Global Head of Macro Strategy
Summary: The market sentiment has soured since New York City last night warned that all public schools will be closed from today. We also have the specter of an EU budget impasse to consider. In FX, the riskier currencies have headed lower versus the US dollar, with the euro under modest pressure as well, though the market seems asleep at the wheel on possible EU existential risks creeping back onto the agenda over the budget.
Today’s FX Trading focus:
Is a new EU existential crisis brewing? Market doesn’t seem to think so.
As the ECB continues to merrily crush yield spreads across the EU – with Portugal-, Spain- and Italy-to Germany 10-year yields at 123, 65 and 61 (!) basis points, respectively. But at the same time, we seem to have more than a little problem at the periphery of the periphery, as Poland and Hungary vetoed the recent 7-year MFF, or EU budget and the accompanying recovery package, revolting against the rule-of-law provisions that would only allow disbursement of funds if the recipient countries follow guidelines on issues like freedom of press, an independent judiciary, etc.. Hungary’s Orban is the most aggressive in railing against the loss of sovereignty implied. For him, and to a degree for the Polish leadership, their opposition is existential and they are unlikely to back down as long as the rule-of-law strings are attached to these budgets.
What happens next, then? Today, EU leaders are set for a videoconference. Another issue difficult for Poland and Hungary and others to meet will be the aggressive climate targets. The longer the situation drags out and delays the new outlays from the budget, the more this could weigh on the euro. As for PLN and HUF, they seem to have entirely failed to absorb any negative flows on their currencies or in their credit spreads. Rather surprising, to say the least. Is the market assuming that the EU will continue to disburse generous stimulus to these countries far in excess of their contribution to the EU budget with no strings attached by merely striking out the rule-of-law provision simply to ram the vote through? The situation bears watching closer.
Chart: EURJPY
EURJPY was pushing back into an interesting area overnight after having almost entirely erased the enthusiastic bounce on the announcement of Pfizer’s Covid-19 vaccine last Monday. If safe haven trades pick up a bid again, and particularly if the market begins to smell trouble with the EU budget and the risk of a stand-off with Poland and/or Hungary, downside in EURJPY would likely be the path of least resistance. The 200-day moving average, currently at 121.40, is perhaps the bull/bear line.
The US dollar – December FOMC shaping up as critical
I have written at length on the murky outlook for the US dollar in the nearest term, given the ongoing lack of political clarity and the wait for the two Georgia run-off elections on January 5. Meanwhile, the weak USD narrative is generally one of: political gridlock will more than be made up for by a hyper-accommodative Fed providing the necessary USD liquidity to keep the USD under pressure. On that note, the December 16 FOMC will prove a key milestone with many touting the potential for the Fed to already look into a maturity extension of its purchases or announcing an expansion of its rate of purchases after the recent episode of rates climbing toward post-pandemic outbreak highs. The great and balanced Tim Duy penned an excellent post yesterday questioning whether the Fed is at all ready to wax dovish as its pleas for fiscal are also a kind of expression of the belief that expanding QE would be ineffective, something it has more or less also stated. And with financial conditions about as good as they get, there is no compelling argument for QE from that angle. Worth considering the risk that the market is over-reliant on the dovish Fed narrative in the near term through that December FOMC meeting.
Talking Turkey
The powerful recent TRY rally reversed all of the prior sell-off from late October and then some once Turkish President Erdogan made it clear that he was willing to allow a more traditional approach to reversing the risk of a chaotic currency devaluation. That leads to today’s Turkish central bank meeting, at which a rate hike of 475 basis points is now the consensus, which would take the key rate to 15.00%, a far more fitting policy rate for Turkey’s situation. The near-term question is whether this move is already priced in tactically after a more than 10% appreciation in the lira versus the US dollar from the top.
The G-10 rundown
USD – The US dollar climbing on the decline of risk sentiment after New York City announced a closure of its schools in what seems a moment of reckoning with what will be a very tough slog for the economy in the US over at least the next couple of months and possibly longer on the need to deal with th. Thoughts on December FOMC above.
EUR – a smooth path to fiscal stimulus is needed and soon, otherwise the euro at risk of bogging down here – watching for the potential of wider fall-out on the existential front, where there is no evidence at present on the ECB’s purchases
JPY – the yen firmed broadly on the bout of weak risk sentiment into this morning, but with the USD likewise firming and USDJPY back testing above 104.00 as of this writing, the move lacks urgency – probably need a more notable bid into US treasuries (US 10-year benchmark below 75 bps again versus current 85?) for the yen to draw more focus.
GBP - sterling poised for a deal announcement that could usher in a rally that may prove surprisingly modest, unless the UK position looks particularly submissive. The key level lower in EURGBP 0.8867 for potential opening toward 0.8600.
CHF – interesting that the bout of risk off here still sees EURCHF in the tight area of consolidation around 1.0800 area. Watching 0.9200 in USDCHF for flow potential as well if USD upside follows through here.
AUD – great jobs data out of Australia last night as the October data captured some of the improvement from the lifting of the Victoria lockdown. In less positive news, China delivered a list of 14 grievances to Australian media that had Prime Minister Morrison out on TV defending his administration’s position. The situation is more than a bit fraught, with Chinese companies directed to not import seven goods categories this month, including copper ore and wine. AUDUSD has room to consolidate here, with bulls only starting to suffer if it works below 0.7225/00.
CAD – the pivot high in USDCAD at 1.3173 is the trigger risk for a squeeze to 1.3300 or higher if the focus on the near-term gloom drives another sell-off in crude oil.
NZD – the NZDUSD move higher looks overdone in light of where other USD pairs trade – room to consolidate there to at least 0.6800 without rocking the boat for the bulls.
SEK – with focus seeming to revert back to near term Covid-19 doom and gloom this winter and risk sentiment, you guessed it, EURSEK has risen sharply off yesterday’s lows. If the 10.30 area is triggered on a more extended bout of concern about the outlook, EURSEK could be in for a more notable consolidation, if one we would like to eventually fade.
NOK – EURNOK needs to hold below the recent highs/200-day moving average or we risk another squeeze up to the top of prior range well above 11.00.
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