The ECB monetary policy meeting takes center stage today. There are two debates at play. The first comes down to whether the Central Bank will take pre-emptive precautionary actions by slashing the deposit rate or will prudence ensue by not getting involved in further easing until the new ECB macro projections are published.
The second discourse, perhaps not as urgent to be delivered as the steps to properly formalize its commencement are yet to be telegraphed, involves the re-activation of asset purchases as part of a new stimulus package aimed at re-invigorating growth in the EU.
The Sterling has been sold hard to start the week, losing over 1.5% in its index measure as the scenario of a ‘no-deal’ Brexit is clearly no longer taken for granted. There was always the big assumption that a soft Brexit will eventuate, but with Boris Johnson’s ‘dream team’ flexing their muscle by warning that the working assumption now is a ‘no-deal’ Brexit, the market has been given the green light for the valuation of the Pound to keep catching up to the current political climate. The USD and the EUR, especially the latter, continues to enjoy the approval of the market to sustain the bullish momentum on the back of an ECB that failed to overdeliver last week. However, further gains may be harder to come by as the EUR index tests a key resistance on low volume. In the case of the USD index (equally-weighted vs G8 FX), while gains have slowed down, it’s achieved 7 days of gain in a row even if the quality of the rise is waning. The USD has not out on such a run since early March this year. When it comes to the Oceanic currency block, both the AUD and NZD indexes have reached meaningful technical levels of support, and I do suspect that more efforts will be made to revert the bear trends near term. The Swissy and the Canadian Dollar, even if more so the former, portray an interest technical setting as the Swissy index breaks into new highs. The Yen is still finding a decent amount of demand as falling real yields and steeper curves in US yields incentivizes Japanese investors to hedge out their US exposure by buying JPY in greater sums.
The puzzle is not easy to put together by the Fed, and that’s why it may result in today’s FOMC meeting to conclude that not only a 25bp rate cut was needed as an insurance, but amid such dicey global backdrop and low inflation, it’s best to keep sufficient dovish options on the table.
The market didn’t get to hear what it wanted and by Powell resorting to a somehow conditional stance with flexibility to adjust on the go to new developments was not sufficiently committal rhetoric to satisfy the market, which for now has fallen victim of its own high-bar setting dynamics.
Thursday’s US President Trump decision to escalate the trade war by imposing 10% tariffs on $300b of Chinese goods by Sept 1 has really hit the Achilles heel of the risk curve, with capital scrambling to bid the Yen, bonds and gold in a text-book ‘risk-off’ day. The strength of the Japanese Yen, especially, defies gravity but it also reflects the renewed concerns by market participants that this latest action by Trump will be quite costly for global growth and the extension of suppressed inflation. The Swiss Franc also managed to find solid bids as safe-haven flows swiftly moved into safe-haven assets. The US Dollar traded quite stable, barely changed on a daily net basis as the market digests the news of additional tariffs on China in a month time and what the dovish repercussions for the Fed and the rest of Central Banks. The Aussie, Kiwi, and Cable kept the bearish inertia that has characterized these 3 currencies since mid-July. Meanwhile, the EUR and CAD trade relatively unfazed, especially the former, while the Loonie does feel the pressure of ‘risk-off’ dynamics much more so. Today’s Non-Farm Payrolls report is the next key even if the tariffs news has stolen the limelight.
In the last 2 trading days, as US President Trump’s patience worn thin on China, which led to the announcement of further tariffs by Sept 1, the market is behaving as if both sides are moving closer to a full-blown trade crisis where the favorite trade, for now, has been to bid the Yen and the Swissy to the boots. Flows hitting the USD and the EUR saw a rather neutral performance of the respective indices, with both currencies suffering from its own demerits as the knock-on effect of a protracted trade war means the ECB and the Fed look poised to stick to their easing paths (QE II + rate cut by the ECB, back-to-back rate cut by the Fed). But it’s not only the Fed or the ECB, the pathetic performance by the AUD or NZD, other than the influence risk-off has had, also tells us the RBA and the RBNZ will be forced to flex their muscles by further adjusting policy into an easier mode as we head into Sept/Oct. The RBNZ meets this week, and with such a dicey environment, a dovish outcome looks highly likely. In terms of the CAD and GBP indices, the former looks still quite constructive as the BOC has not been as explicit in its dovish bias compared to the rest of Central Bank, while we all know that GBP and the BoE continue to be in a hostage situation due to the political process of Brexit. As a full-blown trade war is an event being currently discounted, it revitalizes the central thematic that it really is a race to the bottom in the currency market as Central Bank are forced to ease, which leads to flows headed into old school plays by backing the safe-haven status of the Yen and Swissy as global yields implode discounting gloomy times ahead.
The first week of August 2019 will mark the time when China finally opted to draw a line in the sand by telling US President Trump, enough is enough. That’s the key takeaway by not intervening in the USD/CNH but instead letting market forces determine the exchange rate, which as of the close of NY, sit around 7.10. The US Treasury has been fast to label China a currency manipulator, which essentially puts the nail in the coffin to any glimmer of hopes for trade negotiations to continue. The markets are obviously engulfed by a sense of fear and uncertainty about this new environment as the focus shifts from a trade-centric conflict into a currency war. The ramifications in the currency market, amid a vivid risk-averse environment, has been for capital flows to stick with the usual suspects (Yen, Swissy, Gold, Bitcoin, Bonds) as equities sell-off in a disorderly manner.
The PBOC finally acted as the circuit breaker to ameliorate financial conditions by setting a firmer Yuan fixing and looking to conduct bond operations to soak up offshore Yuan liquidity via a series of bond issuances in Hong Kong. It did make the trick to soothe the market’s mayhem seen, with stocks rebounding hard even if bond traders are not buying into it by keeping the long-dated US paper under extreme downside pressure, which implies that the outlook for the US/global economy keeps deteriorating. That’s been reflected in another fully priced-in rate cut of 25bp by the Fed in Sept, with chances of a 50bp cut ranging from 15% today to as high as 50% at one stage yesterday. The rampant demand for Gold is yet another sign that the current setting remains ugly to see a sustainable recovery in risk trades. As we head into Wednesday, the USD has managed to contain its moderate fall, while the Canadian Dollar comes under the siege of sellers under intense pressure just as Oil keeps falling to new lows. The market’s favorite long plays (JPY, CHF) finally found a meaningful phase of profit-taking as risk appetite made a temporary appearance although dip buyers are lurking around. The Euro remains supported from the unwinding of risk positions as EUR-funded carry trades get closed. The Sterling is drawing more interest from buyers too, as is the AUD despite a slightly more dovish RBA. Lastly, the NZD was smashed after the RBNZ went out of its way to cut the benchmark rate by 50bp to 1% and match Australia’s rate-setting level.
The favorite play by the market has been to keep a sustained bid on funding-currencies (EUR, JPY, CHF) as derisking dynamics led to an unwind of carry trades. Capital that was borrowed in low yielding currencies and put to work in a high-return currency has scrambled to the exits as the problem becomes that on episodes of ‘risk aversion’ as seen in the US-China trade conflict morphing into a currency war, these positions tend to quickly go underwater as the market psyche resorts to old fashion safe havens. However, we might be approaching a key inflection point in the charts where funding currencies take a breather from its elongated movements just as the PBOC continues to make sure that the volatility and weakness around the Yuan slow down as global Central Banks commit to more easing, some quite aggressively as seen by the RBNZ. The Fed and ECB, amid this backdrop, are also readying more ammunition to come to the rescue to control volatility, even if might be harder to do so if the focus stays on currency wars. The key barometer to determine the market profile on a daily basis remains the Yuan valuation, and in line with the synopsis presented today, we continue to see a PBOC that has taken the foot off the gas pedal by relaxing the fixing rate, which came not as weak as expected. This appears to be helping risk trades early on Thursday.
The anticipated transition into calmer waters in financial markets as the PBOC relaxes its approach towards a weaker Yuan has so far played in favor of risk trades to be revitalized, as reflected by the weakness seen in funding currencies, especially the Euro and the Swissy, while the Yen keeps a more combative stance. The USD traded lower as US President Trump engaged in a series of tweets looking to jawbone the USD lower, leading to an unwinding of longs. In an environment of higher US stock valuations as the S&P 500 extends its impressive bounce, even if the bond markets are sending us the complete opposite signal, commodity currencies the likes of the AUD, NZD, CAD did better. On the flip side, both European currencies (EUR, GBP) went through similar poor performances as the chatter of elections in Italy and the UK gets some air time.
In the last 24h, we’ve learned that the appetite to keep a bid on funding currencies continues to be the most profitable way of expressing the fluid risk-averse environment, as the market comes to grips that the weaponization of the Yuan is a sign of a fresh new chapter in the escalation of US-China trade tensions. It implies that as the flooding of capital back into bonds, gold, bitcoin, and funding currencies (JPY, CHF, EUR) keeps pouring in, the global growth slowdown (risk of recessions) may intensify as supply chains get disrupted and trade activity affected in large scales, just as corporates mull to overhaul decades of an infrastructure intended to capitalize on a globalized world as opposed to an era of deglobalization. Even if one can rest assured that Central Banks will be watching closely from their fences to act as volatility suppressors, the market is walking a tight rope if it buys into the perpetual notion of Central Banks acting as price stabilizers. Should markets start to envision with higher certainty that even the US faces solid chances of suffering a major bump in its economic growth, we may quickly transition into a stage where the Fed must step up to the plate by shifting its message to ‘aggressive dovishness’, hence injecting further vol into the market. It will, therefore, be the combination of recessionary woes, which cements risk aversion dynamics, alongside the caving by the Fed to ease much more aggressively, that may hopefully guarantee the steady pick up in volatility that we are seeing. As August reaches its midpoint, with US-China further apart in trade relationships, the Fed will, before we know it, be caught between a rock and a hard place, having to make up its mind between a much higher USD or an aggressive easing cycle. In either outcome, looks like higher volatility prospects should continue on the rise.
A classic ‘risk-off’ day took hold in market dynamics as manifested via the relentless appreciation in funding currencies the likes of the CHF, JPY and the EUR to a lesser extent. With the S&P 500 falling by more than 1%, accompanied by similar weakness in the DJIA and the Nasdaq, coupled with the US 30-year bond yield about to break into an all-time low, it was logical to expect commodity currencies (AUD, NZD, CAD) to suffer the consequences too as seeking high-beta options under risk aversion barely ever go hand-in-hand. Meanwhile, the Sterling was given a bit of a boost in demand today, closely following the solid performance of the funding currency complex. Remember, the signals being sent by Mr. Market are still quite worrisome, with the current ebbs and flows seeking out protection via safe-haven assets the unquestionable trend to support. It’s hard to see how, unless a US-China breakthrough occurs (highly unlikely), the ‘risk-off’ profile can be altered in any meaningful way during the month of August.
The last 48 hours of trading since Trump partially blinked on tariffs to China have provided an important revelation in terms of the opinion the market has formed about the new all-time low in trust between the US and China, even if both sides stick to the pretense of further trade talks by early Sept. The market is essentially not buying into the latest concession and instead it has swiftly returned into a ‘risk-off’ tone. The Japanese Yen, the Swiss Franc and the US Dollar drew the most interest, while high beta G 10 FX (AUD, NZD, CAD) had a miserable day. Another type of record low, this time on the long-dated US 30y bond yield, was also seen, which represents a watershed mainstream moment as a headline grabber to raise the awareness of how bleak the outlook for inflation and growth in the US look. This measure of projected financial conditions, via bond valuations, was further cemented after the US yield curve 2y-10y inverted for the first time since 2017. Add into the mix the negative growth in Germany for Q2, alongside the lowest industrial output by the latter, and one can find even more logic why markets can’t find lasting enthusiasm.
Two of the currencies most punished in recent times, the Aussie and the Pound, kept finding buying interest as the market adjusts expectations over the timing of the next RBA rate-cutting decision given the strong Aus jobs, while a no-deal Brexit is marginally priced out as labor leader Corbyn looks to join forces aiming for a no-confidence vote. In stark contrast, the market was alienated against the Euro this time, as ECB’s Governing Council member Rehn hinted that an overshooting of the upcoming QE2 is preferable. On the contrary, the market kept finding solid reasons to keep a bid in the USD as domestic economic data dump out of the US came upbeat on aggregate. In an environment where the relentless sell-off in global bond yields simply doesn’t abate, the Japanese Yen kept finding buyers while the Swissy appeared to be drag by the Euro this time, amid a better tone in the equity market in the US as the market corrects Wednesday’s down day in the S&P 500, which was one of the sharpest falls this year. Lastly, the Canadian Dollar and the New Zealand Dollar remain technically bearish as the market now starts to suspect the BOC is the next CB to bite the bullet with a rate cut later this year.
It hasn’t really made much of a difference whether the pendulum in risk swung left (risk-off) or right (risk-on), the steadiness of the US Dollar to hold its ground speaks volumes of the broad-based interest to accumulate the world’s reserve currency at a time with little to no alternatives. Besides, the US Dollar index (equally-weighted vs G8 FX) is starting to look awfully dangerous for an upside macro resolution as larger flows pile in to join the bid. All the insights can be found in the charts section. Currencies, unlike the USD, that have been negatively affected by the recouping of gains in risk-sensitive assets such as bonds or equities include the Swissy and the Yen. The Sterling and the Canadian Dollar, amid the increase in the risk tone and political maneuverings to block a no-deal Brexit, start the week in a bullish mode, even if as I elaborate on the charts outlook, the Sterling may find it much harder to keep up its upward march at the current levels. The Euro, the Kiwi remain the most fragile currencies as the market keeps pricing in aggressive easing policy actions by the respective Central Banks, while the Aussie holds its ground slightly firmer after last week’s upbeat Australian jobs report.
The US Dollar continues to attract the most buy-side flows in the Forex market as the thematic of ‘no alternatives’ to put one’s capital to work in the currency space makes, by default, the world’s reserve currency still the best destination to obtain a bit of a yield rolling in. The dominance is clearly reflected by the breakout of a key resistance in the prop US Dollar index (equally-weighted vs G8 FX) that we follow here at Global Prime. The fact that a slightly less hawkish Fed’s Rosengren made no difference to dethrone the victorious parade of the USD speaks volume of the bullish sentiment at play. By the same token, the commodity currencies (AUD, NZD, CAD) saw opposite dynamics, with an improved risk tone in equities and bonds not sufficient to attract buying flows, which is a clear troubling signal going forward. The Euro held steady as evidence mounts that Germany readies a stimulus plan for its ailing economy coupled with renewed hopes that Italy may form a new government after all. The Sterling had an uneventful day. Last but not least, the Yen and the Swissy have traded quietly despite the rebound in risk, which by itself should be a fairly positive sign, as it tells us the interest by the large capital to de-risk its protection by diversifying away from the favorite safe haven vehicles remains quite low, which should read as the uncertainty still at too elevated levels.
The Sterling was the main winner, and even the move occurred in the blink of an eye, in an otherwise lackluster Tuesday. The light calendar and low market participation as the summer doldrums settle in were certainly not helping the proceedings to get some directional inspiration. The currency market remains confined in tight ranges this week as we await today’s FOMC minutes, but most importantly, the Central Banks’ Jackson Hole Symposium, in order to clarify where Fed’s Chair Powell (due to speak on Friday) stands in terms of monetary policy. The chart below clearly shows how dead vol has been in the last 48h. But the compression, one would think, is set to be followed by fresh directional movements as the market gets a much-needed update about the intentions of the Fed, which as of now, is expected to cut rates by another 25bp in September.
The Fed minutes dominated the proceedings in the US session, with a message largely in line with the ambiguous/conditional dovish expectations they aimed for back in July. However, the minutes no longer reflects the new lay of the land as vol picked up aggressively in August, which is why to really get a more accurate picture of where the Fed’s thinking process stance, the market needs Fed’s Chair Powell to disentangle this horrendous low vol activity we’ve had this week. On aggregate, the USD trades firmer, as does the Aussie and the Canadian Dollar, the latter boosted by an inflation report that overwhelmed expectations. The safe-haven currencies keep edging lower, more so the Swissy, as the bid tone in equities and the pause of the bloodbath in fixed-income allows for the pullback to stay its course. Out of all the currencies, the pinnacle of tranquility could be found in the Euro, which attracted very little interest to move in either direction as we await today’s ECB minutes and a bunch of European PMIs. Lastly, the Sterling gave up part of Tuesday’s gains as the market re-adjusts expectations about the impossibility of the Brexit backstop renegotiated following the latest comments by Merkel and Macron.
It’s been a long wait for those trading USD-centric pairs but the event of the week set to revitalize volatility is almost upon us. All the eyes will be fixated on Fed’s Chair Powell this Friday at 14:00 GMT, scheduled to speak at the Jackson Hole Economic Policy Symposium in a speech billed “Challenges for Monetary Policy”. The title is apt to the times we live in and an opportunity for the market to re-adjust its outlook towards the Fed’s Sept policy decision and forward guidance. Aside from Powell, we definitely saw a fair share of action in the Sterling, by far the best performer, after optimistic comments by German Chancellor Merkel in finding a backstop solution by the Brexit deadline. One should really take this rhetoric with a major pinch of salt as the position by the EU has been unshakeable in terms of the backstop not being negotiated. The Kiwi is another currency that suffered from solid sell-side flows until RBNZ Governor Orr spooked an overly committed short market by implying that the RBNZ may not have as much urgency to keep lowering its rate as previously thought. Meanwhile, the Euro, even if the Eurozone PMIs came a tad better, could not sustain the early gains as the index shows. The Swissy was a notable loser on Thursday as the risk tone was kept relatively stable. Again, a better performance was seen by the Yen, rather neutral for the day. Lastly, the Aussie and the Canadian Dollar traded under more selling pressure in the last 24h, the former influenced by a weaker offshore Yuan.
As the gloves go off in the trade war between the two economic superpowers, the predictable nature of how funding currencies would react when ‘true risk-off’ hits the market has resulted in a very strong appreciation of the Yen, the Swiss Franc, and also the Euro. The equity market is on free-fall as capital also flocks off to Gold and Bonds.