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G-10 Market Views

Stephen Innes
US Q1 GDP and Australia Q1 CPI will highlight the G-10 calendar.

The Euro

If I had a dime for every time I’ve been disappointed by the Euro‘s behavior the past two years I would have a Lamborghini parked in my driveway. But now is not the time to fold the cards on the long Euro. Soft qualitative data continues to be the scourge for the Euro bulls, and when compounded by the low volatility G-10 environment the US dollar remains the preferred parking spot during any global growth or risk sentiment wobble. With financial conditions super cheap, central banks winning the volatility argument so far, currency trading has turned into a wrenched chase for yield. as USD continues to sit perched atop the G-10 carry trade pecking order, although I wouldn’t go as far as calling it ” greatest carry trade in the world” it does provide a good safety net when markets turn uncertain.

Why we remain guardedly bullish EURO

The further downside in volatility is limited, and with increasing signs of a global cyclical upturn, which should ferment in Q2, it’s likely to lead to a weaker US dollar especially as the Fed remains on hold. The view is predicated on the belief that the Greenback remains one of the most countercyclical currencies in G-10. But more significantly for the Euro, is that over time the improving China economic landscape will help the markets see through the Eurozone soft financial data. All roads on this trade lead through Beijing, and with the Euro positive beta to global growth, the combination of a dovish Fed and an accommodative Pboc will be enough oil to grease the global economic engine and send the Euro higher.

If traders regain a high degree of optimism about global growth, Eurozone soft data will shoot higher, and the Euro can easily bridge the valuation gap and move closer to the 1.1700 level.

What’s our most significant Euro downside risk?

Donald Trump signs a deal with China; he will pivot to Europe and slap tariffs on European cars. This topic is picking up a lot of voice in chat rooms and around G-10 banter. It does make sense from the perspective as the focus is on election 2020 and Trump will want to appease his America first electoral base even more so after agreeing to a watered-down trade deal with China.

It’s no secret that the German car industry is an EU economic powerhouse and critical export sector. But last weeks German PMI print is a bit concerning despite a significant easing in global financial conditions and surging China data as purchasing managers sentiment has yet to bridge the gap been market, expectations. But in reality, EU  big auto is not bouncing back after a considerable slump aggravated by the diesel scandal. The fact we are not seeing China stimulus feeding through to the sentiment data suggests something is amiss in Germany, that’s for sure.

This Feb 17 Reuters article is making the rounds again. But as the interest rate carry costs continue to mount with absolutely no joy above 1.1300, I would be amiss not to put my self through a sanity check if this mind-numbing range trade persists.

The Australian Dollar

It will be a massive test for our bullish Australian dollar resolve this week as we could expect the RBA to turn the rate cut wheels in quicker motion on a benign inflation print given the RBA minutes suggested they remain open to rates cuts if inflation remains low.

But for those looking at last week New Zealand CPI miss as a foreshadow of Australian inflation  – there are very few components in the NZD CPI that provide enough synchronic correlations with the AUD CPI.  Although telling by last week price action, it certainly emboldened those commentators with dovish RBA views.

But there appears no escaping this monotonous low volatility market as it seems we are in a cycle doomed to mindlessly repeat past patterns as the infinite sequence of lather, rinse and repeat takes hold.

Indeed we are stuck in a quagmire trying to weigh the odds of an improving global environment versus the slowing domestic economy. However, keeping in mind the counter-cyclical proclivities of the USD, so ultimately the global growth updraft which should intensify in Q2 will push the Australian dollar moderately higher although RBA dovishness will likely blunt any notion of explosive gains.

I have been riding this trade for a while now, and unless we get a surprise on the CPI print this week, I’m resigning my self to hold the position for US-China trade war resolution knee jerk higher.

Indeed kits a sad day in the currency pit when trading views are predicated on knee jerk flights of fancy.

Asia FX views

In EM, we will be following monetary policy announcements in TRY and IDR, as well as exports data in KRW, TWD and THB.

China: Yuan continues to strengthen?

The China bulls had an encouraging week as USDCNH moved below the critical 6.70 level. But what’s promising this time around is that it came on the back of solid China economic fundamentals and not due to increasingly repetitive trade resolution headline or a broadly correlated USD move, but yes simple domestic fundamentals were the primary catalyst.

China’s economic data was robust last week supporting a growing consensus view that  China is on a soft-landing trajectory which will continue to lend support to domestic capital markets but should also give backing to a plethora of cross-asset markets.

While the robust data and as confirmed by the latest Pboc policy statement suggests a shift towards a less dovish stance and will lift the standard for additional Pboc easing through 2019, but this will also play out favorably for the Yuan in the rates markets. From the USD-CNY interest rate differential perspective, at least by historical measures it too suggests, the Yuan could strengthen and lends further support to our view that on a US-China trade deal the USDCNH could fall to 6.50 or below subject to the removal of US tariffs.

With that said, this does not mean China regulators will sit on their hands quite the contrary as the Pboc will continue to provide more targeted easing while indicating a preference for fiscal policy to take charge all of which suggests stimulus in one form or another will act as a rudder for the recovering China economy.

Malaysia: Ignore the FTSE Russel noise?

The Norges exiting Malaysia Bond holdings coupled FTSE Russell possible exclusion provides a significant technical overhang for the Ringgit, and when factoring a dovish BNM backdrop, it suggests the Ringgit will struggle for traction and could trade with a weaker short-term bias. The  Norges and Russel shocker aside markets are positioning for a benign inflation print this week that should lend support to a growing chorus of calls for the BNM to drop interest rates next month.

In the absence of a robust offshore Ringgit market, liquidity can dry up quickly especially when foreign investors are all running for that small exit at the same time. Bid to offer spreads increases dramatically which tends to exaggerate currency moves. This phenomenon is what occurred last week as Malay bonds repriced on panic fear which caused currency traders to price in a substantial premium for possible outflows. But given the macro policy backdrop remain supportive, the market faded the Bond market move which in turn stabilized the Ringgit.

None the less, we remain short term bearishly biased on the Ringgit as the writing does appear to be on the wall. BNM has revised growth forecasts lower, benign inflation is the new norm, while the definite shift in central bank rhetoric adds more enthusiasm to the chances for a rate cut next month.

Foreign outflows related to Norges shifting away from EM bonds and WGBI potentially dropping Malaysia from the index perhaps got the markets nudging to the 4.15 level a bit quicker than expected. However, this week’s inflation report should validate our shift to the BNM  rate cut camp which suggests less yield appeal for the Ringgit. Indeed a possible interest rate cut would lessen MYR forward rate currency premiums and could take a bit of shine of the local currency. Keeping in mind in the mind-numbingly low volatility currency environment investors continue to seek out currency carry appeal

However, given the decisive economic pivot in China suggesting global growth headwinds are easing and factoring in a possible US-China trade deal, so over the long haul we should expect the Ringgit to remain supported t and to piggy-back, the strengthening Yuan as China economic resurgence will have a prosperous effect across all ASEAN economies.

Indonesia: Surprise Rate Cut??

I don’t have a position on IDR, and one of my rules is not sound like a windbag and comment on markets I don’t have skin in the game. But I thought the IDR is worth a mention as I’m considering positioning for a surprise rate cut this week.

Global central banks have turned uber-dovish; inflation is at the lower end of the BI range, and real interest rates are near historical peaks. The question comes down to how quickly the BI will cut. Against the market consensus, I expect BI to cut interest rates this week reverse a portion of last year’s emergency rate hikes.

I’m very neutral on the IDR, but with foreign bond positions, a tad stretched, as  Indonesia saw large debt inflows of over USD5bn in Q1 and with BI intervention providing a decent backstop likely accumulating reserves. Indeed, conditions are ripe to play the contrarian view and put some capital to work as after all is said and done,  playing for 1 % drop in the IDR on a surprise rate cut might not be all that bad of a risk-reward.

This article was written by Stephen Innes, Head of Trading and Market Strategy at SPI Asset Management

This article was originally posted on FX Empire

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