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.