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FX Week Ahead: Blind Faith – First It Was In The US, Now It’s The UK

Courtesy of ZeroHedge. View original post here.

Submitted by Shant Movsesian and Rajan Dhall MSTA from

We have seen many instances of blind faith driving the rates and currency market, with last year's post Trump victory reflation trade the leading example.  Promises of policy reform focused on taxes and health-care lead many to anticipate a growth busting administration in full flow, but as we have seen, the vociferous and controversial president has had it anything but his own way.  Of late, there have been seeds of optimism with his address in Indiana highlighting the more specific changes he will push for in Congress including corporation tax no higher than 20%, a three level tax rate system and simplified coding which will make returns easier to fill out. None of this will generate USD strength in the meantime unless there are genuine prospects of getting through, but both Steve Mnuchin and Gary Cohn believe this is achievable, so it is now a case of wait and see – the markets will naturally remain sceptical.  

Nevertheless, we have been calling for a USD correction among the minority, and having recovered some ground over September, the greenback has edged back to levels where USD bears will start to see value in reinstating their longer term view. This will be selective however, and in that respect, levels in USD/JPY but less so USD/CHF look a little vulnerable under the circumstances above.  US Treasury yields have recovered well, and show little sign of an immediate return to the recent lows, with some of the data as well as a little more commitment from Fed Chair Yellen bolstering for now.  He more pertinent comments were that rate rises will not be 'too gradual', and this along with some of the growth metrics have put a Dec rise in Fed Funds firmly back on the table.   Job done, the market will now be looking to 2018 to judge whether further USD gains a justified, with the 10yr T-Note faltering a little above the 2.30% mark, where higher up we expect 2.50% to hold firm.  USD/JPY will struggle to improve materially on 113.00+ as a result, and as we have already seen in the past week.

Plenty of data in the run up to Friday's major risk event which is the Sept non farm payrolls report, but don't expect any firework's in the numbers or indeed the response as the Hurricanes distort the readings to immeasurable levels.  ISM manufacturing PMIs may perhaps be a better gauge of economic activity given the above, so Monday's release may well set the tone for much of the week.  More data in the ISM NY business conditions on Tuesday and non manufacturing PMIs on Wednesday alongside the ADP survey.  Aug Factory orders to look for on Thursday. 

So back to blind faith, and nowhere is this more so prevalent than in rate pricing in the UK, where the market has been hanging on the words of BoE governor Carney and his fellow members who have also prompted the market to (re-)price a 25bp rate hike this year and more beyond.  Last Aug we saw a panic move cut the base rate from 50 to 25bps and at the time I was among others who thought this was a policy mistake, and nothing has changed my mind since, instead believe now they have (already) made another one.  Following on from Messrs Saunders and McCafferty, Vlieghe (who was said to be keen for the rate cut last summer) and Broadbent have helped tip the balance of power towards the hawks along with the governor himself and implied rates have shifted higher and will no doubt see the banks preparing to adjust mortgage rates accordingly.  Should they temper their signal – as I believe they should – that this is a case of one and done (in reversing last year's move), then we should see some moderation in the 10yr which has touched 1.40% this week, and the Pound should come back a little in response.  

Having met with strong resistance above 1.3600 in the week before last, there are plenty of traders who were and are ready to fade this move, and irrespective of some of the data showing signs of resilience in the economy with positive results and surveys from the high street as well as the unemployment rate easing back to 4.3%, few see higher inflation levels as a healthy development in light of the impact this will have on disposable incomes.  The BoE tell us that household debt is not a concern at present, but we have heard this in the past, and with Brexit hanging over the UK, this is not time to be calling a recovery in process and one which warrants the start of a tightening cycle.  

That said, we are not expecting an outright collapse in the Pound.  At 1.2000, we saw value in Cable given the circumstances at the time, but with Article 50 now triggered and the negotiations under way, little has changed despite the recent press conference revealing constructive talks.  Thankfully, EU citizenship is finding common ground, given peoples lives are impacted, but those who believe that any agreement on the exit payment (which is still far off) will lead to positive developments on trade and single market access, will be left disappointed.  On this, we believe the mid 1.30's are not a platform for a move to 1.4000 let alone 1.4500.  EUR/GBP may have also set its base at 0.8750 or so as a result, though we still see a small probability that this may be extended closer to 0.8600.  

This will likely depend on whether the EUR/USD correction has run its course to the low 1.1700's, and as yet, we are not convinced.  Nothing has really changed on the political scene in Germany to have led directly to the move back to 1.1800, which in itself is a modest upturn as yet, but any sign of coalition agreement then the upside will have further to run.  Even so, we still expect to see much of the price action here as consolidative in the near term, and the option market seems to agree as the lower delta risk reversals have aligned with the 25's to suggest a range of 1.1600-1.2300, potentially into year end.  We see the downside as the more vulnerable, with market dynamics pointing to the upper levels as exhausted but still open to modest extension rather than an outright resumption to trend.  

Manufacturing PMIs are the highlight of the data schedule in the Euro zone next week, due out on Monday, but on Thursday we get the ECB minutes which can have some interesting additions – currency 'mentions' have surprised more recently.  Draghi speaks the day before.  German factory orders on Friday will be of interest after the weak stats in Jul.

UK data points to focus on ahead lie in the UK PMIs, the services component of which is on Wednesday, but Theresa May's party conference starts this week, and pundits will be watching for any deviation on Brexit from here speech in Florence. 

Over in Canada, currency appreciation has had little more substance behind it with the BoC having raised rates by 25bps in 2 consecutive meetings.  Alongside the second hike, the statement highlighted this as the removal of stimulus measures effected in 2015, but the market went on to price in more until governor Poloz decided it was time to manage expectations once again.  Before his address last week, we saw the Canadian 10yr rate touching 2.20%, along with a 50/50 call for another move in October.  We can rule this out after his comments that rates are not on a predetermined path – they never are – but the latest data also suggests caution in the market, which saw the sweeping tide of CAD buying take us into the mid 1.2000's.  Too fast too soon? Yes, but that's not to say the longer term picture does not favour fresh upside.  Moderation is what is required here, but we seldom get it in a fast money environment. At 1.2500 again, the BoC can stand easy for now, though we still see room for the yield curve to moderate a little further, and this may well push up the correction to test into 1.2600-1.2800 initially.  

Canada also releases its jobs report next Friday, the last one of which saw sizable shift back from full to part time jobs.  GDP for Jul was also flat as seen Friday last, and Thursday's trade data could signal whether we should expect more of the same and the rapid CAD appreciation (10% in 3 months) was to blame.  

Over in Australia, the RBA meet on Tuesday, but judging by the rhetoric from governor Lowe, few will be expecting anything other than a neutral and cautious statement.  No change to rates here this time or indeed any time soon given last week's address and it has hard to see anything changing his or the board's view since then.  There will be room for some positive aspects to be considered, not least of all improvement in Q2 GDP and a healthy jobs market, so it's not doom and gloom either – just neutral.  

Over the weekend, both the official and Caixin manufacturing PMIs were released due to the Chinese holiday next week, but with divergent results.  The former saw a rise from 51.7 to 52.4 in Sep, while the Caixin index fell from 51.6 to 51.0, so the response in industrial metals price at the start of the week will show which one the market is ready to believe – and AUD will follow.  

Nothing out of NZ other than the Global Dairy Auction on Tuesday, but politics dictate the market here also after another election results in a hung Parliament.  Along with the 'neutral and cautious' (you are going to hear this a lot) RBNZ statement, we saw NZD brushing off the ill effects of last weekend, and indeed has resumed the upside vs the AUD as the cross rate continues to hover over the recent lows around 1.0825.  

In Japan, the Tankan survey – which was a market mover back in the 1990's – will be viewed from a longer term perspective given the BoJ's devotion to getting inflation back to target.  While some have questioned their 'ambitious' objective, others see the 2.00% level as arbitrary in the current climate, but steadfast are the central bank to the accommodation in policy, while sticking to yield control in the 10yr.  

When the JPY decides to turn and trade off domestic fundamentals is something to consider much further down the line, but worth watching for now, with periodic bouts of risk aversion the only positive driver – which then leads to an unfavourable pace of gain.  Divestment flow is now a market staple in times of positive risk mood, but noticeable is the general growing appeal of Japanese stocks in recent months and this could start to weigh on all JPY pairings, limiting the upside in both the good and (naturally) bad times.  For USD/JPY, we see circa 114.00 as a key area going forward.

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