Brexit Developments Sharply In Focus

Two major market risks have been sidelined, though admittedly not taken off the table.  Firstly the prospects of an intensification of the US-China trade war appears to have diminished and secondly the risks of the UK crashing out of the EU without a deal have lessened.  This presents a calmer and less volatile backdrop for markets even as global growth continues to remain under pressure.  Separately markets are hoping and expecting for some icing on the cake in the form of Fed easing later this month. As long as US Q3 earnings are not too bad, this suggests a period of calm ahead.

US-China trade developments are likely to take a back seat in the run up to the APEC meeting on 16-17 November in Chile where a ‘Phase 1’ trade deal may be signed by both US and Chinese leaders.  Talks rumbling in the background appear to progressing well, with US Treasury Secretary Mnuchin and Trade Representative Lighthizer scheduled to speak to China’s Vice Premier Liu He this week by phone.  Markets will carefully eye what the prospects are for a delay of the $156bn of US tariffs on China that are due to take effect on December 15.

Brexit developments will move sharply back into focus today, with UK Prime Minister Boris Johnson set to make a fresh attempt at passing a ‘meaningful vote’ today or gaining a majority in a vote on legislation implementing the deal tomorrow.  This follows having to jettison a vote on Saturday and being forced to write to the EU requesting a three-month delay to the Article 50 exit process.  The government thinks it has the number of votes necessary to pass the vote and the fact that GBP has only lost a little ground today (at the time of writing) suggests that markets think the chances are high.

Other than this, the European Central Bank meeting on Thursday will garner attention although President Draghi is unlikely to offer any further changes in policy, having come under criticism from hawks in the ECB governing council who opposed the renewed bond buying from the ECB.  Expect Draghi to maintain a dovish stance at this meeting.  Other central banks in focus this week include Norway, Sweden, Turkey and Indonesia.  The former two are likely to leave policy unchanged while both Turkey and Indonesia are likely to ease policy.


ECB meeting, Brexit, Fed minutes, China trade, India elections in focus

This week there a number of key events to focus attention on including European Central Bank (ECB) policy meeting, Federal Reserve FOMC March minutes, the commencement of India’s general elections, China data, and further Brexit developments as UK Prime Minister May tries to gain a further short extension to the Brexit deadline, until June 30.

The better than expected US March jobs report, revealing a bigger than expected 196k increase in jobs, with a softer than expected 0.1% monthly increase in hourly earnings, which effectively revealed a firm jobs market, without major wage pressures, helped US markets close off the week on a positive note. The data adds to further evidence that the Fed may not need to hike policy rates further.

The European Central Bank decision is likely to prove uneventful though recent comments by ECB President Draghi have fuelled speculation that the central bank will introduce a tiered deposit system to alleviate the impact of negative rates on banks.   EUR is unlikely to benefit from this.  Separately Fed FOMC minutes will be scrutinised to ascertain how dovish the Fed has become as the markets shift towards pricing in rate cuts, but it is unlikely that the minutes provide further fuel to interest rate doves.

Friday is the deadline to agree on an extension with the EU to prevent a hard Brexit.  Meanwhile PM May is set to restart talks with opposition Labour Party leader Corbyn to thrash out a cross party agreement on Brexit terms ahead of an EU summit on Wednesday that will look at her request for a Brexit extension until June 30.  GBP has lost momentum lately and investors appear to be fatigued with the daily Brexit news gyrations.

Meanwhile, US-China trade talks appear to be edging towards some sort of a deal while Chinese data this week is also likely to be supportive for risk assets.   As China eases financing conditions, evidence of a pick up in the credit impulse will be evident in March aggregate financing, new loans and money supply data this week.   Meanwhile China’s March trade data is likely to look better or at least less negative than over recent months. This suggests that risk assets will likely fare well this week.

India will be in the spotlight as India’s multi stage elections kick off on Thursday.  Prime Minister Modi is in good stead to ahead of elections, boosted by his government’s reaction to recent terrorist attacks on Indian paramilitary in Kashmir.   Concerns that Modi’s ruling BJP would lose a significant amount of seats in the wake of state election losses towards the end of last year have receded.  Nonetheless, election uncertainties may keep the INR on the backfoot this week.

Taking the wind out of the EUR, JPY watching the flow, AUD watching RBA

Market activity was limited yesterday due to holidays in the UK and Japan but will pick up today as both markets reopen. The positive reverberations from the US April jobs report continue to provide a fillip to markets but the impact is already fading.

Once again risk assets are relying on central banks to provide the steroids for further support. In this respect it was the turn of European Central Bank President Draghi to take up the baton yesterday as he noted that further interest rate cuts are possible. Today’s data slate is thin, with the Reserve Bank of Australia policy decision and German March factory orders the main highlights.

ECB President Draghi took the wind out of the EUR’s sails as he highlighted the possibility of further policy easing. Also helping to keep the EUR under pressure was the rise in US Treasury yields; the 10 year yield differential with bunds has widened to close to 52 bps, which due to the strong correlation with EUR/USD is likely to cap any gains in the currency pair.

As Draghi noted prospects for further easing will be highly data dependent which in turn means that the EUR will be more data sensitive in the weeks ahead. The prospects of negative deposit rates in particular will continue to send shivers down the spines of EUR bulls. Look for EUR/USD to be capped around 1.3168.

As Japan returns from holiday USD/JPY is verging once again on a test of psychologically important 100 level. The trigger for the renewed bounce in USD/JPY was a jump in US bond yields following the better than expected US jobs report. In the absence of major US data releases this week Fed speakers including Chairman Bernanke will give further direction to bonds and in turn USD/JPY.

A further widening in the US yield advantage over Japan will be required to push USD/JPY higher especially as recent flow data have shown both Japanese investor repatriation and net foreign buying of Japanese portfolio assets. Despite these inflows we expect a break of 100 to occur very soon, with appetite for foreign assets from Japanese lifers and government pension fund, providing much of the ammunition for a sustained move higher.

AUD has started the week badly having suffered in the wake of the weaker than expected Chinese service sector confidence data and the surprise drop in Australian retail sales in March. Reports that the Australian Treasury will lower growth forecasts for the next two years in part due to AUD strength does not bode well for the currency either.

The data has emboldened doves looking for a policy rate cut from the RBA today and while the decision is a very close call as reflected in market pricing and consensus expectations, the balance of risks suggests that the RBA will hold off this month. This may however, come as scant relief for AUD as markets will likely push back easing expectations to the next meeting on 4 June.

Nonetheless, downside for AUD is likely to be limited, with speculative positioning already at a relatively low level. Strong support for AUD/USD is likely around the 4 March low at 1.0115.

JPY selling momentum slows

Markets have few leads to trade off following yesterday’s President’s Day holiday in the US. Nonetheless, caution appears to be settling in ahead of this weekend’s Italian elections, especially in Europe.

European Central Bank President Draghi’s address to the EU parliament did little to stir markets as he didn’t elaborate much on his post ECB press conference in February. The most notable comment was that he urged the G20 to have very “strong verbal discipline” on talking about currency movements.

Despite the Italian election caution most risk measures appear to be well behaved. Equity volatility has continued to drop and gold prices have stabilised following the recent sharp decline. The highlight of the data calendar today is a likely gain in the February German ZEW survey.

Currency markets are rangebound but it is notable that USD/JPY has struggled to sustain gains above the 94.00 level, with upward momentum in the currency pair appearing to fade. Comments by Japan’s Finance Minister Aso that the government was not considering changing the central bank law at present or buying foreign bonds helped to dampen USD/JPY.

Although the G20 meeting effectively gave the green light for further JPY declines, a lot is in the price in terms of policy expectations and any further JPY weakness is likely to be much more gradual. USD/JPY 94.46 will offer strong resistance to further upside.

Asian currencies continue to deliver a mixed performance, with JPY sensitive currencies including SGD, KRW and TWD remaining on the back foot. The SGD is the most highly correlated Asian currency with JPY, with a high and significant correlation between the two. Any further drop in JPY will clearly bode badly for SGD but the inability of the JPY to weaken further may help to moderate pressure on the SGD in the near term.

Although the KRW has rebounded over recent days one risk to the currency is continued outflows of equity portfolio capital. South Korea is one of the only countries in Asia to have recorded outflows (around USD 1.2 billion year to date). However, this month the outflow appears to have reversed, with around USD 500 million in inflows registered month to date. In part the outflows of equity capital from South Korea in January reflected concerns about North Korea. Such concerns have receded but the risks remain of more sabre rattling and/or more nuclear tests from the North.

Fed passes the baton to the ECB. EUR and GBP downside risks

Although the Fed’s inaction overnight was perhaps a little disappointing for markets the FOMC did note that it “will” provide further stimulus to the economy if needed. The USD rallied but risk currencies came under pressure. However, any sell off in risk assets will be limited as markets look to the FOMC meeting on September 13 for more action. This will also coincide with updates of the Fed’s economic forecasts. The below consensus reading for the ISM manufacturing index in July which came in at 49.8 added to the slight disappointment, with the data consistent with flat growth in manufacturing.

Attention now turns to the European Central Bank (ECB). Warnings by the Bundesbank President Weidmann for the ECB not to overstep its remit sets the scene for a stressful policy meeting today. Although markets have pared back their overly bullish expectations from the end of last week a lack of action by the ECB to reduce peripheral bond yields will disappoint and lead to a sell of in risk assets and EUR/USD but support around 1.2150 is likely to hold. Even a restart of Securities Market Purchases on its own would not be a game changer.

The Bank of England also decides on policy today but unlike the ECB there is little expectation of any action from the MPC. Inaction by the BoE today will highlight that after a GBP 375 billion in asset purchases there is limited room in the tool kit aside from lowering interest rates further. A weaker than expected reading for UK July manufacturing confidence weighed on GBP, with the data following a rash of disappointing data releases over recent weeks. I continue to see downside risks to GBP both against the EUR and USD, however. Indeed, my quantitative models reveal that GBP/USD should be trading around 1.5144 while EUR/GBP should be around 0.8242.

ECB risks, more JPY jawboning, Asian FX supported

Risk assets have given back some of their Draghi inspired gains but expectations of European Central Bank action on Thursday continues to provide a solid underpinning for markets. Although European equities closed higher US equities slipped while the VIX ‘fear gauge’ rose. Ahead of the ECB policy decision attention will be on whether German resistance to a more aggressive ECB stance eases. Given that markets have priced in a positive outcome the risks are asymmetric in the days ahead, with a bigger sell off in risk assets should policy makers disappoint.

One indicator worth highlighting is the Baltic Dry Index which has dropped by over 20% from its high on 9 July and continues to head south, indicating rising global growth risks. Economic data releases including the Eurozone ‘flash’ July Eurozone inflation data, and US July consumer confidence will offer some direction for markets but we suspect that a tone of consolidation will continue ahead of the ECB and Fed meetings and the July US jobs report at the end of the week.

Japan continues to jawbone about the strength of the JPY, with Finance Minister Azumi delivering a further threat of FX intervention. Azumi notes that the advance of the JPY has been one sided, does not reflect fundamentals and that no measures will be ruled out when it comes too FX action when needed. He also hints that any intervention may be supported by other countries. It is doubtful that Azumi is setting the scene for actual intervention although a sustained drop below 78.00 will sharply raise the odds of Japanese official JPY selling.

EUR/USD looks supported above 1.2118 but a drift lower is likely ahead of the ECB meeting. Reports in Der Spiegel that Draghi’s pledge of action has created discord within the ECB while Germany continues to resist action to restart the ECB’s securities market purchase programme. The risk is that Draghi has set the ECB and risk assets up for a fall if agreement cannot be reached ahead of the ECB policy meeting.

Asian currencies look supported going in the near term and its worth noting that equity portfolio flows to the region have pocked up over recent days led by South Korea. The USD will be restrained ahead of the Fed meeting allowing Asian currencies to grind higher. We favour KRW and IDR although gains are likely to be limited ahead of the key central bank policy decisions this week. On that note, a likely unchanged decision from the RBI in India today, may act as further disappointment for the INR.

Hopes run high ahead of major central bank decisions

Expectations are running high that central bankers will deliver on further policy steps at the Federal Reserve, European Central Bank and Bank of England meetings this week. Indeed, following strong hints by ECB President Draghi last week, which provoked a rally in global markets, there are high hopes that the ECB restarts its bond buying programme.

Opposition by Germany’s Bundesbank could result in disappointment, however. A meeting today between Draghi and Bundesbank president Weidmann will shed further light on the issue. Also on the table is the potential for the ESM bailout fund to be given a banking licence though this seems unlikely any time soon. Given the rally in risk assets at the end of last week, any lack of action by policy makers this week will provoke significant disappointment.

Similarly a run of weaker US and UK data has led to growing hopes that the Fed and BoE will also ease policy further on Wednesday and Thursday, respectively. While recent press speculation suggests that the Fed is edging closer to further balance sheet expansion the Fed FOMC may want to wait for further news on the economic front before embarking on more quantitative easing.

Meanwhile, the BoE appears to be edging towards further easing too, but rather than more QE a rate cut is looking like the preferred option. I suspect that such action at this week’s monetary policy committee (MPC) meeting is unlikely, however. Adding to the drama of this week’s events is the US July jobs report at the end of this week and yet another lacklustre report is expected, with consensus forecasts for a 100k increase in jobs.

Currency markets are likely to settle into ranges ahead of the key events above. The USD lost a fair bit of ground over recent sessions but further direction will await the ECB and Fed meetings. EUR/USD looks firmly settled above support around 1.2241 but upside traction will be limited until there is further clarification from the ECB. I suspect that last week’s short squeeze has run its course, with a further drop in peripheral Eurozone bond yields required to drive the EUR higher.

Asian currencies look well supported in the near term ahead of the major policy decisions. The SGD and KRW have led gains over the past week and their high degree of sensitivity to risk suggests that they should continue to outperform. The INR has also edged higher on the back of firming risk appetite but much will depend on the outcome of the RBI meeting tomorrow. According to my quantitative models the PHP and TWD will underperform.

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