Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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Euro rallies as interest in Italy fades
John J. Hardy
Global Head of Macro Strategy
The action across markets, but especially in Italian sovereign bonds and the euro suggests that we may be on the other side of a near-term climax from the political situation in Italy. Further questions remain, of course, and there could be another downdraft if the populists' fresh attempt to cobble together a government fails. That news could come as soon as today, as at least one Italian news source (La Stampa) reports that it is do or die today for a government formation to avoid the appointment of Cottarelli as caretaker prime minister (and the assumption that this act leads to a fresh round of elections).
The populists have somewhat cheekily proposed appointing the controversial Savona, who was the immediate cause of President Mattarella’s recent veto of the proposed new government, as foreign minister rather than finance minister. A less controversial appointment for the finance minister post has been aired, according to the Italian press this morning.
The US dollar and the Japanese yen have been the chief victims of a resurgent euro, and are also broadly weaker against all risky currencies and especially EM as global asset markets are breathing a collective sigh of relief. The lifting of some of the pressure from the Italy focus reminds us of the dovish Federal Open Market Committee minutes developments last week that had lowered US rate expectations and were USD bearish independently of the EU existential concerns that were USD bearish as the Fed has pointed.
Yesterday, the Bank of Canada surprised with a “hawkish hold” as they heavily revised the language describing their stance on future policy moves, eliminating the “cautious” consideration of further rate hikes and instead adopting a “gradual” hike stance. Rate expectations bounced slightly – and from that perspective the CAD reaction appears a bit exaggerated. But given the recent downshift in US rate expectations, the rebound in the euro and risk appetite yesterday, not to mention a strong rally in oil prices, were also afoot yesterday, adding to CAD potential.
If the market can look through Italy headlines today and tomorrow, the data calendar is getting more interesting, with the latest April PCE inflation data point from the US (the core level finally rising close to the 2.0% level and expected at 1.8% YoY vs. 1.9% in Mar.) The EU reports its latest flash May CPI estimate after German flash headline CPI ran much hotter than expected this month (+2.2% YoY vs. 1.9% expected).
Chart: USDCAD
Yesterday saw USDCAD pushing into the key 1.30-1.3100 pivot zone ahead of the Bank of Canada. With the strong reaction around this zone, the strong implication is that we have a cap in place for now and can focus lower toward 1.2500 and even 1.2000 eventually, with the latter more likely if oil prices continue to stay elevated, Fed rate hike expectations remain sideways to lower post the US FOMC meeting and risk appetite remains solid or better.
The G-10 rundown
USD – the greenback should prove the weakest of the lot if risk appetite improves and global growth concerns are sidelined and especially if the FOMC minutes continue to underline the “symmetry” theme and the desire to steer the Fed away from a preset course for more rate hikes, as this could allow the policy convergence theme to re-emerge for a time.
EUR – the euro is bouncing smartly from the lows very near the structurally pivotal 1.1500 area in EURUSD. Remaining uncertainties could certainly provide another nasty dip in the euro in coming sessions, but headline risk may have peaked for now, even if the EU existential showdown will be with us for years to come until we settle the question of whether there will ever be a true European Union.
JPY – the yen may outperform the USD slightly in the least favourable scenario for the US dollar we outline above, but could prove weak in the other crosses if risk appetite and yields can engineer a sustained recovery here.
GBP – sterling is looking isolated again if Italian spreads continue to tighten and EURGBP avoiding a chunkier sell-off during this recent episode of EU existential pain, which speaks volumes on sterling vulnerability without more Brexit progress.
CHF – the safe-haven bid for CHF is fading rapidly as EURCHF has bounced back above the prior 2018 lows around 1.1450. It will take considerable improvement to point the needles back higher for the pair after this latest damage, as a lasting “existential discount” may plague the euro from here.
AUD – the Aussie rebounded smartly yesterday with the recovery in global risk sentiment. Stronger than expected official Chinese PMI data are also providing a bit of wind in the Aussie’s sails. The technical implication of the reversal pick up further if AUDUSD can take out the 0.7600-50 zone to the upside.
CAD – as discussed above, the CAD reversal to the upside took place in a critical area and we’ll take it at face value, particularly if energy prices remain bid and today’s Canada GDP figures don’t throw up any hurdles.
NZD – the kiwi is rallying in sympathy with risky assets everywhere, but we’re most interested in the relative value situation versus the Aussie, as AUDNZD is having a look at the important support/pivot zone back at 1.0800-50 that has been in play as far back as last summer. Locally, arguably, the pair can slip as far as 1.0750 without fully reversing the rally.
SEK – we prefer SEK to the euro, even with the euro in recovery mode as the recent high energy sell-off suggests that we may have reached the end of the crowded short SEK trade. Resistance is 10.30 and then not until perhaps 10.50 – but we look for a test of 10.00. USDSEK shorts look compelling after yesterday’s sell-off if the highs yesterday hold.
NOK - the Norwegian krone has been a difficult one of late – waiting for a solid break of the cycle lows in EURNOK again to pick up interest in NOK upside.
Upcoming Economic Calendar Highlights (all times GMT)
0830 – UK Apr. Mortgage Approvals
0900 – Eurozone Apr. Unemployment Rate
0900 – Eurozone May Flash CPI estimate
1230 – US Apr. PCE Inflation
1230 – Canada Mar. GDP, Q1 GDP
1230 – US Initial Weekly Jobless Claims
1345 – US May Chicago PMI
1500 – US Weekly Crude Oil and Product Inventories
1620 – Canada Bank of Canada’s Leduc to speak
1630 – US Fed’s Bostic (Voter) to speak
1700 – US Fed’s Brainard (Voter) to speak
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