Ok, so it’s Sunday which, as we’re fond of reminding you, means that tomorrow will be Monday – right up until Trump does something that takes the whole of idea of there being a “tomorrow” off the table…
Speaking of Groundhog Day, we’ll all be watching the same things this week we were watching last week. Namely: inflation, crude, and carry.
Inflation because the Fed just hiked into a deflationary impulse and because, well, because this:
And crude because we just careened into a bear market amid persistent supply jitters and worries about just how long HY as a whole can remain resilient in the face of widening HY Energy spreads that have blown out by something like 110bps since the beginning of last month:
And carry because let’s face it, picking pennies in front of steamrollers is the only way to go these days what with the Big 4 central banks having increased their collective balance sheet by ~12% YTD, suppressing vol. and making anyone who’s put on a decompression trade look like a complete fucking idiot for daring to think that hedging or doing anything that results in negative carry is socially acceptable.
So with that as the backdrop, below find your full week ahead preview from Barclays followed by the customary DM event calendar courtesy of BofAML…
DM currencies should return to centre stage this week, with May US core PCE and Japan CPI (both Friday) highlighting continued cyclical convergence in G10 that should reduce differences in interest rates and returns to capital. We expect US core PCE to moderate to 1.4% y/y, while Japan nationwide CPI ex-perishables (core) should have risen 0.5% y/y in May. We remain concerned about US inflation dynamics and expect core inflation to remain just below 2% by the end of 2017. Together with the growing doubts about a US fiscal stimulus, the core inflation dynamics call into question whether the FOMC will raise rates again in December.
Despite the generally benign market environment we envision over the coming quarters, we still see several factors supporting USDJPY depreciation including: 1) Japan’s closing output gap, large current account surplus and JPY undervaluation (23% according to our BEER model and 15% vs. the USD in PPP terms); 2) Japan’s above-potential domestic growth; 3) the JPY’s consistent safe-haven properties, making it an attractive portfolio hedge. In line with this view, we have recommended long JPYKRW spot positions.
Oil prices have been a source of macroeconomic volatility recently but have likely bottomed with the peak of summer demand season and global inventories drawing. We expect oil prices to average USD55 in Q3. We look for oil’s eventual rebound to induce differentiated responses in the commodity currency space. Interest rates have become more important than oil for the IDR and CAD, while oil dynamics remain central for the RUB and NOK. Hence, even in an oil rebound, we still recommend fading the recent strength in the loonie and expect material currency depreciation.
More generally, a dearth of themes and convictions, low volatility and absence of near term known risks are fueling carry trades in EM space. With positioning much cleaner following last week’s washout, we expect investors to re-engage in positive carry positions in rates and FX over the summer months. We continue to recommend long carry through a variety of trades such as short CADINR spot, long USDTRY 1×2 put spread, short PHPIDR, and short USDCNH.