FX Focus: The new safe haven and sterling’s next move

Relentless dollar hampers commodities

The current focus in the market away from geopolitics is clearly the out-performance of the US (real) economy, which for now continues to push US rates and yields into the recent highs. We are however, now seeing some hesitation which suggests the market (and indeed the economy) may not be ready for the next leg higher which would see the benchmark US 10 year note (see chart below) taking out the 3.00-3.05% level.

As has been suggested by a number of fund managers, this would likely spur demand into fixed income and with the equity markets having already shown signs of vertigo, we are in a precarious position which can only point to some movement into the safe havens.

Source: TradingView        Past performance is not a guide to future performance

At the present time, the market is choosing the US dollar (USD) as a safe haven rather than the traditional Japanese yen (JPY) and Swiss franc (CHF), but we expect this dynamic to turn tail at some point as, at the start of the year, the US twin deficits were the key focal point behind heavy selling of the greenback, but the data perspective has changed this in the short term.

We still feel the currency moves in the FX market are a function of a corrective process, which naturally aids the likes of the European Central Bank (ECB) who have consistently warned of the impact on the exchange rate – if only in an indirect manner. We have seen what effect this has had on EU inflation, with the core rate struggling to move above the 1% mark – nb, we pulled back and away from this level in the latest readings last week.

Inflation data to consider later this week, preceded by the PPI data which will put an interesting angle on the numbers. As many have mentioned in the past, there is good inflation and bad, and if the latter burns into base-line profits, then it is surely not a matter of raising rates (in the US) in order to temper this.

We have had the same dynamic in the UK where higher CPI levels have brought the hawkish voices at the Bank of England’s (BoE) Monetary Policy Committee to the fore, but with the recent run of data, the odds for a rate hike – at the BoE – have dropped from circa 95% to under 10%.

As such, we have to factor in the impact of US CPI on wages and consumption, so despite higher levels which the Fed described as symmetric to their targets, they seem more inclined to weather any overshoot given the added burden rate hikes will put on the US householders.

We are now starting to evaluate the extent of the rebound in the USD (based on such a short time frame) and, while we see room for further gains later in the year, some level of moderation is likely across the board. Given the above risks, we expect the upside in both USD/JPY and USD/CHF to start to fade at the recent highs. 110.00 was always going to be a tough nut to crack, and, as we saw last week, the move above the psychological figure level was small and very brief. But, for now, the pullback has run into support ahead of the mid 108.00’s.

Below here, 108.20-107.90 should also be a sticking point, so long as stocks can stabilise and Treasury yields hold up. It is a little more harder to forecast on the CHF rate given the widely acknowledged Swiss National Bank operations in the market, and this has been clearly highlighted by the steady levels in EUR/CHF amid broader euro (EUR) weakness, which in turn has helped propel the USD/CHF rate above parity in the meantime.

Source: TradingView        Past performance is not a guide to future performance

Losses in EUR/USD highlighted the swiftness in the USD move more so than the above, but here we have to take into account the overcrowded longs which are starting to unravel, and this is likely to continue unless we get some material pick up, which looks unlikely given the price action seen.

We look to be headed back to 1.1800 here, which, under the circumstances, may seem a modest call, but we have to consider the ground already covered, as well as the impact current levels will have to the data out of Europe.

Germany has suffered in terms of exports and orders, so it is not just a case of the affect EUR levels have on inflation, so we expect the move below 1.2000 (against the USD) will see some of this headwind fade, and perhaps turn into a tailwind as we move under (if we do that is ) 1.1800.

Source: TradingView                   Past performance is not a guide to future performance

For GBP, the realisation is finally setting in. For all the optimism over the Brexit talks, there is still plenty of ground to cover, and looking past the key issue of the Irish border, the trade talks themselves will be fraught with disagreements which at the very least put pressure on the timetable – March 2019 getting ever closer!

Beyond this, the MPC’s hawkish leanings have been somewhat easily accepted by the market, which has sent the Cable rate to new post-Brexit highs of 1.4375, but in a manor which seems to have been oblivious to the potential impact that the Brexit process has already had on the economy.

While there are many aspects to this, we will focus on labour and productivity, and if higher wages are a result of skilled labour shortages, then economic growth – which has already disappointed this year, is set to lag its peers for some years to come, and we expect this will limit any GBP gains we may see from any positive developments in the EU talks.

We maintain uncertainty is the overriding factor here, we are open to developments leading to a more amenable outcome for both the EU and the UK, given the prospect of a lose-lose situation which naturally both sides want to avoid.

Does this spell a GBP return to the lows – unlikely, but we do not rule out an eventual move to 1.3000 in Cable, while the range of 0.8650-0.9050 is still very much in play and we see little at this stage which can break this with any significance.

Source: TradingView                   Past performance is not a guide to future performance

This brings us to the other key trade talks in process, and that of NAFTA, which look much closer to resolution than seemed the case some months ago.

While the Mexican representatives have been a little more balanced in their outlook this week, both the US and Canadian camps are more hopeful on a deal sooner rather than later, with progress made on the rules of origin on Autos – so we are led to believe.

None of this seems to be helping the Canadian dollar (CAD) to stand out in any way, and against the USD, we have seen a pretty strong and unrelenting bid in the mid 1.2800’s sending the pair to what seems to be an intended test on 1.3000 again.

This also seems to be ignoring the rate perspective given the Bank of Canada (BoC) has raised three times since last summer, but their more cautious tone going forward is having more resonance at the present time despite the underlying data showing healthy economic performance as higher capacity utilisation suggests.

Feb GDP rose 0.4%, but off the back of a small drop (-0.1%) in Jan, but noted a very strong Ivey PMI number last week which rose from sub 60.0 to 70.0 – also ignored. We expect the CAD to come back with some force after this latest upturn, which looks to be USD based to a larger degree.

Source: TradingView                   Past performance is not a guide to future performance

This leads us onto the Aussie dollar (AUD) and a lesser degree New Zealand dollar (NZD), where the impact on commodities is effectively a double whammy for AUD/USD in particular.

We have seen industrial metals prices trying to base out and push north again, but this is being consistently challenged by the resurgent USD, which is now up around 4% in the last 4-6 weeks.

The Reserve Bank of Australia are now widely expected to stay on hold until the middle of 20149 – as are the Reserve Bank of New Zealand – but given healthy exports, albeit with concerns over demand from China, job growth and healthy growth forecasts over coming years, the knives are out for the Australian economy.

Despite near term price action, we see value in the near term in the mid 0.7400’s, but would not be surprised by an over-extension towards 0.7400 if not a little under. NZD/USD targets on the downside lie at 0.6900, but as we saw today (again), budget surpluses have been better than expected, so internal finances and low household debt are plus points for investors away from significant liquidity issues which can impact severely during times of risk off.

Source: TradingView                   Past performance is not a guide to future performance

Base metals have started the week on the front foot as traders and investors look to be betting on good news that China’s growth is robust. Zinc in particular has had a great start rising 1.5%, while copper looks to have made $3.00/lb a base level.

Since September last year copper has found itself in a consolidation area between $2.78 – 3.29/lb and in recent times the strong USD seems to be curtailing and possible appreciation. After posting a very bearish candle three weeks ago, downside momentum had not managed to materialise and we found prices manage to hover around the psychological $3.00lb area.

My play here would be to keep an eye on the data from China this week and look for any retracement in the recent USD strength for a move higher.

Next week, one of China’s top economic officials will visit Washington to continue trade talks after it was said that the last round failed due to Trump’s long list of demands. If talks are positive, we may see a strong surge in metals due to some easing of protectionism.

Source: TradingView                   Past performance is not a guide to future performance

Gold has been looking very bearish on the weekly chart (see below), last week’s candle bounced off the $1,300/oz psychological support, but until the persistent USD strength leaved the markets its hard to see how we could get a retracement.

There is a clear consolidation pattern where price currently sits and, if we see a conclusive close below $1,300/oz, my view would stay bearish at least to a test of the trendline shown in the chart.

Source: TradingView                  Past performance is not a guide to future performance

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