Head of FX Strategy
Summary: Positive risk sentiment making a clean sweep of it, with bonds and defensive currencies on the run and risky currencies, led by the riskiest of EM currencies, pulling higher ahead of the FOMC meeting tomorrow, where Powell and company will have a tall task in framing the accelerating balance sheet expansion.
We’re faced with an unprecedented set of circumstances heading into tomorrow’s FOMC meeting as risk sentiment has lurched into a veritable melt-up on the hopes that the US and China are set for trade war détente (Trump has domestic political wars and a stock market to support for the 2020 election cycle…) and on expectations for the Fed to respond with sufficient liquidity provision, regardless of scale, and a rate cut as the market has posted record highs. Maybe the market is right, or maybe we have the perfect set-up for a sell-the-fact over tomorrow’s FOMC meeting. It has been – and still is – hard for us to wrap our heads around the idea of a melt-up in equities and risk sentiment with weak earnings and the US economy spiraling into a recession. The key hurdle for any sustained melt-up scenario is whether we begin to see contagion from the strain already evident in the riskiest corporate debt types (lowest rated and leveraged loans) as well as signs of private equity deals going sour
Chart: USDMXN
The bottom is dropping out of the greenback versus EM currencies, nearly across the board, as the market feels confident it has the Fed where it wants it with a new permanent balance sheet expansion getting into full swing and at least tomorrow’s rate cut on the immediate horizon. Will Powell and company deliver as supportive a message as the market is gunning for at the FOMC meeting? For a pair like USDMXN and the high carry differential, I don’t think longer term traditional chart technicals have relevance (because of drifting fair value), but clearly the 19.00 to 18.50 area looks pivotal for the pair and whether a wider EM melt-up can unfold from here or whether the USD once again holds firm.
A very long speech today from the RBA Governor Lowe, who discusses the challenges faced by central banks, given the current backdrop. Fairly clear from this and previous comments that Lowe will not be in favour of negative rates in Australia and that he emphasizes “maximisation of welfare” and the labour market more than inflation, which points to less reactivity to CPI releases like the one coming up tonight for Q3, perhaps, relative to employment-related releases. Prominent in the speech is that the central bank can do little to “improve the investment climate” as rates scrape to their effective lower bond and that policy stimulus has to come from elsewhere – namely the government and business, with investment projects that offer long term payoffs.
The G-10 rundown
USD – The US dollar is weak against the riskiest currencies, with the next test whether the Powell Fed continues to deliver liquidity in the size needed and whether the market is over-complacent on that front, not to mention how the market absorbs bad US economic data we see as likely on the way.
EUR – uninspiring price action for the Euro – need to see a positive catalyst for Europe as much as negative catalysts for the US dollar to excite bullish interesting above the 1.1200-1.1400 structural pivot zone.
JPY – the yen getting the worst of it as higher long yields correlated with JPY weakness and strong EM with strong yen carry trade interest.
GBP – Pity poor Boris, as his latest attempt to call an election has failed, with the opposition knowing that his mandate will very likely increase. Johnson will try other tactics to get the December election on track, as the LibDems are happy to cooperate, given where they are polling. But with the current full-bore melt-up in risk appetite and the fact that No Deal is effectively off the table, why hasn’t sterling firmed further?
CHF – with the backdrop about as supportive as it has ever been, EURCHF should be higher still, but it isn’t, so we’re cautious.
AUD – AUD finally catching a bit more of the positive risk contagion and perhaps firmness in CNY and hopes for the US-China trade deal. But for AUDUSD to continue higher through the key zone through 0.7000, we’ll need to see plenty more of the same backdrop here. Australia Q3 CPI up tonight!
CAD – The Bank of Canada seen as standing tall with the highest policy rate among developed economies after the FOMC rate chop tomorrow. An extension of the current environment could drive a considerable further sell-off in USDCAD if 1.3000 is taken, but a US recession scenario means a Canadian recession scenario and Canada has far more to worry about in private leverage terms.
NZD – AUDNZD tempting higher, but yield spreads will have a hard time supporting anything dramatic, meaning we may need a specific negative catalyst for NZD to drive a revaluation toward 1.10-1.1300.
SEK – the recent EURSEK sell-off did enough damage to the prior rally to maintain technical downside interest as long as the pair trades south of 10.80-85, but with such a supportive backdrop, its disappointing that we haven’t already followed through lower.
NOK – the krone posting new lows, but the disconnect with market conditions getting painfull stretched. Tempted to see a divergent momentum setup here in EURNOK on a weak close.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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