Equities: New extremes and a challenging opportunity set
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Head of FX Strategy
Summary: The USD is weaker again this morning, led by USDJPY trading below 108.00, but also EURUSD and other USD pairs testing support for the greenback. After the Powell Fed tried to shift the policy outlook into neutral, incoming data will set the tone over coming days, obviously over the US jobs report later today but also through the ISM Non-manufacturing survey release next Tuesday.
The FOMC meeting this Wednesday, with its downshift into neutral and clear reliance on incoming data for establishing the course of the Fed’s next move, means that data releases are likely to trigger larger moves than they have in the recent past. Today we have a look at the October Nonfarm payrolls change, expected well south off 100k after a slight beat in September, though the 6-month moving average has suffered an obvious drop since this spring – after running well over 200k though all of late 2018, it has now run around 150k for the last three month. Pay close attention to the two-month net revisions as well as the data for this month, and also note the private payrolls data, as US 2020 census hiring is set to pick up for another several months. Later it is on to the ISM manufacturing, where yesterday’s very weak Chicago PMI for October has raised the risk of a weak reading (even as the Chicago number was probably largely down to specific Boeing and GM strike issues) Given Powell’s hope that it is the consumer that is holding up the US economy, next Tuesday’s ISM Non-manufacturing survey takes on a bit of added weight.
We have noted on many occasions that implied volatility in the major currency pairs has descended to near record lows. An example is EURUSD 1-month volatility, which is dropped as low as 4.5% recently, a level it has only attained on two prior occasions, once in 2007 and again in 2014. Each time, this preceded incredible trending moves in EURUSD – in the earlier instance a brutal rally from around 1.35 to 1.60 as the Fed was seen chopping rates in response to the sub-prime crisis. The 2014 move was even more violent, driven by the “policy divergence” theme of a Fed seen continuing to normalize while the ECB sent signals it was laying the ground work for real QE – EURUSD went from around 1.3500 in July of 2014 as implied volatility was lowest to 1.05 by March of 2015. This time around, if we face a scenario in which the Fed chops rates back to zero and provides endless liquidity to prevent massive Trump deficits and USD liquidity issues from destabilizing funding markets – the USD could be set for a strong move lower soon. This scenario offers some rough parallels with the 2007 scenario. Let’s also realize that the US budget deficit will accelerate precipitously if a recession is on the way and even more so if Trump’s desperate ploy to bring a payroll tax cut to prop up election hopes sees the light of day.
Yesterday, a Bloomberg article citing Chinese sources indicating an unwillingness by the Chinese side to make any deeper trade deal with a volatile US President Trump set in motion a considerable sell-off in risk appetite. But by now the idea that US and China will only be able to agree on a narrow, “phase one” style trade deal is probably consensus, so concerns that longer term trade deal hopes never materialize are likely a non-factor day to day for markets. The market is complacent, however, that we will get that phase one deal, a deal that includes some partial climb-down from the US side on tariffs in exchange for Chinese purchases of agricultural and other products. The market assumes that Trump won’t want to re-aggravate trade issues from now until next November to avoid denting the economy and the stock market during his re-election campaign.
South Korea’s exports and imports were both down nearly 15% year-on-year, an ugly sign of ongoing weakness for this bellwether of an exporting economy and offering some counterpart to China’s slightly firmer Caixin Manufacturing PMI print overnight (improving to 51.7 vs. 51.0 expected and 51.4 in Sep.).
The USDJPY reversal post-FOMC picked up additional energy yesterday on the back of concern that the US-China trade deal prospects are on the rocks, but also responded to a possibly related strong rally in long US treasuries. The move deepens the impression that the pair has made a critical turn here – but traditional USDJPY is one of the most sensitive USD pairs to US data, so to further cement the sense that the USD is turning lower here we’ll need a look at the data through next Tuesday’s US ISM-non manufacturing. A close south of perhaps 107.50 begins to suggest a more profound breakdown.
The G-10 rundown
USD – the USD under real pressure here, and again, it looks like pressure broadest on the greenback if we get soft data and resilient risk appetite, while exceptionally bad data could begin to creep into risk spreads and mean that USD weakness is more selective.
EUR – EURUSD trying to turning higher and may have weaker beta to the weak US data than USDJPY, but still very interesting with more obviously interesting levels in EURUSD coming up just above 1.1200.
JPY – often the most sensitive to US data – but only likely to strengthen broadly on the combination of weak US data supportive bonds and weakening risk sentiment at the same time.
GBP – sterling sufficiently resilient and the USD sufficiently weak to see GBPUSD pushing on the 1.3000 area and likely set for more upside if the USD weak elsewhere after today’s data.
CHF – the franc torn between robust risk appetite and lower bond yields. Tough to pay attention here any more- but the 1.1050-60 area an important trigger zone if the pair to rally.
AUD – yesterday’s AUD rally dented on the US-China trade deal doubts, but not sufficiently to argue we have seen a reversal just yet in AUDUSD, which looks pivotal here on the USD outlook over key incoming data.
CAD – CAD managing to stabilize versus the weak USD, but has weakened sharply in the other crosses after the BoC’s dovish caution this week. On that account, USDCAD could prove low beta in a weakening USD environment.
NZD – we head into the US data with NZDUSD testing a very well etched upside down head-and-shoulders formation neckline around 0.6435 overnight and this morning.
SEK – some kind of shift in the market’s assessment of SEK going on here, as the krona largely shrugs off a very weak PMI (46.0 vs. 47.0 expected and 46.33 in Sep.) this morning and heads higher. Suspecting that a strong EUR could mean an even stronger SEK if EURUSD is breaking higher after today’s US data.
NOK – a strong PMI from Norway helping EURNOK back lower and we like the setup for a more significant sell-off on a close south of 10.20 – a classic momentum divergence pattern.
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