Well, it’s Sunday which, at last check, means tomorrow will be Monday and that means a new trading week is upon us.
It certainly seems like the Fed’s dovish slant (which, you’re reminded, effectively turned a hike into a cut) was an attempt to i) allay fears that recent hawkish rhetoric presaged rapid tightening by a committee that thinks it’s woefully behind the curve, ii) get out ahead of potential volatility tied to the French elections and buy the Trump administration a bit more time in terms of moving forward with growth-friendly tax reform and fiscal stimulus.
That’s good for risk which was looking a bit shaky heading into Wednesday following a collapse in crude prices that hit high yield and EM hard.
Moving forward positioning is still extended in crude and the massive Treasury short remains…well… remains massive according to the most recent data we have from the CFTC. Dollar longs are hurting as dovishness undercut the notion that a further widening of rate differentials would support the structurally strong USD thesis. Meanwhile, collapsing cross-asset volatility is set against a backdrop fraught with political risk.
Here with more on the week ahead is Barclays.
An “unhurried” Fed boosted risk assets and weakened the USD last week. The Fed raised the target range for the federal funds rate to 75-100bp in a well-telegraphed move, but seemed in no hurry to project a higher path of rate hikes next year (the median policy rate forecast remained unchanged at three hikes in 2017 and 2018), contrary to our expectations. We continue to forecast two more rate hikes this year and three hikes in 2018 (approximately one hike more than the market is pricing) and expect to hear more from the committee about its balance sheet policies at the June FOMC.
We expect further near-term USD weakness, concentrated primarily against high-yielding currencies. History suggests that this point in the Fed’s tightening cycle is typically followed by further near-term USD weakness, stable equity prices and lower 10y UST yields (Figure 1).
Although low-yielding G10 and EM currencies will likely struggle to materially strengthen further against the USD, the drop in cross-asset volatility (Figure 2) will likely support high yielders, particularly the ones with positive idiosyncratic stories (RUB, INR, IDR and BRL), in our view. Additional USD consolidation is also likely, amid still elevated long USD and short UST positioning, according to CFTC data (Figure 3).
Recent oil price volatility has been notable, however. In the near term we favour carry currencies that could either benefit from lower oil prices or prove relatively immune to a sudden uptick. We view the recent oil price softness as temporary and remain bullish medium term on the commodity. Yet, the prospect of elevated near-term volatility and potential downside for oil sensitive currencies, particularly over-positioned ones like the RUB, makes us look for yield in currencies which could benefit from lower oil prices or remain relatively immune to a sudden uptick, like INR.
DM inflation has recently rebounded, albeit from historically low levels. In this regard, UK CPI data (Tuesday) and Japan’s Shunto wage negotiations will likely gain traction. Higher-than-expected February UK CPI inflation of 2.2% y/y (consensus: 2.1%; BoE: 2.3%; previous: 1.8%) should support GBP this week, in the context of a BoE policy reaction function that has increasingly shifted to prioritising inflation deviations from the target. In Japan, the first round of Shunto outcomes released last week showed +2.06% wage growth, a relatively firm outcome considering weaker corporate profits and CPI last year. Rising inflation and solid growth in H1 17, should see the BoJ raise its 10y rate target in Q3, considering constraints of its monetary policy.
Finally, several central banks will be setting policy this week. In line with analysts’ expectations but contrary to market pricing, we look for the CBR (Friday) to keep policy unchanged (consensus: 10.0% market pricing: 25bp cut) and see room for RUB strength and curve flattening. Elsewhere, we expect the RBNZ (Wednesday), PHP, and BSP (both Thursday) to keep policy settings unchanged. Finally, we look for Banrep (Friday) to cut its reference rate 25bp, in line with consensus expectations.