
The BoE can call for the market to price in higher rates on the curve further out, but at this stage, I believe this is a policy mistake, just as it was to cut pre-emtively last Aug straight after the referendum. Any move this year, to correct that, will be just that and that only, with uncertainty set to keep the MPC sitting on their hands until we get some sign of agreement at the UK-EU negotiating table in order to genuinely revive hopes of business investment here in the UK. Progress we are told, has been nowhere near enough, so that is all we need say on Brexit at this stage. On Theresa May, I echo the words of ex PM John Major who also calls for unity in the Tory party and her leadership, and calling her weak due to a mid speech coughing fit is ridiculous and unnecessary, not to say unsettling at a time when the UK needs some stability at its core. GBP sales on the latter should have run its course, but over the longer term, developing rate spreads (with US Treasuries) are now more likely to pull Cable back towards 1.2500-1.2600.
Expectations for EUR/GBP to parity over the longer term also remain a possibility, but I am a little more comfortable with 0.9500 over the longer term. For now, we may struggle with 0.9000 due to European unrest. UK industrial production is one for the algos, but of interest is the trade balance which should benefiting from broad based GBP weakness these days.
In Canada, last week’s data schedule reported its trade deficit widening, and with the contraction seen in the US balance, the natural shift higher took us above 1.2500, testing 1.2600 either side of the US and Canadian payrolls reports. The latter came in pretty much as expected in the headline (gain of 10k), but the ‘make up’ was a complete turnaround of the Aug data which saw a wholesale shift from full to part time jobs. We are not quite sure what to make of this reversal – perhaps a reporting or accounting error – but the subsequent CAD retrace reflected some of this change, but not too convincingly as yet. Even so, short term metrics suggest we have pushed far enough for now, and circa 1.2500 looks about right until we get the next round of growth data in particular, after the flat reading we saw for Jul. Nothing of note in the week ahead.
It is equally barren on the Australian and NZ data schedule, not that it would matter much. Recent prints have had such a modest response from the respective currencies, which in all cases are trying to push lower against the USD, and coming up with dip buyers – much as they are in the EUR. This is more so the case for AUD rather than NZD, where the leading National and Labour parties continue to fight it out for government after the former fell short of majority in the elections – votes all now in and finalised. Business confidence is slipping, and on this development it is not hard to see why, but NZD/USD has retraced some way from 0.7500+, and now 0.7000 will likely attract the arbitrary test from intra day day traders.
For AUD, and with the CAD to a lesser degree, we watch the commodity markets, where industrial metals have adjusted lower. Copper has dipped under $3.00, but has since stabilised, though we have China back this week which should liven up activity here to some degree. Oil prices are now coming off their better levels, but as we have consistently said, this will not disturb the CAD unless we gather pace on the downside and/or WTI retests $45.0 a barrel.
Still no breakout in NOK/SEK, but it looks as though we will continue to pressure the downside, as parity beckons here. Inflation numbers in both Sweden and Norway out this week, and on current levels, SEK out-performance looks justified but for rate differentials and a Riksbank refusing to let go of its cautionary stance.