Key Themes at Play in the Forex Market
- Notwithstanding a round of sell-off into the month and quarter end, the USD ended on a strong footing last week, especially against the likes of the yen, Swiss franc, euro or pound. Less so against the oceanic currencies or the Canadian dollar. The latter has been boosted on the prospects of a NAFTA deal.
- One aspect worth highlighting is the commanding bullish outside week on the DXY last week. While factors such as the month andquarter end flows were at play, price action is king and it definitely feels like a major victory by the bulls. The recovery in appeal by the USD comes on the heels of an FOMC last week that reinforced the notion of a hawkish stance short term. However, for the USD to further anchor its price action advantage, we now need to see a few scenarios play out. These include risk aversion conditions which lead to safe-haven bids, a renewed steepening of the US curve, orfurther pressure in Italian yields, and that alone by default may see the continuation of last week’s theme where market participants resort to the attractiveness of the USD as an alternative option. Also, one must keep a close eye on the 10-year US yield and whether or not acceptance continues to be found at 3%, also key this week.
- The situation in Italy remains very fluid, as Italy stick to its 2.4% budget deficit to GDP target. The country is flooded with high debt and this episode of defiance against the European Union won’t help. As a result, the Italian 10-year bond yield, which has acted as a barometer, spiked to 3.12% last Friday, the highest levels since May, when fears of the populist government coming to power were at its peak. October 15th is the time to submit the budget to the European Union for review. One should expect both sides to play hardball but overall, the month of October is off to a rough start for the Euro and the prospects are not looking any better as long as Italy dominates the headlines. Keep an eye on the Italian yield as the ultimate gauge for the risks emanating from Italy. Also notice that unlike last Thursday, on Friday we saw Italian stocks sold aggressively, and that’s going to weight further on the negative sentiment in the Euro, as its evidence of a loss in confidence towards Italy. Remember, one of the extreme yet conceivable scenarios is for the populist government of Italy to threaten theEU with an exit of the EUR. I personally don’t see that happening at all, but the volatility it may cause could be quite damaging for the outlook of the Euro short term, even if that’s a debate for another time altogether.
- The Canadian dollar has received a trifecta of positive inputs all at once. An upbeat Canadian GDP reading last Friday, which came at 0.2% vs 0.1% exp, coupled with USD selling flows during the month and quarter end led to intense selling. The straw that broke the camel’s back as Asia open on Monday is the emergence of new reports that seem to suggest the US and Canada are very close to a NAFTA deal. If the latter is confirmed, the Canadian Dollar should see a wave of buying interest throughout the week, with the usual initial retracement as short-term momentum trader take profits, leading up to a temporary removal of liquidity, before the real money steps in to keep riding the trend.
- A headline over the weekend by Fed’s Williams, which in a way has been the member endorsing the most the concept of neutral rates, confirmed that the Fed is moving away from utilizing neutral rates as a communication strategy. Williams said neutral rates is less relevant as policy normalizes. This is very much in line with Fed’s Powell position to simply adapt to economic data, and it somehow vindicates that the Fed can’t come to an agreement where the short term neutral setting stands.
- Over the weekend, we saw the Chinese PMI figures missing out expectations. Both the Caixin and official headlines came on the soft side and as Caixin notes, after 15 months of expansion, export orders fell the fastest in over two years, suggesting U.S. tariffs are starting to take a toll on the economy’. Personally, I think we shouldn’t forget that even if US sanctions start to bite the Chinese, a lower Yuan has an offsetting effect. USD/CNY broke above sept range. Overall damage from the trade conflict on China’s economy much less than 0.5% of GDP, even if the policy is not loosened again.
- It’s worth highlighting the incredible resilience by the Sterling even as the negative headlines around Brexit keep pouring in. What this means is that if some progress is achieved or at least the perception of it, even if eventually carries little substance, the Sterling looks set to benefit. The positive headlines have been consistently giving buyers a greater bang for their buck, which has led to speculators recently bailing out of their perma bear view as the most recent COT illustrates. Back to the negative headlines, late last week, we learned that UK PM May is losing support from her own cabinet and that essentially makes her option of a no-deal brexit one teetering to collapse. As a reminder, that’s one card May can still play to threaten the EU in case, as it’s expected, the EU rejects the chequers proposal. May keeps saying that a no deal l is better than a bad deal” and that remains, as said, her only plan B as the convoluted state of the Brexit negotiations stand. Volatility in the Sterling is set to be dependent on a brexit headline by headline basis but at the same time, from this week, the focus will too be shifting towards the Tory party conference, which comes at a time of growing dispute between UK PM May and Boris Johnson.
- Looking ahead, the key events for this week include: German retail sales, UK manuf (today) and services pmi, US ISM manuf (also today) and non-manuf PMI, Australia’s RBA policy decision and Australian retail sales, two speeches by Fed’s Powell, and the monthly job reports by the US and Canada. Don’t forget, the Chinese markets are closed the whole week.