Turkey hikes, ECB and BoE don’t. Trump dampens trade hopes

Despite comments from Turkish President Erdogan railing against prospects for a rate hike, Turkey’s central bank, CBRT hiked the repo rate to 24%, a much bigger than expected 625bp increase.  This may not be sufficient to turn things round sustainably but will at least prevent a return of the extreme volatility seen over past weeks.  The decision saw USDTRY drop by about 6% before reversing some of the move.  Undoubtedly the decision will provide support to EM assets globally including in Asia today.

Elsewhere the European Central Bank (ECB) delivered few punches by leaving policy unchanged and reaffirming that its quantitative easing will reduce to EUR 15bn per month (from EUR 30bn) from October while anticipating an end after December 2018.   The ECB also downgraded its growth outlook but kept the risks broadly balanced.  The outcome will likely to help put a floor under the EUR.  Unsurprisingly the Bank of England (BoE) left its policy on hold voting unanimously to do so, leaving little inspiration to GBP.

President Trump poured cold water on US-China trade talks by denying a Wall Street Journal article that he faces rising political pressure to agree a deal with China.  Trump tweeted, “They are under pressure to make a deal with us. If we meet, we meet?” . Meanwhile US CPI missed expectations at 0.2% m/m, 2.7% y/y in August, an outcome consistent with gradual rate hikes ahead.   The data will also help to undermine the USD in the short term.

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China Trade talks, ECB, BoE and CBRT

Today marks the most interesting day of the data calendar this week.  Central banks in the Eurozone (ECB), UK (BoE) and Turkey (CBRT) all announce policy decisions while US CPI (Aug) is released.  The ECB and BoE meetings should be non events.  The ECB is likely to confirm its €15 billion per month taper over Q4 18.  The BoE monetary policy committee is likely have a unanimous vote for a hold.

The big move ought to come from Turkey.  They will need to tighten to convince markets that the central bank it is free from political pressure and that it is ready to react to intensifying inflation pressures.  A hike in the region of 300 basis points will be needed to convince markets.   This would also provide some relief to other emerging markets.

The big news today is the offer of high level trade talks from US Treasury Secretary Mnuchin to meet with Liu He (China’s top economic official), ahead of the imposition of $200bn tariffs (that were supposedly going to be implemented at end Aug).  This shows that the US administration is finally showing signs of cracking under pressure from businesses ahead of mid-term elections but I would take this with a heavy pinch of salt.

Mnuchin appears to be increasingly isolated in terms of trade policy within the US administration. Other members of the administration including Navarro, Lighthizer, and Bolton all hold a hard line against China.  Last time Mnuchin was involved in such talks with China in May they were derailed by the hawks in the administration.  So the talks could mark a turning point, but more likely they are a false dawn.  That said it will provide some relief for markets today.

EUR and GBP losing ground

Safe haven currencies including JPY and CHF will be the main FX beneficiaries of the current bout of risk aversion although the USD has also edged higher in part due to some slippage in the EUR and GBP. I had noted at the beggining of this week that EUR/USD will remain a buy on dips on any decline to 1.3775. However, after hitting a high around EUR/USD 1.3916 following the European Central Bank’s inaction at its policy meeting last week the currency pair distinctly looks like it has topped out this week. Technical and positioning indicators are also looking less positive for the currency, with the RSI (Relative Strength Index) at a stretched level and speculative positioning above its three month average.

Comments by ECB Vice President Constancio that the markets had not fully taken on the message from the ECB last week that policy will remain accommodative also helped to dampen sentiment for the EUR. Further slippage to technical support around 1.3778 looks likely in the near term.

GBP has lost ground overnight too. Softer data including yesterday’s January industrial production data as well as comments from the Bank of England have weighed on the currency. As noted last week GBP/USD was looking vulnerable above 1.6700 and will face some further short term pressure, with a test of support around 1.6538 looming.

GBP/USD struggling above 1.6700

Although the Bank of England meeting is likely to be a non event today from a market perspective GBP/USD is clearly struggling to sustain a move above 1.6700. GBP/USD has breached 1.6700 12 times since mid February but only closed above this level 4 times. Over the near term strong resistance around 1.6769 will cap gains in the currency pair, with GBP continuing to look vulnerable above 1.6700. Some recent misses on the data front have not helped GBP’s cause, suggesting that caution for GBP bulls is warranted. GBP bulls may find more traction versus EUR instead of USD, with EUR/GBP set to come under further downward pressure as the EUR weakens anew. A break below 0.8200 beckons.

Calmer market tone ahead of key events

Markets have taken on somewhat of a calmer tone in part due to hopes that discussions between the US and Russia will find some form of solution to the recent escalation of tensions in Ukraine. The nearing of European Central Bank and Bank of England policy decisions today and the US jobs report on Friday have also led to inaction and range trading in markets. Consequently US equities ended flat overnight while risk appetite improved.

Meanwhile, investors are continuing to ignore poor US data attributing it to the weather, with a weaker than forecast February ADP private sector jobs report (139k versus 155k consensus) and February ISM non manufacturing survey (51.6 versus 53.5 consensus), registered overnight. Notably the Fed’s Beige Book repeatedly highlighted the weather impact on US data. Clearly weaker data is not being seen as changing the path of Fed tapering over coming months.

Geopolitical tensions to weigh on risk assets

There continues to be a disconnection between rising geopolitical risks as tensions between Russia and Ukraine intensify, and the performance of equity markets. US equities ended the week on a high note despite a bigger than expected downward revision to US Q4 GDP and risk sentiment overall remained supported according to our risk barometer. Other data were helpful for markets as February Chicago manufacturing confidence (PMI) and Michigan consumer confidence came in better than expected. The firmer tone to risk assets will not last, with risk aversion set to intensify today.

Markets continue to give US economic data the benefit of the doubt, downplaying the harsh weather impact on economic data. This is set to continue this week, with the release of a plethora of US data including January personal income and spending and February ISM manufacturing confidence, February vehicle sales, the Fed’s Beige Book, January trade balance and last but not least February non farm payrolls at the end of the week. All of the data will be hit by recent unseasonable US weather and therefore will look weak on balance, but markets will once again not fret a great deal.

There are several other key events this week that will garner market attention including central bank decisions from the Reserve Bank of Australia tomorrow, Bank of England, and European Central Bank on Thursday. Hopes that the ECB will easy monetary policy were dashed somewhat by a higher than expected reading for Eurozone HICP February inflation although there is still a possibility that some easing in liquidity conditions are announced. The RBA and BoE are not expected to change monetary policy settings this week.

USD undermined, GBP supported for now

Despite its overnight bounce the USD index is trading close to its lowest levels this year undermined by a series of weaker economic data and related to this a failure of US bond yields to push higher. Alongside this relatively soft USD tone is a generally subdued and range bound tone to FX markets in general.

Even my quantitative models suggest little impetus for big moves in EUR/USD and USD/JPY. However, I expect this to change over coming weeks. Once the US economy shakes off the shackles of poor weather conditions the USD will be in a better position to recoup its recent losses.

In the near term Fed Chairman Yellen’s testimony today will garner some attention but the speech is unlikely to break the USD or FX markets out of their malaise.

GBP is holding up well, taking advantage of a subdued USD tone. As a consequence of firmer data the market appears to be gearing up for an eventual rate hike, with Bank of England members sounding more upbeat, even if it is unlikely to occur anytime soon.

Consequently over the near term GBP looks well supported although eventually we expect the currency to settle back to earth. In particular 3 month interest rate differentials with the USD appear to suggest that GBP/USD gains are overdone.

This doesn’t mean that its time to sell now but market positioning has turned more positive over recent weeks, above its 3-month average, suggesting further short term gains will be more gradual, with strong GBP/USD resistance around 1.6745.

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