While the stock markets are poised for some strong gains in the aftermath of the G20 meeting, it is – as ever – best to stand back and look at the overall economic landscape on which to base the medium-term outlook. It was, as some would have anticipated, a natural reaction to what some perceive as one less risk factor to contend with, even if it is only a temporary ceasefire where the US has seemingly agreed to hold off raising tariffs on Chinese goods as long as China agrees to buy more goods from the US. While this is all well and good for the time being, we cannot help but think that stocks are all too quick to price in the best case scenario, which then suggests that any upside is dependent on global growth and the financial conditions we are operating in
On the latter point, the Fed is still shrinking their balance sheet, and while the prospect of a shallower rate path is also cause for some near-term relief, the undercurrent of quantitative tightening is and will not go away. Maintaining the level of valuation in stocks in a tightening environment is what is now at stake and portfolio managers will be seriously considering value in long end Treasuries at over 3.00%. For the brave, fixed income yields look attractive in countries such as India, though I can see little sign that the markets are ready to differentiate. EMs are, therefore, still largely viewed as a positive ‘risk-bloc’ rather than considering the individual components.
How this translates into macro FX is uncertain as yet, and made more confusing by the widely acknowledge of breakdowns in a host of traditional correlations. The JPY has been particularly resilient in times of stock market stress, with the USD rate pushing higher on the narrative that the greenback is both safe haven and yield play. No surprise then that the persistent move higher has been relatively unscathed, though there are clear signs that we have exhausted the upside into 114.00. At this stage, repatriation risk looks underpriced, and even if we see Japenese investors switching to fixed income, the argument for the yield play also falls down. Consider that the BoJ will continually reassess their uber accommodative stance, and note the perfect recipe (storm) for a material adjustment in JPY levels.
Moving onto GBP, tomorrow week sees the House of Commons convening for the vote on the latest EU deal. By latest, the EU will have us believe that this is the final deal they are prepared to offer the UK, so the slim prospect of this getting voted through on the 11th sees the market trying to price in a no deal outcome. In this instance, we still expect to see both sides renegotiating on a lesser scale (so to speak) on an arrangement which will avoid the chaos following a ‘cliff edge Brexit’. The free flow of goods and maintenance of supply chains benefit both the UK and EU, so it is hard to imagine this will be sacrificed in the name of political ideology – as naive as that may sound!
Technically, it is hard to put any faith in levels on either EUR/GBP or Cable, but we note that since the recovery from the flash crash 2 years ago, 1.2500-1.2600 has established itself as a key area of significance. If breached, however, we must assume the lows closer to 1.2000 will be tested, though as yet, we note a rebellious tone once we get to 1.2700. EUR/GBP is mirroring this in the low 0.8900’s as we can see with the numerous failed attempts to push above here, resulting in (as yet) shallow dips.
This may be down to the EUR’s own weaknesses at the moment. Aside from the EU’s ongoing battle to try and rein in some of Italy’s spending plans, Eurozone growth continues to cause nervousness over the medium term. Oil prices have also dropped significantly to suggest headline inflation is heading lower, yet if the core rate moves in the opposite direction, we could see this having an outsized positive impact further down the line. It is hard to argue the point at this stage, though at the present time, it seems that there is little more we can ‘throw’ at the EUR, so there is also evidence that on longer-term valuations, we may be close to, if not already have set a near-term base just ahead of 1.1200. Should we push above 1.1500, better still 1.1625, then we can be a little more confident in suggesting a period of wider consolidation which may or may not result in an eventual move towards 1.1800 again.
Naturally, this will also depend on how US growth develops into 2019. It is fair to expect
a deceleration in the pace of expansion, and as we have seen with comments from Fed chairman Powell, data dependency is paramount from here and we expect the USD to be a little more sensitive to any softness in the numbers. Based on the heavy positioning in the greenback, it is also fair to assume some profit taking over the next few weeks, though we cannot discount the reluctance to do so ahead of the FOMC meeting later on this month.