Head of FX Strategy
Summary: The US dollar is closing the year with a whimper, but a busy flurry of event risk and market risks await. First is the US Senate treatment of the larger stimulus checks followed next Tuesday by the key Georgia Senate run-off elections that could yet allow Democrats to set more of the agenda under the Biden presidency. Today, I offer the last rundown G-10 FX and CNH for this year as we roll into 2021.
FX Trading focus:
The US dollar near cycle lows as the New Year comes into view.
In my most recent post on Monday, I outlined the key factor that could yet disrupt the USD bears’ narrative rather quickly next year – not necessarily ending it, but providing some pushback and two-way traffic: the long end of the US treasury curve and whether it is poised to break higher, with the 100 bps level for the US 10-year treasury benchmark the nominal break level (currently 94 bps). Until that eventuality occurs, we may yet see smooth sailing in the early days of next year, though the Georgia Senate race looming next Wednesday still presents two-way risks.
And again, if US yields are not pulling higher rather quickly in coming weeks, where will traders draw support for the reflationary recovery narrative? Playing a bit of devil’s advocate to the very notion that the market is fully on board with the reflationary recovery scenario, perhaps the pressure on the USD is easiest to maintain as long as economies continue to show signs of deceleration and we see more and more liquidity injections via fiscal impulses like Trump’s $2,000 stimulus checks…
Chart: EURUSD
EURUSD has been one of the more straightforward ways to trade a weaker US dollar in recent weeks and the next obvious objectives are the 1.2500 level and the range high from early 2018 slightly higher still, though note that the highest weekly close was barely above 1.2450 back then. First, however, we have a calendar roll and a number of important questions looming on stimulus, the composition of the US Senate and US yields. As well, momentum is a bit divergent here (new price highs without new highs in momentum indicators) if the pair doesn’t follow through quickly higher in the first trading days of 2021. In short, it looks like a tactical do-or-die situation next week for the EURUSD bulls.
Polish central bank shocks PLN lower
The Polish central bank governor Adam Glapinksi shocked the market, and sent PLN tumbling as he issued a statement saying the central bank there is considering the impact of rate cuts into negative territory for possible implementation in the first quarter of next year. This was not at all anticipated and seems aimed directly at FX weakening to stimulate the Polish economy.
We saw with the confrontation between the EU and Hungary and Poland over the EU budget and pandemic recovery package that the EU is simply not ready to take up the fight on the “rule of law” provisions that could have seen the blocking of distribution of funds. This inspired a bounceback in PLN. But the decision was a punt, and not the end of the matter. I was asked recently by a Polish journalist to provide some thoughts on 2021 and the budget issue remains a key source of potential downside for the currency if fresh confrontations over the rule of law materialize. Another potential risk would be a fresh rise in inflation that fails to see any response from the Polish central bank (especially given above), as a previous bout of inflation in late 2019 was entirely ignored by the central bank at the time, driving very negative real rates ahead of the Covid-19 crash in inflation.
The G-10 + CNH rundown as 2021 rolls into view
USD – the first orders of business are the Georgia Senate run-off elections next Tuesday, the current stimulus check proposals and US treasury yields and whether they break higher. No change to checks, both Georgia Senate seats not going to Dems and US yields breaking higher the most USD supportive combination, is my presumption.
EUR – the euro is neutral, absorbing strength by default, though if we do get a strong global rebound in the wake of vaccinations, the euro stands to benefit via its export sectors. But what happens if inflation rebound sends inflation higher in the EU as well – a place where the ECB’s heavy hand keeps yields at below US yields even for Portugal? Consider the discussion around inflationary outcomes and policy capping long yields in this great discussion: https://www.youtube.com/watch?v=91BxHoAXB6E (worth watching in its entirety).
CNH – recent market action suggests that China is not interested in seeing further pronounced isolated strength in the yuan as the progress lower in USDCNY was halted weeks ago. The key for CNH in 2021 will be the course of US-China relationship, with CNH generally resilient if China’s currently successful bid to attract major capital inflows continues.
JPY – the political leaders of Japan have declared a floor of 100 on USDJPY and the recent dynamic suggests they will have little trouble defending that level unless growth stumbles badly in 2021 and risk sentiment suddenly collapses. In that case, JPY upside pressure would more likely be greater elsewhere, in AUDJPY and NZDJPY, etc.
GBP - sterling is very cheap and the while the tactical disappointment is rather significant for bulls hoping to see a rally in the wake of even this rather “thin” deal, it is difficult for me to see the currency significantly lower in the near to medium term unless we lurch very quickly into a real inflationary mess that plunges the UK into steep negative real rates. I suspect sterling can rise modestly versus the euro in 2021.
CHF – the market doesn’t like a negative yielding currency and the SNB sight deposits have grounded. A reflationary recovery could drive a modestly weaker CHF in 2021.
AUD – the Aussie would likely be considerably higher in places were it not for the ongoing showdown with China. The US-China confrontation is an important longer term risk, even if Australia is well positioned in export market terms for a reflationary global recovery (save for levels of debt in its economy, which should keep the currency well away from a 2010-11 style valuation extreme in the next cycle)
NZD – I like AUDNZD higher in 2021 if the reflationary recovery unfolds (driving a widening current account surplus for Australia while NZ’s remains in deficit) does unfold and perhaps uninteresting and sideways if it does not.
SEK - the krona should do well if the global economy does manage to snap back, as the Swedish economy is pro-cyclical. But the inflation question hanging over the EU is just as dire for Sweden, so the ceiling could be a bit lower than in previous cycles. First order of business is the huge 10.00 level in EURSEK.
NOK – the preferred Scandie for a proper reflationary recovery over the 2021-22 time frame as the underinvestment in crude oil will eventually mean much higher prices. NOKSEK upside one way to express this.
2024: The wasted year
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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.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
