Head of FX Strategy
Summary: Risk sentiment is in a hopeful mood to start the week, driven by goldilocks US data and hopes for de-escalation of US-China trade tensions next month. The Euro and safe haven currencies are weak and risky currencies are resurgent in hopes that the good times will continue. Biggest event risk on this week’s calendar the ECB meeting.
Trading interest
The ECB meeting is this week’s chief highlight as we all question whether the market has overpriced the scale of the easing package Draghi and company are set to deliver and whether any new easing is pushing on a string anyway. President Draghi is no doubt ready to bring out the big policy bazooka, but there seems a noisier contingent of ECB “hawks” leaning against significant activism. On the way at this Thursday’s meeting is some mix of rate cut (odds only slightly favour 10 vs 20 bp cut), tiering (a must for core banks with the huge reserves paying negative interest), new cheap loans to banks (most important for peripheral banks to continue to roll bad debt) and asset purchases (likely the most controversial topic among ECB governing council given where yields are trading, nonetheless estimates start with EUR 20 billion per month and pick up steeply from there).
The net effect of these measures will bring some degree of relief for the banking system in particular – an absolute must to pull the European financial sector out of its death spiral and avoiding the current policy environment from inflicting active harm on banks and credit transmission. Still, the more powerful medicine for the economy (and the euro) would be coordination with EU governments to link QE with significant fiscal stimulus and perhaps combining this with Bank of Japan-style yield curve control, but it appears too early to look for this. As for the EUR, the single currency is rather weak against risky currencies after last week’s surge in risk appetite, but has pulled back to critical levels against the US dollar, as we look at in the chart below.
The coverage of Brexit and UK Prime Minister Boris Johnson’s political travails and the comeback in sterling don’t take into account that the machinations of parliament to seize control and avoid a “cliff edge” No Deal on October 31, and even the chaos in his the Conservative party could eventually play straight into Johnson's hands in an election scenario, as polls continue to indicate strong outcomes for the Conservatives. In other words, No Deal Brexit odds may be higher than ever beyond a new January deadline and investors looking positioning for “No Deal or Corbyn” now have far better prices and implied volatilities to work with for downside sterling scenarios. This week, Johnson will again look to call for an election, though there could yet be drama around the bill to force a deadline extension.
China fixed USDCNY eleven basis points lower overnight, and it won’t be surprising if USDCNY is closer to 7.05 than 7.15 – or at least kept very quiet – through China’s National Day celebrations at the first of next month and ahead of the US and China talks sometime thereafter.
Chart: EURUSD
EURUSD is at a crossroads this week as we await ECB easing measures and whether the market has overpriced these. The rejection of the recent break below 1.1000 in EURUSD is a hopeful development for bulls, but not yet forceful enough to reverse the trend. The 1.1000-50 area looks pivotal over this week’s ECB meeting and the prior price action in recent months is not encouraging for structural bulls unless the narrative somehow changes, as every rally has eventually faded and long positions are costly to hold because of the carry differential.
The G-10 rundown
USD – the August jobs report was not encouraging, but odds are dropping for a 50 bp move from the Fed next week as the immediate threat of trade war escalation between the US and China has faded. The US dollar has reversed back lower after a surge to new highs last week – the situation looks technically pivotal right now for the greenback and will remain so through the September 18 FOMC meeting.
EUR – before judging that the euro looks firm versus the US dollar and the yen, have a look at EURCAD and other EUR/risky crosses, which suggest that the market is looking for strong easing from the ECB – these may be the most prone crosses to a severe correction in the event the ECB disappoints on the hawkish side.
JPY – the yen on the defensive as risk sentiment has improved and bond yields have backed up. For broader JPY outlook, watching the 107.00 area in USDJPY for whether the yen remains the weakest of the weak here.
GBP – sterling is not out of the woods yet – thought technically, the EURGBP reversal is impressive. Very headline driven.
CHF – prospects for ECB easing holding EURCHF down, while risk sentiment and yield back-up driving in the opposite direction. Seems time for a consolidation, especially if yield consolidation higher continues.
AUD – the Aussie trying to mount a comeback here, finding fuel on crowded short positioning and the prospects for US-
CAD – if equities continue to stage a comeback here and risk sentiment finds encouragement from the ECB and then next week’s FOMC meeting (even more important) potential for USDCAD to test all the way to 1.3000.
NZD – AUDNZD seeking out local support and so far finding it not far below 1.0650 – AU/NZ yield spreads continue to point the needle higher for the pair as the next hurdle is the 1.0700+ area recent highs for a possible go at 1.1000
SEK – the resurgent risk appetite and solid PMI data out of Sweden last week boosting the SEK and have EURSEK challenging the key pivot area below 10.65 that could open for 10.50 and more if the good mood continues across markets.
NOK – Solid GDP print this morning has EURNOK digging lower below first key area around 9.90, but bigger breakdown requires taking out the 9.80-75 area: probably a full recovery in risk sentiment and hopes on the other side of the ECB and FOMC meetings that the central banks are getting ahead of the curve needed for significant EURNOK downside traction to develop.
Upcoming Economic Calendar Highlights (all times GMT)
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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