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FX Weekly Preview: USD Turnaround Hard Fought; Still A Correction Despite Stronger Data

Courtesy of ZeroHedge. View original post here.

Submitted by Shant Movsesian and Rajan Dhall MSTA

In recent weeks, we have continued to look to further gains in the USD, initially led by a belief that the bearish scenario had been exhausted, but later on improving data.  Time frame is a key factor in our metrics for where we see currencies finding value, and given that we have seen some strong gains against the CAD and JPY in recent weeks, we may be close to congestion levels, which these days tend to develop into significant tops.  

On Friday we saw the employment report missing on expectations, but the disruptive factors from Hurricane season saw the negative impact on the USD as temporary, with traders responding to the stronger ISM non manufacturing PMIs later in the day.  Wage inflation was something we could not determine this time around with the return of workers on the lower end of the pay scale dragging hourly earning back to 0.0% on the month, the yearly rate at 2.4% still down on the previous year.  Factory orders were also strong, and we can put this down to – in part – USD weakness seen over the large part of the summer.

Looking ahead, we have little in the way of US data to provide immediate drive for the greenback, so focus will be on the tax reform proposals, and whether much of the recent economic improvement is now largely priced in – not easy for an algo dominated market reliant on specific prompts.  

Selective gains suggested the EUR and GBP could come under pressure at the hands of the greenback in the week again, with EUR/USD set to grapple with demand into the mid 1.1500's and Cable eyeing a move on 1.3000 at some point.  

In Europe, we have German factory orders first thing on Monday followed up by final readings in the services and composite PMIs across the Euro zone as well as the Sentix indices.  German industrial production and trade stats later in the week will show us if economic momentum is as strong as recent data has shown us, and as we have seen with excessive currency strength within certain time frames, this can impact considerably.  Case in point is the Canadian economy, which had to weather a 10% appreciation, albeit from overextended levels, but all in the space of 3 months.  Quite how the market expected EUR/USD to push on from 1.2000 to 1.2500 after such a sharp change in tide from calls for parity at the start of the year continues to surprise me.  

The crosses could also come under a little pressure off the back of the data, but EUR/CHF will continue to be smoothed off on the downside, while Japanese investment flow keeps EUR/JPY in the running.  

EUR/GBP however is one on its own as attention in the UK turns away from the interest rate perspective; the BoE following through on its rate hike but doing well to calm some of the euphoria on expectations of more to come.  The longer end of the Gilts curve duly took a hit as 2 more rate hikes over the next 3 year horizon will be open to plenty of buffering from what may or may not develop over the EU negotiations.  As we pointed out last week, the crux of the stall in talks is purely down to commitment over the divorce bill, with the UK insisting this should be agreed on at the end of discussions.  The EU 27 clearly want this resolved before a move on to talks on trade agreements, and herein lies the stalemate.  

Domestically though, the UK data is holding up, and Friday's UK services PMI moved higher and above the 55.0 mark, containing the downside and keeping the 1.3000 intact for now.  Next week's numbers are all stacked up on Friday, where we get construction output, industrial and manufacturing production as well as trade, but Brexit talks resume the day before, with another press conference to contend with the day after.  Sub 1.3000 should see limited mileage in the interim, with 1.2950 and 1.2825-50 all levels the optimists will point to on the charts, but we see little prospect of a material breakout in EUR/GBP beyond 0.8750 and 0.9025 either side of current market. 

Also tightly range bound has been the JPY, with last week's inflation downgrades by the BoJ a recipe for continued weakness as the central bank show no signs of deviating from their current stimulus measures.  At the (BoJ) meeting at the start of the week, we heard some members effectively calling for some moderation, pre-empting an acceleration in CPI rates on the back of such aggressive expansion in money supply.  Economic activity is improving in Japan, but after decades of low growth and low inflation, the central bank will be loath to unsettle this gradual recovery, so the carry trade continues with relative ease.  As such, spot and cross JPY rates are shallow in any dips, but with Japanese investor outflows prevalent in the run up to the election, we have seen little evidence of any fresh movement in this direction and we sense the USD can benefit little more with Wall Street at current levels.  114.50-115.50 is a major resistance area which based on recent price action, looks unlikely to be breached. 

Japanese data of note next week includes core machinery orders and bank lending, while foreign investment numbers are also due for release.  

Risk sentiment naturally dictates also, but with equity markets in the developed nations practically immune to everything, JPY shorts feel comfortable enough for now.  

Chinese trade data out on Wednesday, where the export/import balance is expected to widen the surplus back out to nearly $40bln.  President Trump will naturally have something to say if it does. 

Central bank meetings in both Australia and New Zealand next week, and we are not expecting any changes at either event.  Despite some strong data out of Australia of late, sluggish inflation has reared its ugly head in this part of the world also, with CPI rates slipping out of the RBA's target range where the lower bound is 2.0%.  Retail sales also came in on the soft side lately, and comes alongside current 'sensitivity' to weak wage growth.  On these bases, we expect governor Lowe and the rest of the board to maintain steady policy for some time, and last week's data release alone saw expectations for the next move (up) delayed until H2 2018 at the earliest.  This could pull AUD/USD below the recent 0.7625 base, but much like the EUR, downshifts will be hard fought and 0.7450-7500 is a stronger area which traders (still wary on the USD) will look to buy against.  

The comparative level in NZ looks to be at 0.6815-20, and while we have seen some healthy employment numbers from Q3, there looks to be a lack of conviction on the upside until we get more clarity on the new government's policy profile which is expected to favour social investment over business.  On RBNZ mandate reform, where full employment is now set to be included in central bank considerations, the Q3 data mentioned above should take some of the pressure off NZD.  Above 0.6900, we are running into resistance just ahead of the half way mark, but have seen a decent reversal in AUD/NZD which could now extend closer to 1.0900 or so.  

No change in policy from the RBNZ anticipated, where the 1.75% base rate still stands out in the list of most actively traded currencies, but in GDP terms ranks 50th in the world.  Liquidity issues therefore apply to some degree, but the domestic finances are strong despite how the government decide to put their surpluses to use.  

It was another surprise in the Canadian data, where both July and August GDP reads have disappointed – a minor contraction seen in Aug.  As alluded to above, the rapid acceleration in CAD buying after rate hike expectations will have contributed to some of the economic fade, especially with Canadian exports a major contributor, but looking at the labour stats, another strong rise in full time jobs shows it is not all doom and gloom.  The BoC have tempered some of the exuberance which has lifted longer end rates significantly, but the currency has at least pulled back some way.  1.2900-1.3000 was highlighted as a strong resistance zone which has held well, and we continue to expect it to do so.  

Just as the AUD has not been reacting to the strong pick up in industrial metals prices, CAD has also been ignoring Oil, but here perhaps traders are anticipating highs close by.  WTI is still pressing on levels for $55.0, but shale production will be back on track soon, and are watching Oil imports in the DoE report, which are falling again, and this should rein in some of the strength seen which has already surprised large parts of the market.  OPEC are clearly happy, but want to see a 'floor' at $60.0.  Wishful thinking some will say; $50.0+ an achievement in itself, but influenced to a significant degree by the disruptions in the US.

Inflation data out in Norway at the end of next week, and this could put a fresh dent in the pick up in NOK/SEK seen in the past week.  Nothing really changes materially unless we break out of 1.0350 or so, with the move last Friday rejected pretty emphatically.  Swedish industrial production of note in the early part of the week.  

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