The question in the title is the question which is on everyone’s’ lips at the moment, everyone and anyone focused on currencies at least. As is widely telegraphed, G10 implied and actual vol rates have been depressed to levels last seen in 2014, and at a time when global risks are plenty. We need hardly mention Brexit, trade tensions with China or the European economic slowdown, which as we have seen from reactions to the PMIs in recent months, has hit global sentiment through the equity markets. How quickly stocks recover comes as little surprise these days. After a healthy tranche of Chinese data recently, fears have abated with the added backdrop of what many now see as the end of the Fed tightening cycle. I would concur with this view at this stage, with last years projections of a neutral rate of 3.5% (10yr) a clear stretch, as proved by the reaction in risk assets when Treasuries hit 3.25%.. We are at neutral now and a stable inflation rate along with mixed US date validate this.
So what is driving the FX markets? In short, carry. All one has to do is look at the USD/JPY rate to see that currency investors are happy to earn differentials, with the major currency pairs all having seemingly reached their extremes against the greenback for now. This seems to be the effective response to the change in Fed stance to neutral, and one would have reasonably expected to see a more pronounced adjustment in the USD but for the concurrent shift among central bank peers. The USD has still managed to claw out new highs in certain cases, as confidence plays and will continue to play a key part in currency flow at present.
EUR/USD eventually took out the previous cycle low of 1.1215, but only managed to extend this by less than half a cent, and the 1.1150-1.1200 zone provided ample support from which we are attempting to form a base. The above area has some historical context in that it formed the final platform from which the EUR generated its move through to 1.2000+ levels. How economic climate has changed, yet it is not hard to see why as all export-dependent regions are suffering at the moment. In light of this, the recent improvement in Chinese data could have lightened the mood on the EUR, but ahead of the European elections, it is hard to put faith in any meaningful recovery, and so it has proved as we struggle through 1.1300. Recent concerns from policymakers at the ECB that growth forecasts could be a little optimistic in the second half of the year have also pulled the rug from under the feet of the EUR this morning, so near term consolidation is as good as it gets for now. Do not rule out a fresh push towards 1.1400 however. USD softening may offer this opportunity as liquidation risk cannot be discounted given current exposure. We may even see an improvement in the next round of Eurozone PMIs for April which are due out on Thursday.
Underperforming across the board now is the CAD, where next week‘s BoC meeting is being viewed with a dovish leaning. Add in housing market concerns along with one of the highest levels of household debt amongst developed nations and it is not hard to see why traders are ignoring the usual correlations such as Oil price and broader risk sentiment. Sticking points around the 1.3400 may prove temporary, so at this point, I am not going to rule out a return to 1.3600-50 against the USD. Positioning may be better served away from the greenback, though it again begs the question where? Watch out for Canadian inflation numbers tomorrow, which are spiced up with trade data from both sides of the border.
One currency I had high hopes for was GBP. Parliament and now the government have distanced themselves from a no deal exit, and while softer Brexit options, including a customs union attached to the withdrawal deal and/or a second referendum, outnumber a negative outcome, the balance has been tipped again as Westminster is abuzz with talk of a general election. Would it break the deadlock? Can the country stomach it? Strong arguments for no in both cases, but nevertheless, this has reined in the prior aggregate of probabilities which could have warranted a Cable move towards 1.3300-1.3400. 1.3380 was the peak of optimism after the House of Commons voted against a no deal, and this looks pretty safe unless there is a breakthrough in cross-party talks continuing during the Easter Break.
There were faint hopes that the market would refocus a little on domestic data, though the healthy employment report on Tuesday morning did little to shake GBP out of its tight ranges, with EUR/GBP hemmed into 0.8620-60 for now. Cable has covered 1.3070-1.3100 over Tuesday’s session at the time of writing and highlights the lack of conviction in the absence of any major news, leading to this heavy congestion. Inflation data tomorrow is likely to be a non-event, and this is exacerbated by fading market (and business) expectations of a rate hike inside the next 12 months.
Elsewhere, growing interest in the Nordics seems to favour the NOK over the SEK with the cross rate having pierced the 1.0900 level and showing little sign of relent. The Norges bank is going against the grain and has hiked rates by 25bps this year, with another move in June priced in by a little over 50%. In contrast, the Riksbank is happy to sit on the sidelines with negative rates, and the narrative is that the Swedish central bank is waiting for the ECB to pull the trigger first. Perceptions will change if inflation feeds through. CPI is back close to 2.0%, growth is healthy in relative terms as are public finances alongside a positive current account, so I fail to see what there is not to like with the SEK further down the line. Naturally, negative rate differentials are a factor as I have pointed out already, so the obvious route looks to be EUR/SEK looking ahead.
However, price action seems to warrant caution here, as bouts of EUR weakness have tended to have upside impulses to EUR vs SEK, NOK, and PLN. Contagion fears can spark sharp corrections, so Eurozone data risks have and will dent sentiment on no-EUR Europe. The NBP could also surprise with a hike over the coming year, again due to a pick up in inflation, though we are still some way off the central bank’s 3.5% upper limit. Even so, it seems the EUR (PLN) cross rate is eyeing a move on 4.2500 support in anticipation of this.
Finally, AUD looks intent on holding 0.7000l. The figure level sees plenty of 2-way business and with commodity prices higher on the back of the near term improvement in China’s PMIs, it is not hard to see why. Resilience in the currency is all the more impressive given expectations of rate cuts later this year – something which gained some traction after the RBA minutes on Tuesday. It is too early to say if this is priced in, just as it is to say China’s slowdown has been halted in its tracks. For now, it is a case of making hay while the sun shines and there is nothing to say AUD/USD gains will top out at 0.7200. 0.7300 and 0.7400 targets have equal significance on the daily charts if we do break higher, but these constitute medium-term targets in a positive risk environment – of now. There has been a breakdown in the correlation with equities in recent months so there is an element of catch up play here. The AUD/JPY proxy has fought its way back into the picture as a result with the recent range break of 79.60-80 aided by the carry hungry USD/JPY rate.