A Mea Culpa Moment Entering The Weekend.

Markets

With numerous crosscurrents still in play, US shutdown and Brexit notwithstanding, a mild bout of risk aversion seeped into global markets Friday pressuring US equities, oil prices and US bond yields lower and we saw mostly US dollar buying as traders pared back extended short dollar positioning on the EUR and CNH.

There wasn’t any specific catalyst other than the latest concerns over Brexit, the US Government Shutdown as well as a more balanced debate over the USD dollars near term direction which led to a fidgety flip flop Friday of sorts. But I will elaborate a bit more on why I think we saw a sharp drop in the EUR and a retracement in the CNH in the currency market section below.

Brexit uncertainty continues, and the clock is ticking with PM May running out of time to get concessions on the unsettling nature of the backstop.

As for the government shutdown, we could say the writing is on the wall, as Trump threatens to declare a national emergency to bypass Congress. And while there is still no definite end in sight, S&P issued a report estimating that the US economy has already lost USD3.6bn due to the shutdown suggesting the markets will pay increased attention to this issue as those numbers are not small potatoes. And speaking of potatoes, Trump is due to talk to farmers in Louisiana who might not be receiving aide checks due to the shutdown and could turn into a contentious affair.

Fed Chair Powell remained coolheaded as his latest speech drew attention to a ” waiting and watching” FOMC who appear in no rush to raise rates. Despite some Fed members discussing the chance of rates moving in either direction, at this stage of the game, a rate hike remains far more likely than a cut. But overall the FOMC messaging is providing relief to the stock market.’

In late New York, a Fed release raised some eyebrows when transcripts from the 2013 FOMC minutes were released reminding everyone that Chair Powell urged the end of bond buying “well before the end of the year” and encouraged “tapering the Fed’s balance sheet.” Just before the taper tantrum, he urged “taking the next plausible opportunity” to taper bond purchase. Indeed, he was far more aggressive back then than the patience messaging he is delivering today.

Overall, Friday’s consolidation and market adjustments look and feel perfectly normal especially with the amount of turbulence still in the water.

Oil markets

Brent crude oil turned lower Friday on profit-taking as advancing equity markets hit the pause button after sharp gains in both markets this week. Also, traders were very unimpressed by reports indicating Russia had only reduced crude oil production by 50,000 bpd for January.

While the Fed interest rate pause and hopes for a US-China trade resolution continue to support prices, slowing global growth continues to temper top side ambitions as speculation across dealing desks was rife with rumours that China will set a lower GDP target for 2019 of 6.0-6.50%

Who said production cuts are ineffective ? as Alberta’s mandated production cuts have seen the differential between West Canadian Select and WTI evaporate from $50 per barrel last October to under $ 7 per barrel last week as output cuts from both Alberta and Saudia Arabia have caught heavy crude refiners short and now left paying the piper.

Currency markets

Much of the current USD move on the Feds dovish shift is getting played out on the EUR and CNH which makes both currencies very susceptible to extended positioning and retracements into USD haven appeal.

Euro
While it could be argued that much of the EUR/USD push to 1.1570 was a result of short covering, but that would belie the number of EUR/USD longs that were entered on the break of 1.1525 only to have a “mea culpa “moment during the brutal move lower as stops were triggered on the break back below 1.1500.

Still, the Fed’s about-face is significant, and it should play out in as weaker USD eventually, but at least for today, the market disagrees. However, I remain confident that provided we can hold above 1.1450, there is scope for a more significant rally to play out.

Market Conviction LONG EUR/USD with the 200 days moving average at 1.1629 the primary target: Provided the Fed has indeed paused, the EUR is going higher

CNH
First of all, the stabilisation in CNH has no significant domestic economic rationalisation but instead, momentum from a softer Fed coupled with easing in US-China trade tensions is providing the bullish synergy. In other words, its a highly speculative driven CNH rally and uber prone to retracements. And while I’m confident the US administration is pushing for a weaker USD but certainly during this depressing economic downturn, China would prefer a stable to weaker Yuan due to the monetary tightening effect a stronger Yuan generates.

And predictably we did get some suggestion of possible intervention on Friday “Market News International around 8:00 AM EST: “Any further rapid appreciation by the currency, which has risen sharply at the start of this year’s trading, could impact China’s exports, the source said, without saying whether the PBoC would intervene to slow any move in the yuan. Separately, a government advisor told MNI he saw a little further upside for the Chinese currency.”

So, if we are looking for a reason why the Euro fell look no further then the move in USD/CNH that was driven by some concerns that the Pboc could be preparing to slow the pace of the Yuan appreciation.

CNH and EUR connection?
If there were a deal afoot between the US and China to weaken the USD, it would make sense for China to buy Euro given that China has an enormous appetite to diversity from USD over-reliance.

The Ringgit

The “risk on” signs are compelling which should benefit commodity and oil-linked currencies driven by a Fed pause and easing the US -Chian trade tensions.

The Fed pause walks back a lot of long USD positions that were built around the Fed policy normalisation vs BNM neutral stance. And if we get shot in the arm from a definitive Trade war truce, we could see the MYR extend gains to USDMYR 4.05 in a heartbeat.

Over next week traders will put greater emphasis on the dovish Fed vs the already baked in downside risk for the Ringgit.

One of the big key for the Ringgit next week is that Malaysia will soon issue Samurai bond(A samurai bond is a yen-denominated bond issued in Tokyo by the non-Japanese entity). While adding money to the government coffers is always a welcome boost the Samurai issue will remind investors of the fear of a credit rating downgrade, which has been looming over Malaysia capital markets, has left the picture.

Market conviction has improved to guardedly positive from negative territory which is a huge improvement. Provided trade war detente continues to move forward constructively, oil prices extend into bullish territory ( WTI + $ 55) and the Fed has truly paused we could see the USD/MYR trade to 4.075 and possibly extend below 4.05.

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