Global Head of Macro Strategy
Summary: Friday saw markets closing in a celebratory mood on hopes that the US and China are headed toward some kind of trade deal and as the Fed is expected to continue providing liquidity and will cut rates at the Wednesday FOMC meeting, even with US equities near or at all time highs.
The mood Friday went from flat to aggressively positive as news emerged that the US and China may be working toward a “phase one” trade deal, one that could include promises from the Chinese side of maintaining currency stability to remove the US labelling the country as a currency manipulator. It is hard to imagine more complacent market conditions, but these could yet extend further if we get the Friday press conference some sources suggest will happen with chief Chinese negotiator Liu He and US Treasury Secretary Mnuchin in attendance. At the same time, there are strong risks that the terms of the deal could prove too narrow to merit the market’s enthusiasm and weak US data could yet spoil the party as well.
The other background factor supporting risk appetite is the Fed’s easing stance even as US equity markets are bulling up near all time highs, an unprecedented situation. How the Fed ties itself into knots in framing why it is doing what it is doing will be a spectacle to behold at this Wednesday’s meeting, but the Fed has largely lost control of policy and the market thinks that this is a good thing, assuming that the Fed will at every turn simply up liquidity operations to avoid losing control of key policy rates, while in turn losing control of its balance sheet. Luke Gromen (@LukeGromen on Twitter) has described what the Fed is doing as providing “credit easing” for the government to prevent Trump’s massive deficits from driving funding rates massively higher. The only question from here is whether the market thinks that this is Fed behaviour that can scale infinitely in response to a major credit crunch, especially one driven by real risk of a US recession. Cue the incoming data…
Chart: EURUSD
The EURUSD consolidation was quite shallow relative to the prior rally, not even achieving the 38.2% Fibo a bit lower than Friday’s lows. This week, with its FOMC meeting and important US data on Friday, looks important for establishing whether a turn higher continues to unfold. Tactically, we have only neutralized downside risks with the latest rally. To establish a more determined turn in the chart, we need a move well clear of 1.1200 and eventually even 1.1400 needed to suggest the lows are in. To the downside, the bulls’ hopes will begin to wane if the price action dips back below 1.1000.
The G-10 rundown
USD – critical test of the market’s complacent assumptions around the Fed policy outlook on Wednesday and at any time this week on headlines linked to the US-China trade deal issue. The focus switches quickly to incoming economic data on Friday and beyond with the latest jobs and earnings numbers and ISM Manufacturing (next Tuesday’s ISM Non-manufacturing more important than the latter.)
EUR – Germany politics are a risk to the notion that we will see a straightforward path to fiscal stimulus and fiscal unity – the FT reminds us this morning that Brexit will already mean that Germany’s contribution to the EU budget will double next year. And in an election in the former East German state of Thuringia, 31% voted for the hard left Die Linke, with 23.4% voting for the anti-immigration AfD party, outpacing Merkel’s CFD at 21.8%
JPY – the Bank of Japan has nothing effective to reach for and may not come up with much in its policy review promised for this Thursday’s meeting, in the meantime, the backdrop Is about as JPY-unfriendly as possible, but we are increasingly contrarian on further JPY weakness from here – long JPY upside volatility one way to trade for a change of mood.
GBP – sterling sideways as we await clarification on the length of the Brexit extension, with the momentum in the news pointing to a Jan 31 extension as Macron may finally be giving way on this point. Labour is holding out on voting in favour of Dec 12 elections, claiming there must be an iron-clad guarantee to remove the risk of a No Deal Brexit.
CHF – the franc struggling near key EURCHF resistance with the backdrop about as supportive as possible for a rally, given widespread complacency and struggling safe haven bonds.
AUD – less enthusiasm for AUD than one would have thought on increased hopes for a US-China trade deal – and AUDUSD has yet to clear the 0.6900 area hurdle, much less the bigger level up into 0.6950-0.7000.
CAD – this Wednesday’s Bank of Canada an important signal for USDCAD on the degree to which the BoC is comfortable with maintaining the developed world’s highest policy rate. The 1.3000 level in USDCAD critical from here.
NZD – AUDNZD looks more buoyant again after surviving a test of support. Certainly, any further removal of concern on the outlook for China, for example from even a relatively narrow US-China trade deal, could provide more support for AUD than NZD.
SEK – the message from the Riksbank last week both hawkish (get back to zero) and dovish (stay there forever), so we need more support in the form of fiscal, an improvement in the global and EU economic outlook, etc. to get a more determined SEK rally and driver EURSEK down below 10.60.
NOK – the NOK weakness even more notable now as the backdrop could hardly be more supportive. Next test is likely over year end and whether seasonality is a key driver here.
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