Calm has settled over markets as anticipation builds ahead of tomorrow’s Fed FOMC outcome. Equity markets registered broad based gains globally while US yields rose and the USD stabilized. It’s worth reiterating that effective Fed communication is the key to ensure that this calm continues otherwise market volatility will quite easily return.
Yesterday’s mixed data releases did not offer much to the debate on Fed policy as the Empire manufacturing survey rose more than expected but disappointed on the detail, while home builders’ confidence jumped. May CPI inflation data will perhaps offer more clues today, with a benign reading likely to ensure that markets do not get carried away in expecting any major shift in Fed policy. In Europe, a likely decline in the German ZEW investor confidence survey in June will do little to boost confidence in recovery.
GBP/USD has rallied impressively over recent weeks although much of its gain has been spurred largely by USD weakness rather than inherent GBP strength. Nonetheless, UK data has looked somewhat more encouraging, a fact that has played some role in reinforcing GBP gains. Whether this continues will depend on a slate of data releases this week including retail sales on Thursday. CPI inflation data (today) and Bank of England MPC minutes (tomorrow).
On balance, I look for UK data to continue to paint an encouraging picture of recovery, which ought to provide further support for GBP. However, the risk / reward does not favor shorting the USD at present and I suggest playing further GBP upside versus EUR.
CHF has strengthened as risk aversion has flared up. While I remain bearish CHF over the medium term the near term outlook will be driven by risk gyrations (given the strong correlation between CHF and our risk barometer). Both EUR/CHF and USD/CHF have already fallen sharply having priced in higher risk aversion.
Obviously much in terms of risk appetite will depend on the Fed FOMC outcome tomorrow and I would suggest caution about shorting the CHF just yet. Additionally Swiss data in the form of May trade data and more importantly the SNB policy decision this week will be watched closely, especially given the threat by SNB Jordan of implementing negative interest rates. I don’t expect any shift in policy on Thursday, however, leaving USD/CHF firmly supported around 0.9130.
Since Fed Chairman Bernanke highlighted the prospects of Fed “tapering” during his testimony on May 22 commodity currencies have performed poorly. The notable exception has been the CAD which has eked out gains over recent weeks. Like GBP, the CAD has been helped by relatively positive data releases, which in turn have prompted growing expectations of policy rates hikes from the Bank of Canada. Market positioning in CAD remains relatively short, suggesting more scope for gains over coming weeks. Meanwhile, data this week including May CPI and April retail sales will be scrutinized for clues as to the next move from the BoC and in turn whether gains in CAD are justified.