FXDaily Morning Report – FOMC risk as the pace of balance sheet runoff in question

A WSJ report last week set the cat amongst the pigeons on Friday, as the question over the balance sheet runoff was brought to light.  While it is now widely acknowledged that the Fed is set to pause on its series of rate hikes, some are now considering the possibility that the pace of quantitative tightening may be addressed in order to further ease up financial conditions for both the financial markets and the real economy.  Despite the fact that equity markets have materially stabilised, the story has gained traction and the USD has softened as a result, with notable losses seen against some of its weakest counterparts.

The EUR is a clear case in point, with the ECB now clearly concerned about the persistent weakness in the Eurozone data, in what has so far been assumed to be a correction in the strong pace of activity seen through 2017 and very early 2018.  As a result, the governing council sees risks skewed to the downside, though this was already firmly priced into the markets given rate normalisation has been pushed further out into 2020.  Nevertheless, EUR/USD only managed a brief dip below 1.1300 and has since tested back above 1.1400 again in what looks set to be some very tight ranges ahead as we go into the FOMC meeting this week.
Elsewhere, the Brexit mood has been lifted by widespread agreement within the House of Commons that a no deal outcome should be avoided at all costs, but how this then translates into affirmative action remains to be seen as we look to the start of the debates on the various amendments which will be put forward and voted on from Tuesday this week.  In recent weeks, GBP has readjusted the risk probability of a hard Brexit, though optimism may start to run out in the days ahead as we get back to acting on the way forward.  Optimism is one thing, but can only carry GBP so far.  NY desks, followed by Asia today, pushed the Cable rate through 1.3200, but we are seeing some moderation this morning as the realisation that a no deal Brexit is not completely off the table yet.
We then come onto the Fed impact on risk.  Should the FOMC communicate openness towards a resumption in reinvestment, then we expect to see risk assets receiving a further boost over coming weeks.  There are however many crosswinds to consider this week, not least of all the earnings reports out of the US from a number of key names – Caterpillar today, Apple on Tuesday.  We also have the Chinese delegation traveling to Washington this week to resume talks on trade, and while there have been mixed signals from members of the Trump administration on progress – of the lack off – we know at that intellectual property remains a core issue in breaking the deadlock and avoiding an increase in tariffs, which would come into effect at the start of March if negotiations do not bear any positive results.

In the meantime, AUD, NZD, and CAD continue to stay on the front foot, though conviction looks unconvincing as yet.  Based on the fact that bearish sentiment on stocks can return at any moment, bullish sentiment is a long way off, with recent moves here looking corrective at best.  We could pick out the CAD as perhaps the pick of the bunch given Oil prices have stabilised.  There is also the backdrop of continued expectations that the BoC remains on course to raise rates again at some point this year, narrowing differentials with the US as the Fed decides to pause for now.

Ending with USD/JPY, the spot rate is caught between a rock and a hard place.  As USD sentiment will be tempered by that of the mood in stock markets, we look set to remain in a state of limbo over coming sessions, so expect little in the way of movement unless we get poor earnings results this week.  109.80-110.30 continues to provide strong resistance up top, but we cannot help but think that the early Jan ramp in the JPY, and subsequent sharp reversal, has underpinned the downside in the near term.

Forex Analysis: Morning Bullets

USD

* US Senate failed to vote for an end to the government shutdown last night as president Trump refused to budge on his demand for border wall funding.

* Trump is preparing a draft for a national emergency order to get his wall funding through.

* US Kudlow says China must deal with intellectual property theft in trade talks.

* US-Japan trade talks delay as White House focuses on China.

EUR

* This morning, ECB’s Villeroy says that external factors and uncertainty have been largely behind the slowdown.

* ECB Coeure says the slowdown has surprised the governing council.

* German IFO survey out this morning – looking for marginal weakness in the business climate, though expecting another miss.

GBP

* Last night, a report in the UK’s Sun newspaper that the DUP would accept the Irish backstop if a time limit was attached gave GBP a boost.

* Focus on next week’s start of the debates on plan B – GBP has been enjoying strong gains this week, helped by data also (healthy jobs report).

* CBI Distributive Trades Survey for Jan due out this morning.

AUD & NZD

* Uncertainty over Chinese growth this year prompting bearish calls on AUD across the board – some as low as 0.6000!

* Little on the docket to drive trade – Asia quiet, focus on risk sentiment, Wall St futures steady.

CAD

* Oil prices trying to push higher again to give the CAD a modest lift today.

* Canadian budget balance out this afternoon.

Forex Market Analysis – Morning Bullets

USD

* Reports that White House has cancelled meetings with China over IP issues has been denied by Larry Kudlow.

* US press reports that the government shutdown may delay the issuance of tax refunds.

* Senate will vote again on reopening the government – 2 bills, one for Republicans to provide funds for border wall, other to open without funding – both expected to fail.

* US house price index data for Nov due later today.

GBP

* UK Trade Min Fox will use the Davos meeting to discuss replicating EU deals.

* Rees Mogg maintains that the Irish backstop is the only obstacle standing in the way of ERG (Brexiteers) voting for PM May’s deal.

* BoE’s Broadbent speaking later on this morning.

* CBI Industrial Trends Orders for Jan out mid-morning.

EUR

* All eyes on tomorrow’s PMIs and the ECB meeting thereafter – EUR in limbo until then.

* French Jan business confidence index down from 103 to 102 as expected.

* EU’s Moscovici says economic clouds are down to external factors.

AUD & NZD

* NZ CPI came in a touch higher at 1.9% vs 1.8% but is net unchanged from prior reading.

* Westpac-Melbourne Institute leading index down -0.2% in Dec.

CAD

* Nov retail sales due out this afternoon.

* API weekly crude stocks data out this evening.

Forex Analysis: Morning Bullets

USD

* Yesterday, we heard president Trump say that the Chinese growth data shows the need for a trade deal.

* The US is set to proceed with the extradition of Huawei executive according to the Canadian press.

* US existing home sales due later on today.

GBP

* Cabinet member Rudd tells the PM that a number of MPs are ready to quit if she pushes for a no deal Brexit.

* Growing calls from Tory MPs to allow for a delay in Article 50.

* EBS FX and Swaps operation moving to Amsterdam.

* UK employment report and public borrowing figures out this morning.

EUR

* German ZEW survey is this morning’s focus in the Eurozone.

* EU Commission has cut Italy’s growth forecast in 2019 to 0.6%.

* Key weight for EUR this week will be the ECB on Thursday as well as the Jan PMIs the same day.

AUD & NZD

* Chinese CEOs are targeting Australia as a major growth market according to the Australian press.

* Global growth downgrade by the IMF adding to negative risk tone this morning.

* NZ BusinessNZ services PMI falls to 53.0 in Dec from 53.5.

CAD

* Oil prices having less of an impact on the CAD as we see a broad-based pick up in USD demand.

* Lower Gold prices highlight early year demand for USDs away from all other major currencies.

* Canadian manufacturing and wholesale sales for Nov due out this afternoon.

A familiar triumvirate moving in tandem

Once again we are seeing the trio of US rates, currency and stock markets moving higher, reinstating the theme which based on evidence last November, has limited potential given the sensitivity to higher interests on equity valuations.  In the first instance, the recovery in stocks is as yet a moderation in the heavy sell-off seen in the latter months of 2018, and allowing for speculative short covering in the broader indices coupled with a reallocation of funds at the start of the year through discretionary and sectoral bias, we may have a little way to go on the upside before nervousness begins to set in again.
While optimism over a US-China trade deal is also a major factor in the positive change in risk sentiment, we must not forget that the Fed is still reining in the balance sheet and financial conditions are very steadily tightening in the background.  In light of this, the latest pick up in Treasury yields will at some point impact on stocks, and/or start to ease off and set up another potential recovery in mid-curve Treasuries.  At current levels, we would expect to see some degree of caution from portfolio managers, but the US economy continues to stand out above its major peers, despite nominal growth levels in China still outperforming in the global economy.  There are greater concerns on the structure of China’s growth going forward, namely that infrastructure spending has comprised a large part of GDP and output over the last decade and that we are potentially nearing exhaustion in terms of effective viability and profitability of any fresh projects in the future.  China is trying to transfigure its economy towards internal consumption and naturally, this takes time.  Based on this broad-based overview on China, the US remains the go-to-economy at the present time and as a result, we are seeing a continued bid in the USD.
There is another obvious factor in that despite attempted repricing of Fed rate hikes this year, divestment away from the USD requires a viable alternative.  Given the malaise in Europe on a number of fronts, headlined by the economic downturn in Germany, we are unlikely to see a readiness to shift away from the greenback until we get a clear reason to do so.
A resolution in Brexit will naturally prompt a readjustment in the Pound, though this is easier said than done.  At present, the political quagmire parliament finds itself in leaves many to believe that the withdrawal process is very likely to be delayed, if not reversed should proponents of a second referendum get their way in the Commons.  That said, there is a growing realisation that a second vote is perhaps not as popular as it may seem, with many of the Conservative party keen to preserve democratic integrity and this is shared by a number on the opposition benches according to recent rhetoric.  The Brexit mood-gauge (for want of a better phrase) now looks to more inclined towards a deal in order to leave the EU in an orderly fashion, though the power remains in the hands of the EU for as long as the UK refuses to countenance a no deal Brexit – fact!
In Europe, the ECB meeting later this week could prove instrumental in the direction of USD through what is leading component in the DXY – the EUR.  Having failed to capitalise on the breach of range limits at 1.1500, we are once again resigned to a narrow range inside 1.1300-1.1500, where a breakdown of the lower level may well see the USD extend its quest for higher levels – the headline rate still providing to the lead for the rest of the major USD pairings in the current climate.  The Jan PMIs will be a major factor when released later this week – ahead of the ECB meeting in fact, so we expect this to be one of the key market catalysts this week in an otherwise lethargic market for macro-based instruments – reflected overwhelmingly in FX.

Forex Analysis: EUR/USD Technical Analysis

Bearishness in EURUSD continues, in this weekly chart price bounced off the 1.1490-1510 area and has now moved toward the uptrend line marked on the chart.

If the trendline breaks we may move lower toward the 1.10 level.

The trendline level could be used as support.

The downtrend which started at the beginning of 2018 is still intact.

1.13 has looked sticky in the past and looked like a base formation but if it breaks the lower low, lower high sequence continues.

1.1186 is the 61.8 Fib retracement level.

EURUSD seems to be oversold and the repricing of the rate hiking cycle by the Fed did point to USD weakness. The Gov. shutdown does not seem to have affected the USD as much as expected but Europe has its own issues with Italian and French budgetary concerns as well as Macron policy discontent in France. Stock markets have moved back to being risk on and the US-China trade deal could unwind some of the USD strength. Having said that its still a pretty bearish looking chart, keep an eye on the trendline and the consolidation low of 1.1216 for clues.

FX Analysis: Stalemate in the currency markets as the Dollar continues to stand out

Short on narratives, we continue to see the major currency pairs trading in extremely tight ranges, with the majors having threatened a breakout in response to the Fed repricing in the rates market.  That the USD looked to redress some of its strength from 2018 looked inevitable to some degree, but despite a shallower path of rate hikes projected, the fact remains that the greenback still offers yield as well as safe-haven status amid instability in the stock markets.
In the past week, Sterling demand has picked as market participants warm to the prospect that the UK parliament is in agreement on avoiding a no deal Brexit at the very least, even though turning this into something tangible whilst also trying to negotiate a better deal with the EU is still a mammoth task which risks political upheaval to some degree at least.  Nevertheless, we are seeing marked gains against the USD and the EUR, with the latter offering the more comfortable route in light of economic weakness in the Eurozone and domestic troubles in France leaning on the single currency.
Gains against the USD may well see us testing levels closer to 1.3000 to 1.3100 before we start to level off and consolidate, and lest we forget, the UK is trying to find agreement on the withdrawal deal, after which the real trade negotiations begin.  This is not over by a long shot, but as noted above, the market is short on fresh narratives and the recent developments in the UK – aided by Theresa May’s government winning a vote of no confidence – allows for some price adjustment in the Pound.
As for the EUR, markets need to see some moderation in the regional data to even begin to start considering some relaxation of pressure here.  One potential positive for the region has been the drop in Oil prices, which should feed into some degree of profitability in margins.  Europe is a major importer of Oil, and while waning global demand has been hitting exports, lower cost inputs could see some better figures on the horizon to a modest degree.  Against this, headline inflation which is the ECB’s single mandate will come under pressure, but as noted from the president, all eyes are on the core rate which has stabilised around the 1% mark.  If we see some modest upturn from current levels, then we expect this to improve sentiment on the EUR in the interim.
Hopes for a breakthrough in the trade talks between the US and China are looking a little more doubtful than they already were, so any positive carry-through sentiment for the Eurozone also seems to be evaporating again, especially after recent reports the president Trump is inclined to move ahead with auto tariffs.  Even so, we have been trying to base out again, and while it is too early to call the 1.1215 lows from last year a meaningful base, there is room to test the upside a little more without disrupting the overall medium-term downtrend from the highs seen in 2018.
Among the risk-correlated currencies, there still seems to be little to differentiate between the usual suspects.  Barring the sharp move in the first week of the year, we can see AUD/NZD moving in a very tight range with a modest upside bias more recently.  Ranges with the CAD are also contracting, and we have seen little else having a notable impact on the Canadian currency other than oil price of late.  The USD adjustment may well have run its course against these pairs, and judging by the cross rates, look set to underperform based on our negative outlook on risk appetite going forward.

FX Daily Early Morning Bullets

USD

* US Sen Grassley says president Trump is inclined to impose car tariffs.

* Grassley also says that govt shutdown may also delay trade talks.

* Chinese FDI (foreign direct investment) in the US falls significantly.

* Philly Fed manufacturing index due out this afternoon.

GBP
* PM May statement last night urged parliament to come together and find a way forward and a deal which appeals to all.

* Party leaders met with PM May last night, with the exception of Labour leader Corbyn who insists she rules out no deal first.

* At least 130 UK business leaders have urged parliament to seek a second referendum.

* UK Dec RICS House Price Balance falls to its lowest level since Aug 2012; -19.%.

EUR

* EU CPI out this morning – second reading expected to confirm a headline rate of 1.6% while the core rate sticks at 1.0%.

* German govt looking for ways to exclude Huawei from 5G auction.

* ECB’s Lautenschlager speaking later today – yesterday said not surprised by the dip in inflation, still sees economy within ECB forecasts.

AUD & NZD

* Risk sentiment will dictate price action in the related currencies – NZD the underperformer, now a cent off the recent highs.

* AUD also down as Chinese growth concerns will continue to put a cap on the commodity linked currency.

* Australian home loans for Nov fell 0.9%, though a drop of 1.5% expected.

CAD

* Also feeling the turn in risk sentiment, USD/CAD pushes back above 1.3300 this morning.

* Canadian ForMin Morneau says Brexit will not affect Canada but will impact on global economy.

* Oil prices holding their ground, though off the recent highs.

An interesting start to the year ahead – looking for the USD to stabilise and eventually soften but external factors will have a big say.

The key theme last year was that of USD strength in the currency markets, coming off the back of divergent rate paths against which the EUR and JPY were the primary targets, while GBP was also in the mix on broader fears over the withdrawal from the EU.  Looking ahead to 2019, we can expect a softer line from the Fed, and having moderated the call from 3-4 hikes next year, the base case scenario is now for only 2 as both the real economy is decelerating, and stock markets are seen to be a little more sensitive to financial conditions than were previously believed – at the Fed at least.  Lower earnings growth potential should take keep a lid on any recovery in stocks though, at the moment, forced liquidations will continue to dictate the risk mood which further supports the JPY and CHF, with the USD next in line.
Based on the Fed projections for this year, however, the outright view on the USD will be mixed in the first half of the year, with proponents pointing to the lack of alternatives given Eurozone weakness, Brexit uncertainty and a negative view on global growth which has taken its toll on commodities with the exception of precious metals.  It is our view that the market is underpricing the possibility that the Fed may well sit on their hands until the middle of the year before embarking on any fresh tightening, and we believe there is also the outlying chance that there will be no (Fed) move at all in 2019.  Much is dependant on the US data going forward, and we believe there is room for the USD to moderate a little more, though the usual suspects are struggling to garner support.  EUR/USD has again faltered at 1.1500 this week, and we would have expected more of the same had we seen a push back to 1.1600, so we have defined a key area for USD bears to overcome if the greenback is to materially change direction.
For the Eurozone to come out of the doldrums, we will need to see some relaxation in the trade tensions between the US and China, and if they do strike a deal, we expect to see some of this relief reflected in the EUR rate as exporters here will have raised optimism that the US will reciprocate with Europe also.
Brexit is very much a binary outcome in terms of how we come out of the other side of the meaningful vote later on this month.  Every indication suggests the current proposal championed by PM May will be rejected, but there is a majority in the House of Commons in avoiding a calamitous withdrawal with no deal in place, though how we come about this is unclear as it has ever been.  The obvious expectation is that Article 50 will be extended, though GBP will be sensitive to comments from the PM who insists the referendum result will be respected and the UK is leaving on the 29th of March.  Red lines have been shifted in the past and we can see Theresa May giving up further ground.  It is just a case of where and to whom, which is the question at this stage.
Commodities have front run the US stock market sell-off due to the stronger USD impacting on emerging markets, so it is no surprise then to see the related majors suffering at the hands of the greenback.  At this stage, the economic slowdown in China is going to keep the AUD tethered to the lows and possibly lower.  News of fresh stimulus in China is having little soothing effect, as the mining backed currency threatens a sustained move lower, though we suspect the volume is coming through AUD/JPY as the key stock market proxy.
While oil prices continue to attack the downside, there looks to be little reprieve in sight for the CAD.  We have seen losses across the board, with EUR/CAD rallying through 1.5500 to highlight the impact of risk sentiment as much as anything else.  Perhaps shades of early 2016 spring to mind when USD/CAD tore through 1.4000 as WTI slumped into the $20’s, and while this threat is present, it is unlikely we will see a move back to longer fair value levels around 1.2500.
Even so, the USD is not the Holy Grail of safe havens anymore.  While it has taken time for the JPY to catch up, the resilience and later resurgence of Gold prices should have given the market an early sign that USD dominance was and is slipping, though in current times, repatriation flow can wash out speculative positioning with ease – much as we have seen in the collapse of USD/JPY, which was pounding on the door of 114.00 only a few months back.  It would not surprise us to see levels closer to 100.00 at some stage this year, though the catalyst for this is multifold.  As above, the Fed may turn even more dovish than is currently perceived (probable), or we could see significantly larger losses in US equities – which have outperformed considerably in recent year, or we could even see the BoJ finally throw the towel in on their aggressive asset purchasing program.  We expect a change in language at the very least at some point, and we don’t discount broader inflation expectations in countenancing this.
One way traffic in the USD looks set to give way to a little more differentiation at the very least.

Outlook on the USD as Fed Funds set to have a stronger impact

By now, it should have become painfully obvious that USD demand is now predominantly a function of the weaknesses elsewhere, rather than expressing a positive view on the US economy. Naturally, it is hard to argue against a more favourable position stateside, but the US is not without its risks, which will be exacerbated every time the Fed decides to hike. The normalisation process was long overdue, and I argued that the Fed was perhaps a little too hesitant in tightening as Fed chair Yellen, at the time, wanted to wait for clear signals. Well they came through, and while the market focused on the twin deficits, the USD index was pounded into the ground and few could see a reason for the turnaround. And now here we are.

The market cannot get enough USDs, and at a time when the balance sheet is slowing contracting, the backdrop of year-end shortage maintains a relative bid in the greenback despite the prospects of a dovish hike tomorrow night. It would not surprise me if the Fed decided to stick on this one, and as per Jerome Powell’s rhetoric, watch the data. There is, however, one distinct drawback in taking this course of action, that being the perception of yielding to political pressure. President Trump makes no secret of his disappointment in the current Fed path, though come 7.00pm tomorrow evening, we will know through the dot plot whether there has been any moderation in how policymakers now believe the normalisation process should continue – if at all.

Anyone choosing to stick to the script need only look at the housing market, where yesterday’s NAHB House Price Index took another dip from 60 to 56, having fallen from 68 in the previous month to this. Domestically, neutral rates may be closer than the Fed thinks, and their recent commentary is certainly moving this way. Any suggestion of a pause tomorrow night will confirm Fed concerns, so in this respect, perhaps some of the outliers for an unchanged stance are a stretch at this point. The level of market dependency for direction from central banks has been raised significantly in recent years. so policy communication has to be dealt with kid gloves these days. In this regard, we do expect the Fed to direct market participants towards the data and coerce the mindset towards what is actually happening in the economy. It is long overdue.

That said, it is hard to steer the market away from the USD at the present time. The EUR is riddled with political instability in the region, exacerbated by the Brexit fallout, and the domestic data has taken a hammering from export-led weakness. The Pound, as undervalued as it is, faces a crisis of a magnitude not seen since the ERM debacle in the early 1990s and global trade worries continue to weigh on the majors closely tied to Asia. Australia, along with Canada also faces serious housing concerns as well as private debt thereon, and with Oil prices dropping like a stone, we cannot count on the traditional followthrough in the Canadian economy which has been a staple default scenario as a tailwind of US growth.

We still see room for a modest correction in the USD should the dot plot fall in line with market expectations. Whether this can effectively mark a more significant turnaround at this stage is in the balance. It will take some significant improvement in some of the USD’s major counterparts for this to develop, and this is clearly not going to happen overnight. The JPY and CHF look the obvious choice in the current climate, though both the BoJ and more so the SNB will have something to say on this, so the playing field is a bumpy one, to say the least. EUR/USD is making all the running this morning alongside a reluctant push lower in USD/JPY. 116.00 and 111.35-30 are levels we are watching for in either case.

(EUR/USD Technical Analysis)