Head of FX Strategy, Saxo Bank Group
Summary: The bottom has dropped out of JPY crosses on the triple-whammy of weak risk appetite, safe-haven seeking in sovereign bonds and a steep drop in crude oil prices. The USD is largely adrift during this run, potentially held back by speculative positioning.
As for the US dollar, its role as a safe haven has not played prominently here, with the big dollar perhaps held back by speculative positioning (or, finally, despite the prior lack of response, the aggressive acceleration of anticipated Federal Reserve rate cuts is now providing some drag on the USD after failing to do so previously. Thursday and Friday saw an entire, further 25 basis point cut priced in by the December Federal Open Market Committee meeting.
At the weekend, China formulated a position statement on the trade policy showdown with the US, saying the latter was to blame for the breakdown in negotiations and repeating the three points originally brought by Liu He in Washington when the talks failed last month. Still, some saw the Chinese position as leaving the door open for negotiation, perhaps beginning already later this week as trade officials will meet in preparation for the G20 summit later. While some semblance of diplomacy was in evidence, China continues to show a hard stance as it promised to draw up a blacklist of “unreliable” foreign entities – arguably a tit-for-tat response to the US placing Huawei on its so-called Entity List – and even announced an investigation of FedEx practices.
Overnight, the bellwether that is South Korea reported a weakening in its May Nikkei Manufacturing PMI, which dropped to 48.4 after stabilizing slightly above 50 in April.
Looking at the week ahead, the market will be highly sensitive to trade war-linked headlines, now that volatility has lurched back higher. So far, the bulk of the market drama has been in US Treasuries, where yields are in a freefall and now below 2.00% all the way out to beyond five years (and not much above that level out to 10 years, as the yield curve has hardly steepened, even as traders fall all over themselves to price in rising odds of Fed rate cuts).
In equities, selling intensified last week but the VIX is still below 20, and in currencies, nearly all of the volatility has only shown up in JPY crosses and select EM currencies.
Besides the risk-on, risk-off swings on headlines, we also have an important Fed conference this week, kicked off tomorrow with a speech from Fed chair Powell. It is titled "Monetary Policy Strategy, Tools, and Communication Practices". This could be the Fed’s attempt to provide a foundation for a more dovish policy mix to encourage inflation to run above 2.0% for a time.
The bond market is saying too little, too late right now and the still flat curve suggest that the Fed has yet to impress the market with its dovishness thus far. The overriding question is whether the Fed even has the tools to do anything about inflation, or whether only the US treasury and fiscal levers can bring a sustained inflationary impulse, with the Fed merely as a non-independent auxiliary.
An interesting test for the Aussie tonight as the Reserve Bank of Australia has thoroughly flagged that it will cut rates at tonight’s meeting, but suspense lingers on whether this will be a one-off or one in a series of two or more hikes. The market will pore over the statement for clues on guidance. Our suspicion is that two is an absolute minimum for the cycle and more likely four eventually, with QE or similar necessary if trade war risks deepen.
The AUD is somewhat resilient here – is this a product of position squaring as speculators have been heavily short the currency? Hard to see upside here, outside of a minor squeeze on a less dovish than expected guidance. The 0.7000 area is the key resistance zone for bears.
USD – the greenback seeing little in the way of safe-haven flows, but USD liquidity will constantly come back to haunt if credit conditions are tightening globally on concern for the outlook.
EUR – the Euro seeing a modest rally off the lows against the US dollar, but not showing strength generally – the European Central Bank meeting will show whether Draghi agrees that the ECB has an empty toolbox.
JPY – the yen wrecking ball is swinging with full force and will likely continue to do so as long as risk sentiment, oil and yields continue due south. Expect Kuroda to rattle the policy cage sooner rather than later – real policy drama not likely until after G20 at the end of this month, however.
GBP – a bit of selling exhaustion in evidence after EURGBP failed to hold the new high on Friday and momentum could roll over here for a bout of consolidation at least until we’re a bit more clued in on the next steps for Brexit.
CHF – the bottom giving way in EURCHF here – has the market (including us) been complacent on SNB intervention? Some added energy, perhaps from the break unfolding as USDCHF breaks below parity.
AUD – a bit of resilience in the crosses ahead of tonight’s RBA cut – profit taking on crowded specs? An ugly correction in iron ore prices in China is eroding further fundamental support here.
CAD – the loonie rather stable despite the drama in oil markets and last week’s dovish Bank of Canada turn. Have USDCAD traders surrendered all hope of volatility?
NZD – AUDNZD tried to piece together a rally but held back by the 200-day moving average just above 1.0600 – key test tonight for relative strength over the RBA decision as RBNZ likely to more or less tracks the RBA’s moves.
SEK – EURSEK has been taken back to the 9.60-65 pivot area, surprisingly in the context of very weak sentiment (was the oil collapse a driver via NOKSEK late last week?). A significant break through this level would suggest a top in place – stay tuned. This morning saw a strong Swedish PMI survey.
NOK – the carnage in oil markets is keeping NOK sidelined, really a sign of strength that EURNOK hasn’t rallied more notably. Norwegian short rates finally coming under some pressure, waking up to global trends.
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