As political risk continues to dominate the headlines (even as US equities steadfastly refuse to efficiently price it), FX markets will likely remain in the spotlight.
The dollar is grappling with an increasingly draconian stance from the White House regarding trade, but traders are still acutely aware of the Fed’s supposed desire to get in at least two hikes in 2017. Friday’s jobs report was greeted with a conspicuous amount of skepticism thanks to a weak read on wage inflation, giving ammunition to those pushing for a more “gradual” tightening pace. Expect chatter around SOMA rolloff to increase commensurate with the administration’s desire to put a lid on dollar strength as any tightening that does transpire may be shouldered by the long end in an effort to anchor short end rates.
In Europe, Marine Le Pen is ratcheting up the euroskeptic rhetoric in lockstep with Trump’s combative approach to immigration. Here’s a summary of Le Pen’s Sunday comments via Bloomberg:
- French presidential National Front candidate Marine Le Pen says she would seek to immediately recover the country’s “monetary sovereignty” if elected in May.
- Le Pen, who didn’t directly mention an euro exit, says she would negotiate with the EU to regain the “four sovereignties: monetary, legal, territorial, economic” adding that if the EU didn’t “bow” to her demands she would call a referendum to exit the EU
- “The dysfunctional system” of the euro and the European monetary system is “ruining France”
- “Let’s make it a bad souvenir,” Le Pen said about France’s EU and euro memberships
Needless to say, that puts pressure on the euro as traders attempt to price the unpricable: a French black swan.
Meanwhile, Friday saw the Bank of Japan reasserting its power over 10Y JGB yields as the market questioned Kuroda’s resolve after the central bank failed to intervene to put a lid on yields Thursday. With the pressure on, it’s effectively Trump versus Kuroda. If the BoJ fails to step in and anchor JGB 10s (i.e. preserve the YCC story), it will be seen as an admission of guilt with regard to the currency manipulator label.
As for the pound, it’s all about the market coming to terms with the fact that Brexit is real. More on that here.
Below, find a summary of where FX markets stand as we head into week 3 of Trumplandia.
USD: Uninspiring The USD is likely to remain range-bound, as long positioning has cleaned out in the past weeks, but still faces some pressure after the Fed last week showed no rush to hike rates and did not signal it considers the economy to have reached full employment. The employment report was unimpressive despite the beat in headline numbers, as average hourly earnings disappointed, indicating low wage pressures and giving fuel to dovish FOMC members who consider that some slack remains in the economy. Expectations of a March hike declined in response, but the market is unlikely to price out hikes, as the Fed looks set to increase rates at least twice this year.
EUR: Trading within the uncertainty band EURUSD appreciated last week, as softer-than-expected US data, a more dovish Fed and negative headlines on Trump’s policies fuelled further short EURUSD positioning unwinding (Figure 4). In the near term, a quiet data calendar in Europe and the US is likely to keep EURUSD range-bound amid elevated US political uncertainty but less stretched positioning. European political risks and monetary policy divergence should push EURUSD lower towards parity later in the year, in our view. On the data front, we expect German factory orders growth of 0.7% m/m, after a sharp contraction in November (Monday; consensus: 0.5%; previous: -2.5%) and we forecast German IP to post modest growth at 0.4% m/m in December (Tuesday; consensus: 0.3% m/m; previous: 0.4% m/m). Finally, French IP should contract 0.7% m/m, in line with the consensus (Friday; previous: 2.3%).
GBP: Back to focusing on Brexit The bill for the triggering of Article 50 should get its final approval at the House of Commons (Wednesday), suggestive of the UK government’s willingness to trigger it promptly by mid-March. We think clarity and timeliness should be positive for GBP through the reduction of its political risk premium. Last week, the MPC kept policy unchanged but surprised markets by lowering its estimate of the equilibrium rate of unemployment for the UK economy to 4½%, from 5% previously. This suggests more slack in the economy than previously thought and less need for tighter policy amid building inflationary pressures. We continue to see BoE policy as neutral for the GBP over the coming quarters, with currency undervaluation, short positioning and more political certainty benefiting it versus the EUR over the coming year.
JPY: BoJ YCC challenged by JGB While the BoJ maintained its monetary policy unchanged, as expected, market attention turned to its JGB purchase rinban operations, as 10y JGB yields exceeded +10bp, ie the perceived upper limit of its 0% 10y target (Figure 5). The BoJ responded with an increase in rinban purchases for 5-10y by JPY40bn and fixed-rate operations at 11bp. JGB markets rebounded thereafter with the 10y returning to about 10bp, but the rinban operations will remain the key focus for USDJPY, as JGB markets could continue to challenge the BoJ YCC. Externally, US political headlines continued to weigh on the USD, even though most of the economic data were supportive for the currency. The USD has notably diverged from US rates since mid-January, and the increasing risks premia have also weighed on USDJPY (Figure 6).