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.

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A world of lower yields

This is yet another important week for Brexit deliberations as UK Prime Minister May, under pressure to resign, may bring her Brexit deal agreed with European Union back to Parliament.   Parliament could vote on different Brexit options in a series of indicative votes as early as Wednesday, including possible options of a soft Brexit or second referendum.  MPs will decide today whether to take control of the parliamentary agenda.  GBP meanwhile continues its two steps forward, one step back trajectory, but appears to be finding solid demand on any down step.

Also in focus this week will be a number of Fed speakers who will speak at a time when bond yields are sliding globally.  Markets were roiled by growth worries at the end of last week following a sharp drop in German manufacturing confidence (The Markit/BME PMI fell to 44.7 in March from 47.6 in February), which dampened hopes that weakness in the Eurozone economy would be temporary.   Taken together with dovish comments from G10 central bankers, the net result was an inversion of the yield curve and German bond yields turned negative.  Such signs have in the past been associated with the onset of a recession.

Despite a host of factors including lower US yields, a more dovish Fed stance, markets shifting towards pricing in US rate cuts, and restrained USD, emerging market (EM) assets have not benefitted greatly.  EM assets are torn between these factors on the one hand and global growth concerns on the other.  A host of idiosyncratic factors, whether it is political noise and pension reform in Brazil, or the impending Moodys’ review of South Africa this week, Thai elections etc, etc, are also resulting in more discriminatory investing.

US –China trade talks will also continue to be in focus this week, with the US administration’s Lighthizer and Mnuchin schedule to be in Beijing on March on Thursday and Friday to meet with China’s Lie He, who is planned to travel to Washington in the week after.  Structural issues such as technology transfers, state subsidies and intellectual property and the removal of all tariffs, have been stumbling blocks so far.  Latest reports reveal that China is refusing to back down on US demands that it eases restrictions on digital trades.   The absence of progress on trade talks are yet another reason for markets to trade under a shadow.

 

Not much good news

There are a plethora of issues weighing on asset markets though sentiment has improved slightly today.  Weak Chinese trade data over the weekend and a revision lower to Japanese GDP data yesterday added to growing global growth concerns, against the background of waning hopes of a resolution to the US-China trade war.

US administration comments that there was a hard deadline for trade talks have not helped sentiment either.  News today that Chinese Vice Premier Liu He spoke with US Treasury Secretary Mnuchin and US Trade Rep Lighthizer on a timetable and road map on trade talks provided some relief, however.

In the US, growth expectations are undergoing a shift and talk of a Fed pause is growing.  This would be considered as good news for EM if it wasn’t for the fact that a pause could be due to US growth concerns rather than any sense that the Fed was approaching its terminal rate.  US November CPI, retail sales, and industrial production data will give more clues, but I still think the Fed policy rates next week.

In the UK, Brexit worries have intensified following the decision by Prime Minister May to the delay the vote on a deal in parliament given she would most likely would have faced a defeat had it gone ahead.  May will now go on a tour of European capitals to try to improve the Brexit deal but prospects don’t look good, especially as European Council president Tusk has already ruled out any negotiation of the deal and in particular the Irish backstop.

GBP was pummeled as a result of the delay and will continue to struggle in the short term given the lack visibility.  A revised deal appears difficult while a hard Brexit and even a new referendum are all on the table.

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.

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.

EUR and GBP outlook this week

In Europe, the main focus will be on the preliminary estimate of Eurozone Q4 2013 GDP data which is likely to post a gain of 0.2% QoQ as most countries in the Eurozone are set to have recorded positive growth over the quarter. EUR traded more positively at the end of last week but looks like it will struggle to retain gains versus USD above its 100 day moving average around 1.3608.

Markets will also digest the decision by the German Constitutional Court to effectively defer a decision on Outright Monetary Purchases by the European Central Bank to the European Court of Justice. Although there will be some caution ahead of the March 18 final decision on OMT, EUR will find some, albeit limited relief as it seems less likely that the European Court will strike it down.

In the UK the Bank of England Quarterly Inflation Report will reveal an upward revision to growth forecasts but downward revisions to inflation and importantly an adjustment of forward guidance to a broader range of indicators rather than just unemployment. Indeed, as in the US the BoE will not give the impression that they are about to raise policy rates given the sharp fall in the unemployment rate. GBP/USD will be range bound ahead of the release of the QIR, with gains likely gapped around 1.6471.

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