Submitted by Shant Movsesian and Rajan Dhall MSTA at fxdaily.co.uk.
FX Weekly Preview – A ‘field day’ for the algos this week
Back in the early 1990’s when I first started in the markets (interest rates and currencies), the level of volatility was a far cry from the pittance of price action we see today. Through the mid 2000’s, the emergence of algorithmic and systems based trading accounts started to come to prominence, and in the aftermath of the 2007-2008 financial crises when stabilisation outside of the stock market euphoria took hold, ranges started to dwindle as liquidity and market making took shape in a different mold. All well and good while data and event risk is perceived to be low, but then all hell breaks loose once realisation sets in and complacency is knocked.
Well this week alone should offer a return to the times when intra day volatility allowed for price discovery is a little quicker than we normally see – and before everyone jumps down my throat, yes this is distorted beyond all sense of normality in equities – we are starting to see signs that macro themes are likely to become a little more mixed. The cross rates are starting to break out a little more, pointing to differentiation away from just slamming the USD on every rally, though EUR dip buying is still heavily entrenched in the mindset.
This weekend’s SPD confirmation of the vote to join Merkel’s CDU/CSU will somewhat predictably add a bid to the EUR tone first thing, assuming we get the hung parliament in Italy when the voting ends in Italy on Sunday night. This seems to be the consensus view which analysts expect will maintain the status quo in the markets, but BTP spreads have been widening with German Bunds, so let’s wait and see the impact of the vote, whatever it is – all I can see is confusion at this point. Any result can distract or exacerbate the underlying concerns over Italy’s banking systems (non performing loans etc), so we continue to see plenty of complacency over the component ingredients of Euro zone growth led/bolstered by Germany and its bloated current account surplus to boot.
For EUR/USD, the obvious move is to head back to test 1.2400, then 1.2500, at which point specs will look to push the narrative as far as they can and take out 1.2600 which failed in mid Feb. If we don’t, then this will be the fourth time we have rejected 1.2500+, but we have to get there first! Last week’s announcement from president Trump that the administration was to go ahead with the imposition of tariffs on steel and aluminium also gave the pair support which pushed us above 1.2300 here, with the USD also taking its share of the hit against the JPY, and to a lesser extent GBP and CHF.
Naturally, the commodity currencies suffered, with Canada still waiting to see if they get an exemption to this trade policy, so with annualised Q4 GDP failing to match expectations, we saw USD/CAD moving up to key levels at 1.2900, pushing into the offers which are heavy into 1.3000 also. EUR/CAD was the more profitable move which now looks set to extend to 1.6000, beyond which we are looking to the highs seen in Jan 2016!
Less of a response seen in AUD and NZD, which technically should have weakened based on the perceived factors driving sentiment, but there is nothing to say there will not be a delayed reaction once liquidity improves next week. Friday is not the best day to gauge sentiment in the currency markets, and Monday isn’t much better but this week (we anticipated) will be one on its own.
Out of the US, we will be looking for more details on the proposed tariffs, and as alluded to above, Canada and Mexico will be hoping for some reprieve. If not, then the chorus for ‘retaliation’ will be louder, with the EU’s Juncker targeting Harley Davidson, Bourbon and blue jeans already (tic), given the president’s targeting of EU made cars also.
From a data perspective, everything else is a build up to the non farm payrolls report for Feb. While the US outlook is dominated by spending plans and the ballooning affect on the budget deficit, the economic data of late has tempered this, with the ISM manufacturing employment index last week suggesting a strong headline number which is expected by the consensus to tip the 200k market again. Average earnings are expected to grow at a slow and steady pace, and at some point this year, wage increases announced by some of the major corporates like Walmart should also drive this reading higher. How this impacts on the broader populace is another matter and one which can swiftly delve into politics again.
Through the week, Monday’s ISM non manufacturing PMIs will likely be overlooked by political focus on Europe, while factory orders and more trade data over Tuesday and Wednesday will be considered in light of events last week (and this).
In Europe, once we get past the deliberations over events in Germany and Italy, the focal point of the week will be the ECB meeting on Thursday. Will they, won’t they drop the easing bias and/or signal to end QE are questions which will have greater significance for meetings beyond this one, but we can expect the press conference to be scrutinised for every word, hint, hesitation, cough. The pace of policy change is what needs to be considered, in what is clearly developing into a two-tier Euro zone economy with Germany in the fast lane again.
EU wide PMIs and sentiment indices are out on Monday, followed by the GDP for Q4, which is expected to be unchanged at 2.7%. German industrial production and exports on Friday offer a pre NFP distraction. Little data out of Italy.
The BoC also meet next week, and given the recent data run, we can expect a continuation of the cautious rhetoric which has been front-run by CAD weakness now threatening a move through 1.3000. Obviously no one is expecting any change in policy this time around, but markets are still pricing in up to 2 more rate hikes later this year, and this is at risk based on the economic outlook which has lost pace in the second half of 2017. GDP yoy still recorded its best levels since 2011 at 3.3%, but Canadian Oil prices are still trading at a large discount to WTI, so new tariffs on steel as well as any policy extension to other raw materials – lumber already in (heated) debate – put a negative slant on the CAD. which has been suffering across the board as noted above. Canada still looking for clarity on what at present seems a blanket US policy on trade; any exemption could see USD/CAD back to more comfortable levels in the 1.2500-1.2600 area
Trade data out on Wednesday comes just ahead of the central bank announcement, while Friday’s labour report will be an interesting one given last month’s heavy drop in part time jobs which resulted in a headline drop of 88k despite gains of nearly 50k full time positions.
No change expected from the RBA either next week, as they look set to stick at 1.5%, but maintaining – as they did last time – that they still see the next move as up. The consensus is moving towards this happening next year rather than this, but some are still looking for a potential move before the end of 2018. Based on what to expect from the Q4 GDP numbers, it is likely to be a late 2018 move if any, with CapEx spending and the heavy drop in construction work down over the quarter set to hit growth at the end of last year. AUD looks set to move in line with the numbers, but we look to be in a near term bear channel vs the USD and NZD, so next week’s data, which also includes the Jan trade stats should prove influential enough. Longer term, we still expect to see 0.7500-0.7600 to provide strong support, but Australia is also looking nervously on president Trump’s coverage of tariffs, with hopes of an exemption here also given sizable US iron ore imports.
The NZ data schedule is quiet next week but for the next global dairy auctions, but as we have seen lately, AUD/NZD has been a more favourable route to express AUD sentiment, so NZD will still be busy due to external factors.
We are now in the final month of the Japanese year end, and as if the JPY does not have enough supportive factors going for it, repatriation flow (to some degree) will be factored in over coming weeks. Despite the BoJ’s insistence that exit strategy is some way off, the market will get ‘ahead of the curve’ as we have been expecting from the latter part of last year. Just as the ECB have faced taper tantrums, thematic momentum is developing here also, and there looks to be little risk of a move back above 110.00 again despite the central bank maintaining their ‘powerful’ easing program as they have described it. As such, few surprises to expect when the BoJ meet at the end of the week, with any dissent among the ranks minimal in previous meetings, but naturally a risk going forward.
If there are any exemptions to Trump’s announcements last week, then it is reasonable to assume Japan has a high chance of being among them, given the strong cooperation with the US on North Korea. However, this will help Japanese steel makers including Nippon, JFE and Kobe, but the JPY will follow the impact seen on global stocks, and in the latter stages of last week, we saw bonds rallying with the pullback in equities in a rare sight of the more familiar correlations of previous decades. The US 10yr Note is back at 2.80%, and will be significantly influenced by the trade tensions going forward.
China has also responded to last week’s announcement, but its exposure is far less than that of Canada and the EU. South Korean imports are considerable, but we bracket them with Japan given coordinated sanctions on the North.
Key data out of Asia sees Chinese trade data on Thursday, while in Japan, Q4 GDP the day before is followed up by household spending data which is no doubt being keenly monitored by the inflation obsessed BoJ.
Data risk at either end of the week in the UK, with services PMIs on Monday, while industrial and manufacturing production and trade also offer some early morning focus on Friday. In between, is the ongoing exchange of what now seems to be public bartering between the UK and the EU, with last week’s EU draft proposals dismissed by the PM and her government, while the PM’s speech on Friday was again derided for the lack of substance, albeit providing elements which have appeased both hard line Brexiteers and the pro European camp.
While Theresa May admitted that both sides will have to concede and compromise to some degree, something picked up on by EU’s Barnier, there was little in there to suggest we are anywhere near close to a solution on the Irish border, but in showing openness to staying in or working with EU agencies, some may see an element of soft Brexit, especially as the speech started and ended with an insistence that a deal will be reached.
GBP weakness may have been curbed in the meantime, though we have seen EUR/GBP pushing above the 0.8920-25 zone. Sustainability will be tested next week, as will the resistance at 0.9000, while the Cable rate looks to have based out a little early in no mans land to suggest the market has not given up on a return through 1.4000, though we remain sceptical. The Brexit impact on the economy may still be playing out, especially when you look at flat investment over Q4 last year, as well as the under par growth figures which are projected for the next few year. Revaluation has been warranted to some degree, but we are close or at the point when we have to start differentiating again.
UK house price data also due out next week, and a theme we are watching with close interest given the high correlation with credit and spending in past years and decades. The Halifax index is expected to fall from 2.2% to 1.6%, while the RICS balance is also seen coming in from 8% to 7%.
Norwegian inflation on the agenda again next week, and this could impact on the NOK/SEK rate which has rallied to 1.0600 based on a downbeat Riksbank which looks to be reining in their rate path again – also based on erratic CPI rates. Norway’s numbers are expected to see a pick up from 1.1% to 1.3%. If not, the cross rate heads back down again, where 1.0360 is the immediate target.