Head of FX Strategy
Summary: The very weak close in equity markets on Friday after a solid comeback attempt the prior day sets up a nervous week ahead. The USD is caught in the crossfire of opposing themes as we await developments in the testy US-China relationship and sterling traders hold their collective breath for the next twists and turns in the fate of Brexit.
Friday’s ugly close in equity markets not far from the cycle lows and the US 10-year benchmark closing the week well below the pivotal 3.00% level sets up a very nervous week ahead. Arguably, the latest dip in sentiment has been driven by the arrest in Canada of Huawei’s CFO and concern that this spirals into a wider showdown and derails the ongoing US-China trade negotiations. Headlines linked to this story could drive significant short-term volatility in either direction.
The odds of a December 19 Fed rate hike dipped very slight, but remain close to 70% after Friday’s US jobs report for November, which saw a disappointing month-on-month rise in average hourly earnings of +0.2%, even as the year-on-year number was in-line and matched October’s cycle high. Also negative, if not yet statistically significant, the average weekly hours worked dipped unexpectedly and the payrolls change for the month also disappointed. More relevant as a historic indicator, the recent rise in the weekly jobless claims off record lows is beginning to look persistent and has been a better indicator of the state of the US jobs market historically. This number, released every Thursday, could begin to take on more importance.
The US dollar is caught in a crossfire of conflicting drivers, as the unwinding of Fed expectations is bearish, while weak risk sentiment drives a safe haven bid.
Canada’s erratic employment change number printed at a record high on Friday, catching fresh CAD shorts off-guard after a profound shift in the Bank of Canada’s guidance last week. Given the tendency of this data series to mean revert and the fact that employment data is one of the most lagging economic time series, we would pay far more attention to the Bank of Canada’s guidance than an unreliable and lagging indicator.
Besides risk-on, risk-off risks this week, especially if the major US stock indices dip to new cycle lows, the Brexit issue will continue to drive uncertainty in GBP and even EUR. The noise this morning is that May will look to delay the parliamentary vote and is begging the EU for a “lifeline” to provide a breakthrough. But nothing resembling the current deal is likely to pass the UK parliament, which will call the EU’s bluff that it is either May’s deal or No Deal. The EU is not willing to let the economy go down in flames just ahead of the May 2019 EU parliamentary elections. The situation will remain very fluid for now.
Chart: EURGBP 3-month volatility
As the Brexit window draws to a close, implied volatility in sterling crosses is spiking to the levels just before and after the actual Brexit vote back in 2016. The chart below shows the 3-month implied volatility, which doesn’t even take us to after the March 29 Article 50 deadline. Arguably, volatility could be too expensive and taking a directional view on sterling in the options is getting very pricey. One approach could be to trade long call or put spreads, which limits upside, but requires less of a move to realise a profit.
The G-10 rundown
USD – as discussed above, unwinding of Fed rate hike expectations out the curve only help to weaken the US dollar when the market celebrates the unwinding with stronger risk sentiment. This week’s CPI (Wednesday) and Retail Sales (Friday) are the last major US data points ahead of next Wednesday’s Federal Open Market Committee meeting.
EUR – the euro rising within the range short of 1.1500 in EURUSD, but we have a hard time seeing a pointed directional move in euro until something firmer develops on Brexit.
JPY – the JPY can’t seem to sustain a rally, only pulling higher when risk off is afoot and then dribbling back to the downside when the pressure eases. USDJPY hasn’t made a technical statement in over two months.
GBP – don’t let the low volatility in spot EURGBP, for example, fool you, as the market is sitting on its hands, but very nervous on where this goes next – as indicated in the implied volatility in the options market shown above.
CHF – paint is drying in EURCHF, but potential for a reaction on Brexit developments, although curiously, implied volatilities are still muted.
AUD – Any bounce in AUD may prove modest unless we see a sudden positive spin on US-China negotiations after the downward shift in Reserve Bank of Australia expectations.
CAD – as indicated above, the Bank of Canada guidance shift and removal of forward rate hike anticipation speaks louder than a strong jobs report Friday. We prefer outlook for USDCAD toward 1.3800 as long as we hold above 1.3200-1.3300.
NZD – the Reserve Bank of New Zealand’s Orr out speaking late tomorrow and have to wonder if he is beginning to get a bit uncomfortable with the kiwi’s relative strength. Given weak risk appetite backdrop, the strong kiwi of late sticks out like a sore thumb.
SEK – is SEK catching the weak housing market bug started by AUD and CAD? Quite possibly, as EURSEK pops back up into the range and could be in for a further squeeze if 9.35. Still, short rates remain firm going into next Thursday’s Riksbank meeting.
NOK – OPEC plus Russia agree to cut 1.2 million barrels, with Russia apparently to take considerable time to achieve its cuts. Meanwhile, US shale oil production has ramped over 3 million barrels per day over the last two years and the US has become a net oil exporter – not convinced, in other words, that oil about to provide a strong bid under NOK.
Upcoming Economic Calendar Highlights (all times GMT)
0900 – Italy Oct. Industrial Production
0930 – UK Oct. Visible Trade Balance
0930 – UK Oct. Manufacturing Production
1315 – Canada Nov. Housing Starts
1330 – Canada Oct. Building Permits
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
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