Head of FX Strategy
Summary: Risk sentiment has soured further this week after ending on a weak note last Friday. Our focus this week is more on the risk of escalating tensions between the US and China and whether the USDCNH rate drifts to new highs once China returns from holiday on Wednesday. Elsewhere, the euro rally late last week looks odd while most of the rest of the FX is behaving as expected given the backdrop.
US-China tensions are taking most of our bandwidth at the moment, particularly as these have been accompanied by a strong move higher in USDCNH to just short of the Covid19 crisis high overnight. US President Trump has made a number of more negative comments on China’s handling of the virus outbreak since late last week and has brought in the threat of tariffs once again. US Secretary of State Pompeo has made even more pointed comments and claims of evidence that China was negligent, and a Republican playbook on how to drum up voter support for the 2020 election cycle with China-bashing has added to the sense that US-China tensions are back to stay and could get worse. The first order of business will be any message China sends via the onshore CNY exchange rate when the country’s markets come back from holiday on Wednesday. The 7.20 level in USDCNY is the line in the sand for whether a lid is kept on this issue. The AUD has been particularly sensitive to CNH moves over the last few session.
The rather strong euro in the wake of the ECB meeting and to close the week last week has looked rather odd. We argued at the time that there was no evidence that the ECB’s new measures last week drove this rally – on the contrary. At the margin, there may have been a lifting of speculative euro shorts as there was no immediate fallout from the EU council meetings on recovery aid, but US futures positioning point to a very large net long speculative position in euro, with nothing on the chart to suggest why speculators there have built such a large position (normally, positioning is highly correlated with chart trends.)
Positioning aside, there was clear evidence that the change to risk sentiment into a more steeply negative tendency coincided precisely with the timing of the sudden jolt higher in the euro. For now, we will file this move under the category of “hmmm” as we see no reason to support a marked Euro rally unless the driver is that the ECB policy mix on its balance sheet expansion looks modest compared to the Fed’s more aggressive moves. This was a pattern post-GFC as well, with the ECB’s very tardy move into ”proper QE” not coming until early 2015 (as opposed to temporary expansions of the balance sheet via LTROS that quickly saw the ECB’s balance sheet subsequently shrink as banks saw no reason to extend these loans once market conditions had clamed in 2013 and 2014.)
Chart: AUDUSD
The AUDUSD rally has reversed sharply from the peak in risk sentiment from mid last week and has now broken down through the key 0.6450 area. The USDCNH really move late last week is bringing in concerns that China could allow the renminbi to slip to new lows versus a surging US dollar, as markets recall how much uncertainty moves int eh renminbi have generated in the past, most notably in late 2015. Action this morning at one point, in which the AUDUSD traded back toward session highs even as major equity markets were under a bit more pressure at that time point to considerable sensitivity to USDCNH at the moment as the latter was back toward the session lows. The mix of CNH moves and risk sentiment will determine whether the Aussie is at risk of a new cycle of pressure.
The G-10 rundown
USD – the US dollar broadly firmer, but not adding much to Friday’s closing levels. For now, the USD the flipside of risk sentiment in most cases. Not sure that the market will react much to further April data horrors that are likely through the Friday Nonfarm payrolls change, as focus will be on the rate of improvement starting with the May data cycle.
EUR – in addition to the comments above, perhaps worth noting that EU existential concerns are not yet fading – a slow burn issue for now, but Italian politics could be set to get more volatile as Conte is under huge pressure on plans for normalization.
JPY – the JPY performing its normal function over the last couple of sessions, but we need a big acceleration in USDJPY lower to shift attention more forcefully here.
GBP – sterling not the go-to currency in times of turmoil, the evidence suggests, but one to pick up against the Euro eventually.
CHF – the EURCHF always seems to push back lower eventually, this time after the brief rally after last week’s weekly sight deposits showed heavy SNB intervention. Last week saw another big move higher in the sight deposits. Watching 1.0500 to see if the dam breaks.
AUD – the Aussie riding two horses now, the shifts in risk sentiment on the one hand and increasing sensitivity to USDCNH / USDCNY on the other if and when the latter approaches the 2019 highs.
CAD – the Bank of Canada will have a new governor – old deputy governor Tiff Macklem – as of early June. Observers have been slow to pull out a strong angle on him except for his approval of forward guidance. The BoC was never as sorely tested in the financial crisis as it will be from here.
NZD – the kiwi outperforming the Aussie on the latest, heavier China focus. On that account, given the scale of the recent AUDNZD rally, plenty more room for consolidation without reversing the rally, though structural bulls will prefer for the 1.0500 area and the 200-day moving average just above to hold.
SEK – a terrible Manufacturing PMI out of Sweden reminds that even with Sweden’s novel policy response to the Covid19 virus, it can’t escape external exposure for its export industries. SEK under fresh pressure.
NOK – oil under fresh pressure this morning – again or thesis is that EURNOK may have peaked for the cycle, but NOK only stands a chance of a rally when we see far forward crude oil prices (say December 2021 or longer) clearly having built a base and on the mend. The next pivot to the upside at 11.70.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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