Ahead of today’s preliminary Q1 GDP in the US, the Greenback failed to hold onto its recent gains, even if its ascendancy this week remains undeniably impressive. The whole FX universe will orbit around today’s US growth data, as a strong number would most likely seal a weekly close above a massive technical level in the DXY. If the scenario materializes, when combined with a EUR/USD closing sub 1.12 critical support and a USD/CNH above its respective 6.74 resistance, it could really send shockwaves across financial markets, as the notion of a period dominated by broad-based USD strength may gather steam quite rapidly as technicals align. In the meantime, as we wait for the US Q1 GDP, and Japanese Yen has been the outperformer, aided by a reported unwinding of elevated Yen short positions ahead of the Japanese 10-day Golden week holidays. The drop in global yields, including the US 30Y as our bellwether, alongside a rejection of levels near the all-time high in the S&P 500 have fueled the Yen momentum. The Euro, on the heels of yet another negative economic release out of Germany (IFO survey), remains on the backfoot. The same applies to the Sterling, with no Brexit breakthroughs. The Aussie has been under follow-through pressure by briefly breaking below the 0.70 level before a decent rejection. Alongside the Yen, the Kiwi was the other outperformer.
Granted, the thematic of USD strength does not look like it’s going to go away anytime soon if one judges by the weekly closes achieved in the DXY and EUR/USD. It was such a pity that the bullish close outside a well -defined 6.70-75 range could not be replicated in the USD/CNH in order to up to a whole new level the prospects of vol in FX. The positive US GDP Q1 headline number, while it hides underlying softness in the details (lots of temporary factors led to the boost), in my view, should suffice to keep the common theme of USD buying flows at steady levels heading into May as the gap between US growth and the RoW widens. Near term though, there is enough evidence through the hourly price action in FX majors to be cautiously bearish the USD, after some technical cracks in the structures, especially in the Sterling, Canadian Dollar, and the Yen. The former may experience episodes of ultra-low liquidity at certain times of the day this week, as Japan goes offline until next Tuesday in celebration of the Golden Week. To start the week, we are seeing further buying pressure on the Oceanic currencies (AUD, NZD) as China’s industrial profits published over the weekend printed a 10 month high. The Euro must be included in the pack of currencies with the prospects to print short-term gains vs the USD, even if remains one of the most vulnerable.
As we head into Tuesday’s busy European session, the lead to be taken from Asia is one where caution is warranted, not only because of the miss in the Chinese PMIs (both official and Caixin), which has led to some spells of ‘risk off’ and a timid return of JPY buying but also due to the upcoming Fed’s SOMA day. What this means is that as part of the Fed’s QT program, April 30th marks the day when the Central Bank will shrink USD liquidity by 28.1bn in its balance sheet. Whenever liquidity is withdrawn via these redemptions, there is a patter of US Dollar strength, which more often than not, is accompanied by a greater apprehension towards risk-seeking strategies. The miss on revenue by Google does not help the case either, even if by the close of business in NY the conditions look rosier than the picture I am painting. The Aussie is the worst performer after a rapid decline on the back of the underwhelming Chinese data, while the Euro, Pound, and Yen, in this order, are performing with a firmer footing. The Canadian and the New Zealand Dollar, as part of the commodity bloc, were dragged down by the negative news out of China.
The Sterling was on an absolute tear on Wednesday, even as breakthroughs in Brexit are yet to transpire (don’t hold your breath). It’s always going to be a harder task to find a clear attribution to the movements seen during the last day of the month, as portfolio re-balancing on unhedged FX positions tend to rule the movements. In the case of the Euro, which climbed at a steady pace against the majority of its peers (exc GBP), we can clearly pin down the improved European data as the main reason behind the rally. However, it still feels like the data samples need to be expanded not to think that the solid German CPI or higher EU, Spanish GDPs are mere paybacks for weaker previous data. Nonetheless, if more evidence of a minor recovery in Europe pans out, the ECB will feel in no rush to design further stimulatory policies (EUR positive). Another currency where we can clearly link its weakness to a particular event is the Aussie, unloved as a China proxy play after the country fell short of expectations in its PMI releases on Tuesday. The Japanese Yen did fairly well for half of the day, emboldened by the Chinese poor data, only to revert its buy-side flows as US equities were bought strongly off the lows. The Canadian Dollar, notwithstanding a negative GDP for Feb, exploited the slack by the Yen demand deficit late on the day, as BoC Poloz struck a constructive tone on the Canadian economy. Lastly, the two currencies suffering the most included the US Dollar and the Kiwi, the latter battered by a miss in NZ jobs. The focus is now shifting in its entirety towards the US ISM release as a barometer of US economic conditions, followed by the FOMC and Chairman Powell presser.|
As the market adopts a ‘true risk-off’ mood on the back of Fed’s Powell less dovish remarks on inflation, the USD reigns in the forex firmament while commodity-linked currencies see the greatest supply imbalances, especially the Aussie and the Kiwi, both recently hit by negative fundamentals (low CPI in Aus last week & bad NZ jobs on Wed). The Canadian Dollar is holding up firmer as BOC Governor Poloz dials down his dovishness by making the case for a stronger economic recovery from Q2, in which case, considerations for another round of tightening may be justified. Too early to tell but expectations towards Canadian rate cuts have taken a step back. The Japanese Yen, emboldened by the deleveraging flows in equities and global yields, has benefited once again, while the Sterling, driven by tentative progress in the talks between the UK Labour and May’s government on Brexit, continues to follow the Yen in locksteps. Lastly, weakness in the Euro has made its way back as a function of USD strength mainly.
The US is set to release the change in the number of people employed during the month of April, in what should be seen as yet another critical piece of information about the US economy. What’s interesting about today’s set of numbers is that after the volatile range observed from Jan to March, primarily due to the US government shutdown, the data should start to normalize again, so whatever number comes out today, should give us a more accurate picture of the state of affairs in the US labor market.
It’s worth noting that the US jobs market has unquestionably reached levels considered to be at full capacity, with little to no slack to account for. It’s not that workers are not in demand by employers, but the real issue, whenever an economy reaches full capacity utilization of its labor force, is to find the qualified employees due to constrained supply, which paradoxically, tends to pose an increase in downside risk in the headline number, today expected at 175-180k.
What this means is, rather than taking at face value the breakdown of the US jobs number and the unemployment rate, the debate has been gradually shifting towards whether or not employers are forced to increase the average hourly wages paid in order to attract the shortage of qualified labor force. Therefore, the reaction in the USD comes as a function of not simply fixated on the breakdown of the change in the labor force, but it must come accompanied with an encouraging pick up in earnings too.
Let’s now deconstruct the event, category by category, before coming up with some conclusions that could help prepare for the volatile event.
Today’s explosion in volatility in the Forex market right off the gates comes after an incendiary tweet by US President Trump, taking the whole market by surprise at a time when based on the price action across various asset classes since the beginning of the year, a trade deal between the US and China had been fully discounted. The 180-degree turn by Trump, now formally threatening China to hike tariffs to 25% on $200bn by this very Friday, it gives a market with highly committed capital into equities sufficient reasons for a macro re-think, which is currently being manifested by a serious unwinding of positions in the S&P 500 futures, the Shanghai Composite and the rest of equity indexes. The rampant buying on the Japanese Yen or the aggressive selloffs in the Aussie reflects the new state of concerns about the outlook for global growth if China doesn’t buy into Trump’s threats. The fate of the market hinges on whether or nor China confirms the rumors circulating around about the cancelation of this week’s trade talks by Liu He and his team of representatives. Be prepared for a tumultuous week as each unfolding scenario will have ramifications with one common theme to be expected, a volatility pickup.
There is no doubt that the fluid state of affairs in the US-China trade negotiations after Trump’s aggressive tactics is casting a long shadow in financial markets, one that is leading to a major re-evaluation of capital allocations as reflected by the punchy jump in vol on Monday. But before I dive into this new potential conundrum for markets, today’s RBA monetary policy decision, has caused quite a spike in the Aussie after the policy rate was left unchanged at 1.50% amid split market expectations of circa 50% chances of a cut today. The status quo by the RBA acts as a positive near-term input for the Aussie, even if the ability to sustain today’s gains must be reconciled with the new chapter we’ve entered in the US-China trade negotiations. The depreciation of the CNH towards 6.80 after breaking a multi-month stable range is a red flag that poses the following question: Are we really at the end of proceedings of a US-China trade deal or is the market preparing for a new beginning characterized by a break away from the trade truce? If the latter, it will likely lead to a potential new regime of a lower Yuan valuation to offset the increase in tariffs and with it, higher vol in FX. But this scenario still comes with some big IFs, so we should for now, keep monitoring the news. Acting as a circuit breaker is the positive development that China’s trade representatives are still headed to Washington this week to resume the trade talks with their US counterparts as the threat of tariffs hangs over if they don’t agree to the US demands of not re-negotiating laws of IP and proprietary technology. In terms of currency performance, the Japanese Yen has been the major beneficiary of the shift in risk flows, while the USD trades steady even if its performance on the face of ‘true risk off’ is underwhelming, and to make matters worse, the analysis of USD pairs is not painting a great picture either.
The Yen has had no rival this week as the deleveraging in financial markets continues to follow its course at a rapid pace. The psyche of the market has clearly permuted from Trump’s tweet just a premeditated tactic to real fears of a no deal or at least a prolonged delay in an eventual agreement. The sizeable loss of value in Chinese equities or the steady depreciation in the Chinese Yuan are bad augurs for a market filled with renewed uncertainty over the outlook for global growth if the US hikes tariffs to 25% on $200bn of Chinese imported goods by this Friday. In the meantime, on the other side of the spectrum, we find the Kiwi, battered by a surprise 25 bp rate cut by the RBNZ, and the Sterling, pressured as optimism around a Conservative-Labour agreement on Brexit fades away. The USD is another currency that despite the usual promotion of buy-side flows on the back of a pick up in risk aversion, the unwinding of carry trades as the VIX flies above 20.00 is proving to be a major hindrance to attract enough demand. The Aussie is finding demand, spurred by the decision of the RBA to maintain rates unchanged and failing to express a stronger easing bias yesterday; the currency is still faced with the China trade issues, which put pressure on the Yuan, but short-term, the adjustment higher in the AUD is also a fundamental play predicated on the RBA inaction.
There is a huge bump in the road that must be overcome by both the US and China’s trade representative this week, following the discontent by the Trump administration over China looking to backtrack on the majority of conditions pre-agreed as part of the grand trade deal being negotiated.
The modifications in many of the agreed aspects of a deal led President Trump to tweet of an imminent hike in tariffs to 25% on $200bn by this Friday unless China makes good its end of the deal by reverting back to the US demands. These include changes of domestic laws that will look to mitigate familiar issues orchestrated by the Chinese, including the steal of U.S. intellectual property and trade secrets, forced proprietary technology transfers, exchange rate advantage via a manipulated Yuan.
Secretary of the Treasury Mnuchin and top trade representative Lighthizer have reaffirmed the hard-line stance by the Trump administration to enact the planned hiking in tariffs to China’s imports this coming Friday, further exasperating markets, which have been in a state of ‘true risk off’. There was no mention of Trump’s retaliation with regards to yet another increase in tariffs of 25% on other Chinese imports of USD325bn, which Trump has mentioned via Twitter to add further pressure onto China.
The risk sentiment is on the mend as the market awaits further clarification on where we stand in the US-China trade negotiations conundrum. The Japanese Yen, which has been by a country mile the currency to flock off to amid the de-risking of financial markets throughout the week, is on the backfoot. Reports of a phone call between US President Trump and President Xi due shortly has further appeased the nerves. While the increase in tariffs on Chinese imports comes to effect in a few hours at 14h Sydney time, it should be interpreted as a ‘soft deadline’, as exports that have already left Chinese ports before May 10 won’t be subject to the increase. Interestingly, despite the risk on/risk off pendulum has swung in both sides, the end result for the interest of the USD has been identical, a net negative. The Euro is the currency to be in the last few hours, even strengthening against the Yen in times of true ‘risk off’ as seen in the early stages of the last US session. The commodity-linked currencies are also having a solid bid tone.
Last Friday’s inconclusive US-China trade talks kept the markets guessing, what’s next? However, that was not an impediment for a relief rally in risk assets to transpire, even if as I elaborate in today’s report, the sustainability of this movement looks a tall order at the current levels of uncertainty. The soft deadline that represents the hike in tariffs last Friday, as it essentially still gives the US-China an extra 2 weeks to further negotiate the potential removal, influenced the price action. But the market may play the ‘half full’ glass for so long, as will the Chinese the patient hand amid constant aggressive rhetoric by Trump. For now, though, the priority by China is to extend the period of negotiations, which has led to the settling of market nerves a tad. We were left with, I must admit, from a directional standpoint, inconsequential broad-based range-bound price action in FX markets last Friday, with the exception of a Canadian Dollar, re-invigorated by a 10:1 beat in last Friday’s Canadian job report. Further weakness in the Chinese Yuan at the open of markets this Monday, paired with downside gaps in the S&P 500 futures, is a reminder that the dynamics are far from ideal to support risk.
As China bites back by retaliating the US by imposing tariffs on US goods effective by June 1st, the markets are coming to grips that such actions, even if not tit-for-tat, it means that the market is discounting a prolonged rhetoric war between the two countries, with fears of escalating even further. As a result of the re-evaluation of the new dominant trade thematic, and judging by the punchy moves in the Yen or equities, the market seems to have still a lot to re-price. As I will elaborate in today’s report, the RORO model paints an ailing picture in risk assets, both from a micro and macro standpoint, finally re-invigorating vehicles of diversification such as Gold. Commodity-linked currencies, with the CAD no exception as Oil and risk off weights, are feeling the pain of the current dynamics of a battered Yuan, while the Sterling also take a hit as a function of the appeal to bid back the US Dollar across the board, excluding against the Yen. The Euro continues to find firm pockets of demand against most currencies.
Tuesday’s turnaround in risk dynamics should not send the false signal to think we are anywhere near from being out of the woods. The crosscurrents in equities, fixed income credit and currencies, specifically the performance of the USD, JPY, CNH suggest the dominant thematic of ‘risk off’ is not going away, or at least, there is no evidence yet. The disparity in performance between the Yen and the rest of G10 FX should be the first reminder every day one opens the charts to the degree in which financial conditions have deteriorated. The USD and CAD did well on Tuesday, the latter regaining its lost appeal after the best Canadian jobs report in recorded history last Friday. The Euro is starting to wane a tad as the German data remains underwhelming to say the least, with today’s European preliminary GDPs, including Germany, another major test. The AUD & NZD, amid the dicey US-China trade dispute, remain on the backfoot, while the Sterling keeps suffering pains of its own as the political stalemate on Brexit continues.
Risk sentiment was buoyed by reports that the US government is likely to delay auto tariffs to the EU and Japan up to 6 months. The Japanese Yen was the currency most punished by the news just as equities in the US turned around and never looked back. The fact that US President Trump plans to fight one trade dispute at a time rather than having too many fronts open, with his plate rather full having to deal with China and the revised NAFTA deal, was translated in an immediate spike in the Euro. Regardless of the renewed demand for the Euro, the DXY is not backing off, still trading quite firm across the board. The best performer currency was the CAD, supported by a rise in Oil, recently stellar fundamentals in the form of a huge increase in employment creation and risk appetite on the mend. On the flip side, the Sterling, with no Brexit breakthroughs even remotely close to happening, is lacking the love (demand) of markets. The Aussie is also on the backfoot after the market reacted negatively to an increase of 0.2% in the unemployment rate in Australia, despite the rest of the data was quite encouraging, from the total jobs created to the increase in the participation rate.
It cannot be argued that risk continues on the mend. Equities found fresh buyers, bonds sold, the VIX came down to 15.00, but still, a key question must be asked. Is the market growing excessively complacent to the risks stemming from the new highs in USD/CNH? The ongoing depreciation in the Yuan tells us the market is not buying into the thesis that China and the US will reconcile its hard-line stance on trade, which leads me to think, the disconnect between risk up and Yuan down cannot go on much longer. In the meantime, the Yen has been sold in response to more benign conditions as the market goes through a round of re-leveraging into riskier assets. The USD, at times a candidate to depreciate when the market goes ‘risk on’, seems to find a greater endorsement by buy-side accounts on positive US data and improved ‘carry trade’ dynamics. The Canadian Dollar, even if fears of Oil supply disruption in the Middle East keeps the price of Oil underpinned, failed to sustain its strong buy side momentum from early Europe. The three currencies that are finding relentless follow-through sell side flows include the AUD, NZD and the GBP. The former Oceanic block in response to lower Yuan valuations and a mixed Australian employment report, while the GBP remains in incessant selling pressure, driven by technicals, which has deteriorated due to the uncertainty in the Brexit front as Theresa May starts to consider her own (Br) exit strategy as Prime Minister amid the protracted impasse on her withdrawal agreement.
There is a clear winner as the week gets underway, and that’s the Aussie, boosted by the friendly outcome of the Australian national election, where the incumbent coalition government won with what appears to be a parliamentary majority. On the other side of the spectrum, we find the Yen, losing value even as the US-China trade rhetoric worsens, which is why the current hefty levels in JPY crosses look quite rich if one accounts for such an unsettling backdrop. Another commodity-linked currency, as the AUD, recently enjoying a lift is the Loonie (CAD), as the US agreed to lift the steel and aluminum tariffs as part of the US-Mexico-Canada trade agreement. The USD performance, partly driven by the consistent selling on the heavily traded European currencies, especially the Euro, continues to show no signs of abating. The overall risk profile in financial markets has relaxed quite a bit even if judging by the levels the Chinese Yuan trades at, the fundamental backing to justify such a recovery in risk is dubious at best.
We had an uninspiring day of price action in the forex arena on Monday, with most of the US-China trade-led vol concentrated in the equity market. It is precisely in stocks where we are seeing the first technical cracks again as the risk profile worsens, with IT shares suffering the consequences from the high stakes gamble decision by the US to ban Chinese-based Huawei and ZTE Corp from any dealings with US telecoms. Surprisingly, the Japanese Yen has failed to attract sufficient demand, in a ‘puzzling’ move that I explore in today’s report. The Aussie got off to a great week after the positive Australian election news, as the sitting coalition government retained power. However, the RBA Governor Lowe speech today, highlighting the possibility of a rate cut at the June meeting, has thrown cold water on the positive AUD outlook as it gives back most of this week’s gains. With regards to the USD, there was a significant absence of flows coming through the books, with a speech by Fed’s Powell failing to spice things up. Same applies to the CAD, as the USD/CAD comatose trading manifested. Last but not least, the appeal towards the European currencies, especially the Sterling, remains subdued, as the Brexit process stays ‘stuck’ following the failure of the cross-party talks between the Conservatives and Labour. The next Brexit divorce agreement vote is due in early June.
As the market goes through a moderate round of deleveraging, the Japanese Yen, recently disjointed from RORO dynamics amid an overstretched cheap valuation, finally put on a decent recovery, one that I had personally been endorsing judging by the rather depressing risk mood present. The USD continues to attract steady flows as trade uncertainties have forced a re-allocation of capital away from emerging market exporters, making its way back into the United States. The Sterling, once again, has been the least favored currency, as the market prices in an imminent resignation of UK PM May and almost null chances of her Brexit Withdrawal Agreement passing its 4th vote through Parliament in early June. Another currency overwhelmed by a late day supply imbalance is the Canadian Dollar, initially boosted on the back of upbeat Canadian retail sales, only to revert all its gains and then some as the Oil price collapsed amid the shocking build-up of Crude and Gasoline inventories. Sandwiched in between we find the Euro, the Aussie, and the Kiwi, even if the Oceanic currencies are the most vulnerable, both suffering from renewed macro tendencies as the market anticipates further easing in Aus/NZ.
The USD suffered a V-shaped turnaround, in other words, in a matter of hours its outlook went from steady bullish to now head into Friday with clear fragility to further losses. The culprit, after correlating price action to fundamental news, has been attributed to a surprisingly low US PMI read, paired with soft new home sales in the US. In stark contrast, the resumption of a risk aversion with both equities and global yields experiencing sharp slides led to the strong appreciation of the Yen (and Swissy). The Canadian Dollar, amid the continuous collapse in the price of Oil in a risk-off environment, succumbed for the second day in a row, while the Sterling also traded primarily lower, even if the overall weak performance was much more contained as the market appears to have fully priced in the resignation of Theresa May as British PM. The three currencies that managed to keep up with the Yen (and Swissy), albeit at a significant distance, were the Euro, the Aussie, and the Kiwi, in what’s seen as a rise on the demerits of the USD only.