FX strategy: euro, pound push up as dollar offered on risk appetite return

The euro and Sterling were on the front foot on Tuesday, with cable stretching its advance to near a 2-week peak. Whilst the dollar was offered on a broad return of risk appetite, the euro also seemed to get some lift from the ECB, which is giving signals it’s ready to do even more.

Bank of France Governor Francois Villeroy de Galhau, a key member of the ECB’s Governing Council, told a conference on Monday that there is room for the central bank to act ‘rapidly and powerfully’.

Speaking to CNBC subsequently on Tuesday he said there is a need to be flexible with the current round of coronavirus asset purchases, suggesting that the ECB shouldn’t need to bound to capital keys that dictate how many government bonds it can purchase based on the size of each country’s economy.

The German Constitutional Court ruling earlier this month expressly stated that the capital key was essential to avoid distorting markets, so this could fuel further disquiet among those hawks who have been set against the ECB’s bond buying.

Meanwhile, we await to see whether the EU states can agree a fiscal response, with Denmark, Austria, Sweden and the Netherlands countering the Franc-German proposal for a €500bn bailout fund to be financed by the European Commission issuing bonds. The so-called ‘Frugal Four’ want only a short-term emergency scheme financed by loans.

EURUSD chart analysis

Prices are in recovery mode following a rejection of the lows yesterday at 1.0870. EURUSD extended to 1.09730 – with this high formed we can look to recover the 1.1020, the May 1st peak which could open up a breakout from the two-month range.

GBPUSD chart analysis

Meanwhile GBPUSD pushed up to a 2-week high at 1.23 after the 1.2160 support area held and we saw a push through the 1.2250 channel. A break to the upside calls for a return to 1.25/1.26 and the Apr double top highs. Failure to sustain the move beyond 1.23 calls for retest of the 1.2160 support and thence the swing low at 1.2080 comes back into focus.

Fed and ECB previews

First up, the Federal Reserve kicks off its two-day meeting today (Apr 28th) and whilst there is always scope for a surprise, we would not anticipate any change to the policy outlook, chiefly because the Fed is no longer waiting for scheduled policy meetings but is operating in ‘real-time’.  

 

There is virtually zero chance the Fed will remove any accommodation until the threat of Covid-19 has passed. But if anyone thinks the FOMC will go negative they are in for a shock – there is no appetite to cut rates any lower and go below the zero lower bound. Europe and Japan are hardly shining examples of that policy working. Jay Powel has already ruled it out, though that in itself is not a reason it won’t happen.

 

The Fed has already thrown the kitchen sink at the market and the economy, announcing unlimited bond buying  – QE4ever – and expansion of corporate debt buying to include junk. There is not a huge amount left for the Fed could realistically do, save buying stocks outright and taking rates negative, neither or which are palatable or likely in the near term, partly because the efforts so far have calmed market stress and prevented further dislocation.  

 

Markets will be looking for any signal from Jay Powell about how the Fed views the rebound – is he still confident of a bounce back in the second half? Formal projections are not due until June. 

 

It’s a fairly similar story for the European Central Bank (ECB). We think they will not commit to any further policy moves right now but will likely signal they are ready to do so by June. The Pandemic Emergency Purchase Programme (PEPP) QE lift has been initiated with an overall envelope of €750bn, and it appears likely to be expanded by an additional €500bn in the next month or three. 

 

Two key things will be the focus. First the communication needs to be crystal clear – we don’t want a repeat of the spreads widening fiasco from Christine Lagarde. Since then the ECB has been absolutely on-point. The ECB must be continue to show to the market that it stands four-square behind the functioning of markets, the single currency and supporting the EZ economy. And on this, I would anticipate a lot of the focus in the press conference to be on the European Council efforts on a bailout package. Watch the BTPs-Bund spreads for how the market views the ECB performance. 

 

EURUSD – as noted on Monday, speculators are dialling up their net long bets on the euro. The Commitment of Traders (COT) from the US Commodity Futures Trading Commission showed euro net longs rose to 87.2k contracts in the week to Apr 21st, the most since May 2017. Traders turned long at the end of March and have been adding to positions since then. We saw a shift like this in speculative EUR positioning in 2017 it preceded a 15% rally in EURUSD.

Upbeat start for European equities

No Monday morning blues for equities after the Bank of Japan announced more stimulus and we’ve some good news from Italy at last and even Deutsche Bank has reported a profit.

The BOJ laid down the gauntlet to the Federal Reserve and European Central Bank, who both meet later this week, by raising its package of support. The BOJ will now buy unlimited government bonds (JGBs), catching up with market expectations, and is increasing how much corporate and commercial paper it buys.

The moved gave an upbeat tone to trading in Asia. Tokyo rose 2.7% whilst Hong Kong rose 2%. European shares followed suit with the FTSE 100 opening above 5800 and the DAX reclaiming 10,500. Indices remain in consolidation phase and risk rolling over as momentum fades, but the news today is quite positive. US futures are positive after closing higher on Friday but falling over the course of the week.

Italian and German yield spreads came in after S&P didn’t downgrade Italian debt. This is good news for the ECB, which may well increase its pandemic asset purchase programme by €500bn this week.

On the Covid-19 front, Italy is also making progress and will relax lockdown measures from May 4th. Spain has reported its lowest daily death toll in a month. Boris Johnson is back to work.

Meanwhile Deutsche Bank reported exceeded expectations on profits and revenues in the first quarter but warned on loan defaults as a result of Covid-19. Investors shrugged off the warning and shares rose 7%, sending European banking stocks higher by around 3%. It’s a very big week for earnings releases – HSBC, BP, Shell, Amazon, Alphabet, Facebook and the rest.

Oil has taken a turn lower as fears of approaching ‘tank tops’ imminently. The June WTI contract is starting to show stress, gapping lower at the open last night and trending lower to approach $14. Brent is –5% or so at $23.50. Goldman Sachs estimates global storage capacity will be reached in just three weeks, which would require a shut-in of 20% of global output. That would chime with what we’ve been tracking and suggests OPEC+ cuts of 9.7m are – as anticipated – not nearly enough. It will make the Brent front-month contract liable to volatility, though perhaps not quite what we have seen in WTI. Baker Hughes says oil rigs in the US were down 60 in the week to Apr 24th to 378, the fewest active since 2016 and well under half the number this time a year ago.

In FX, speculators are dialling up their net long bets on the euro. The Commitment of Traders (COT) from the US Commodity Futures Trading Commission shows euro net longs rose to 87.2k contracts in the week to Apr 21st, the most since May 2017. Traders turned long at the end of March and have been adding to positions since. The last time a move like this occurred in EUR positioning in 2017 it preceded a 15% rally in EURUSD.

Meanwhile, speculators net short bets on the USD are now at the highest in two years as traders call the top in the dollar. Traders habitually call the top in the dollar and get it wrong. Various actions taken by the Fed to improve liquidity and an easing in the market panic we saw in March has helped, but the dollar remains the preferred safe harbour in times of market stress.

EURUSD – the last time specs turned this long was in May 2017.

DAX – rangebound, approaching top Bollinger band.

UK inflation beats, EZ construction sinks

Cable moved to session highs before handing it all back after a forecast-beating inflation print that takes some of the pressure off the Bank of England to cut rates. Inflation hit 1.8% in January, rising from 1.3% in December and ahead of the 1.6% forecast. There is a lot of noise here and indeed all this week with a slew of UK data, none of which – except the PMIs on Friday – that tell us enough yet about the direction of the economy.

The bulk of the increase came from higher petrol prices and airfares falling less than they did a year before. It was the first increase in the pace of inflation for six months and backs up the MPC’s decision not to cut rates last month. However, this is not just an inflation question. We need to see whether the positive survey data in the aftermath of the Tory election win is maintained with PMIs this Friday offering a big test for sterling bulls. And we must see whether positive sentiment – soft data – translates into more positive hard data by way of GDP. Inflation remains below target but the BoE does not seem unduly concerned by this. What the Jan decision makes clear is that the majority of the MPC would prefer to keep their power dry vis-à-vis inflation as long as economic activity does not start to stagnate too much.  

GBPUSD pushed up towards 1.3030 but the rally fizzled with little in the numbers to really indicate a change in direction by the BoE. The pair has now retraced the move, heading back through 1.30 again to 1.2980. The gravitational pull of this level will require some significant gear change in either the data, or more likely Brexit trade deal talks, to shake off. Range-bound.

Meanwhile disappointing Eurozone data keeps rolling in. Following the industrial production shocker, and German ZEW sentiment survey, the latest is a dismal construction output print, which came in at –3.7% in December year-on-year from +1.4% previously. Terrible but only underscoring the sluggishness in the EZ economy. Both EURUSD and EURGBP are vulnerable to further downside in the near-term although both pairs have eased off their lows of the day.  

Elsewhere, bond markets are not joining the risk rally party today with yields sliding to session lows. That’ll be because of, er, monetary policy expectations, which is exactly what’s lifting markets in Europe to fresh all-time highs. Gold is reacting to this yield play as it should, shooting up to $1609.80 to within a whisker of the recent multi-year highs at $1611.  USDJPY is pushing higher, breaking the near-term resistance at the Jan swing high at 110.20 to trade at session highs. With this level cleared we can now look to the May peak at 110.70 before a move back to the big 50% retracement at 112.70. 

RBA expected to hold policy, but for how long?

Up until a couple of weeks ago markets were pricing in strong odds that the Reserve Bank of Australia would cut the Official Cash Rate to 0.50% from 0.75%.

All that changed after December’s labour market data was released. Unemployment dropped for a second consecutive month, hitting the lowest levels since April 2019 at 5.1%. Unemployment decreased by 13,000, largely thanks to a 29,000 increase in the number of workers employed part-time.

While still leaving the jobless rate significantly above 4.5% – a level be RBA believes will prompt an acceleration in wage growth – the unexpectedly strong report saw markets slashing odds of further easing in February.

The Australian dollar snapped a 5-day downtrend against the US dollar, spiking to test 0.6880, but the selloff quickly resumed as the focus returned to the viral outbreak in China.

AUD/USD chart, MARKETSX, 16.00 GMT, January 29th, 2020

Bets on easing in February drop after jobs data

According to ASX 30 day interbank cash rate futures contracts for February 2020, the probability of a cut has fallen from 56% as of January 16th to 30% by January 28th.

Westpac also noted that the strong data lowered the odds of further accommodation, with chief economist Bill Evans stating:

“Prior to the release of the surprisingly strong December Employment Report we had expected the cuts to be timed for February and June.”

“Given this strength and the significance of the labour market in the mind of the RBA, we have consequently decided to push out our forecast for two further cash rate cuts from February and June to April and August 2020.”

However, Westpac believes that the recent strength in the labour market won’t last, supporting the call for further easing. Evans explained:

“The importance of the April date is that the Board will have seen another print of the national accounts for the December quarter which is likely to highlight the soft growth environment while we expect that the surprise improvement in the unemployment rate will be unravelling.”

Consensus: cuts are still coming

The general consensus is that the RBA will have to ease further as the year progresses. While some parts of the economy are stabilising, particularly the property market (which has of course been helped by 75 basis points worth of easing during 2019), others are flagging.

Construction and consumer confidence are weak, and expectations for retail sales over the Christmas period are low. Construction output has declined for five straight quarters, while consumer confidence has erased most of the rebound recorded after hitting the lowest levels since mid-2015 in October.

There are also questions over the impact of the bushfires upon monetary policy. It is believed that, despite the economic damage estimated to be in the region of $100 billion, the bushfires will have only a short-term impact and therefore may not have any bearing on monetary policy. However, if it serves to further knock consumer confidence, it could be a contributing factor in any decision to ease policy.

The Chinese coronavirus outbreak is another large unknown; Australia trades heavily with China, so talk of factory shutdowns and a reduction in consumption could hurt the Australian economy.

What will the guidance say?

It can take 12 to 18 months for the impact of monetary policy adjustments to be fully known, so the RBA is likely to claim next month that it needs more time to assess the effects of 2019’s trifecta of cuts.

But how much time? Some analysts, like Evans at Westpac, believe the RBA will tee up a cut for April, while others think we may have to wait until the second half of the year to see further easing.

Sterling off highs despite PMI Boris Bounce

Sterling rallied into the PMI release but eased back a touch despite the survey figures being a little better than expected. GBPUSD broke the Wed peak at 1.31524 but came back down to under 12.3140 following – we are talking very, very minor moves here let’s be clear. Bulls are struggling to hold 1.3150 but they may well rally the troops and if reclaimed later today then we could look for a push towards 1.31690, the Jan 8th high, to open up from upside. Looks very well supported at 1.31 for now.

Yes the PMIs bounced back – with the Composite PMI rising to a 16-month peak at 52.4 from 49.3 in December – but this was entirely to be expected and reflects businesses letting out a collective sigh of relief after the Conservative Party victory in the December election as it heralded an end to the paralysis over Brexit and killed off the prospect of a radical Jeremy Corbyn-led government. Businesses ought to be a damn sight more confident as a result – it does mean that we’re out of the woods . Ultimately, whilst clearly diminishing the case for a cut, I don’t see these PMI surveys as being enough to prevent the Bank from cutting – I think they have already decided on this.

The harder data we’ve seen has been a lot less auspicious. GDP is weak and inflation has come off sharply, albeit the base effect is at play. Inflation rose just 1.3% against 1.5% in November. Core CPI was a meagre +1.4% last month, vs 1.7% expected. CPI inflation rates are at their lowest since 2016. It is worth remembering that this data is backward looking and before the Tory victory, but this only adds to the sense that the BoE has a narrow window of opportunity to cut this month, based on the premise that it feels like it got a little behind the curve globally last year as its hands were tied by Brexit.

The Bank doesn’t want to get behind the curve of market expectations, and is seeking to get a jump on markets whilst still teeing up the cut. It would be following the Fed’s playbook in cutting early in order to prevent a downturn. This is the key thing to remember – the Bank does not want to let a weaker economy fester.  

Whilst there may be lots of arguments against a cut, the coordinated dovish commentary from about half of the MPC over the last fortnight appears no accident. Harder data has turned notably softer and the BoE doesn’t want to risk allowing weakness to become entrenched.

ECB Preview: Strategy review in focus

  • Guidance seen unchanged
  • Inflation pick up
  • EURUSD weaker, long-term uptrend barely holds

No major changes, review in focus

The European Central Bank meeting on Thursday is likely to produce some clues about future monetary policy direction, but nothing concrete. The focus will be on the strategy review as it gets underway, which is buying new boss Christine Lagarde some breathing space. She’s only in her second press conference so expect some further honing of communication skills. 

The focus of the strategy review this week will revolve around its scope and the timescale. Of particular interest of course is the mandate relative to price stability and its inflation target. We’d expect this ultimately to result in the ECB taking a more symmetrical approach to inflation. 

Given there are no fresh economic projections and the focus is on the review, guidance is not expected to alter materially. As I say, the review is a good way to buy time as the ECB remains in a holding pattern due to a) Lagarde’s own inexperience, b) the uncertainty over the economic outlook for the EZ and the world, and c) since Draghi embarked on an aggressive cut and QE restart as his parting gift, allowing Lagarde plenty of time to sit on her hands. 

The easing in trade tensions lately should support the ECB’s December view that ‘the risks surrounding the euro area growth outlook … remain tilted to the downside but are ‘somewhat less pronounced’. Of course whether the trade deal holds is another matter – but I would anticipate the signing of the phase one agreement to be reflected in Lagarde’s commentary.

However, ultimately with the market still expecting further easing from the ECB this year, we will need a clearer handle on where Lagarde is steering this ship soon enough.

Challenges: economy still spluttering 

Flash PMIs due on Friday will tell us more. A mild pick-up is seen, with the latest ZEW numbers showing a glimmer of hope, but the EZ is far from out of the woods. German growth has slowed to a six-year low. Green shoots seem few and far between. Even the UK (despite Brexit, if you care to add as an adjunct) is seen growing faster than any G7 European nation in 2020. Signs that PMIs are basing, but little recovery seen – the bottoming phase may linger.  

Inflation picked up in December, with annual headline inflation rising to a six-month high of 1.3%. Core inflation was steady from Nov at 1.3% also. Welcome news for the ECB, particularly the hawks on the council, but it’s too early to call this a material or sustained uptick. Lagarde is sure to be asked about this. Her answer will be of particular interest – and offering some scope for EURUSD volatility – as it could signal whether the ECB is about to raise its inflation forecasts.

EURU/USD: Uptrend in jeopardy 

The broad uptrend since last September remains in force, but near-term downtrend threatens to snap the bulls’ resolve. Following the swing high at the end of last year at 1.12390, the pair has trended lower to break down below the 50-day and 200-day moving averages, as well as snap the trend support around 1.1090 (red line). Key MA support on the 100-day line, which was touched and reject on Dec 20th is formed around 1.1070. The low of Dec 20th also offers some horizontal support close to this level at 1.10660. So, this region will be a key test as we get into the ECB meeting and the flash PMIs on Friday. 

Lunch wrap: bulls limp, pound holds losses

Bulls have been a bit limp, stumbling out of the gate with their tails up but quickly getting bogged down on decidedly heavy going turf.  European markets perked up early but ran out of steam heading towards lunch. Having initially popped higher the Euro Stoxx 600 turned negative, sliding 0.3%, while the DAX edged 0.4% lower before paring losses a touch. The FTSE 100 held onto slim gains as sterling softened as the odds shortened considerably on the Bank of England cutting interest rates this month.

Chinese trade delegation is said to have left Beijing, on their way to Washington to sign phase one deal.

GBPUSD is softer, beating a retreat under 1.30 as markets aggressively reprice for a BoE rate cut this month following comments from rate setter Vlieghe and weak eco data (See earlier note, BoE: Stitch in time saves 9). EURUSD has been steady at 1.112 but USDJPY is firming with the pair crossing key resistance around the 200-week moving average around 109.70/80, to hit 109.9  

Crude oil is steady at $59 with little in the way of catalysts. Lots on the wires from Saudi Arabia on production but long and short is they are looking to extend output curbs agreement come March. Likewise, gold held the line around $1550 but is showing no real direction. 

US pre-mkts 

US stock futures indicate a solid open with the Dow eyeing a c70pt gain, having earlier looked at a triple-digit gain when the cash equity market opens. 

Lululemon shares rose c2% pre-mkt after it said raised its guidance, saying Q4 revenues would be between $1.37bn and $1.38bn, from previous guidance of $1.32bn to $1.33bn. 

Alphabet is on the verge of joining the $1 trillion market cap club. Shares were a little higher pre-mkt after Evercore ISI raised their price target on the stock to $1600 from $1350.  

Tesla bears are throwing in the towel. Shares were up 2% pre-mkt to $488 after Oppenheimer raised its price target to a Street high $612 from $385. Microsoft price target raised to $180 from $155 at Credit Suisse, whilst Apple’s price target was raised to $375 from $300 at Davidson. 

Sterling finds support at 23.6% Fib level

Sterling has found support at the 23.6% retracement of the rally from the Sep 2019 lows to the post-election euphoria highs. GBPUSD pushed through 1.32 at one stage on Tuesday, moving firmly clear from the support level at 1.3140.

The move erases much of the declines from last Thursday and Friday and may signal a recovery that bulls can use to base for a push north of 1.32 again. 50-day moving average support appears at 1.30 and is rising.

The rally ran out of legs at the 50% retracement of the decline from the Dec highs to the recent lows around 1.3220. Corresponding to this move, it’s the 38.2% retracement at 1.3140 that offers support near term. Double Fib support looks powerful.

Sterling trips on new cliff edge, Unilever dips

Sterling tripped over its heels as Boris Johnson is looking to legislate for Britain to leave the EU fully in Dec 2020 with or without a trade deal. That means no possible way to extend the transition period. I must confess to believing he wouldn’t need to be so drastic, that a large majority offered the flexibility yet strength a government craves in deal making. This sets up another cliff-edge and could create yet more months of uncertainty for investors just when we thought all was squared away.

GBPUSD plunged to the 1.3240 area before paring losses to trade around 1.3260. Elsewhere in FX, the Australian dollar was softer as the RBA signalled it’s looking at further cuts, possibly in February. AUDUSD traded at 0.68580 as of send time, its weakest since last Wednesday. EURUSD steady at 1.1140. Signs in the dollar index that it’s rolling over.

Equity markets remain buoyant but we are seeing some softness in Europe on the open. We’ve had a really good run for the last two or three sessions so it’s a good time for a pause and consolidate around this level. In particular we need the FTSE 100 to hold this 7500 level.

The S&P 500 made a fresh record top, though Boeing’s travails left the Dow glittering a little less. Europe’s Stoxx 600 made a record high. Asia took the cue to make 8-month highs overnight. 

Equities

Unilever shares fell 5% in early trade as it warns that sales growth is more meagre than expected. Management expects underlying sales growth for 2019 to be slightly below its guidance of the lower half of its 3-5% multi-year range. 

The company puts it down to economic malaise in South Asia, with the CEO on the conference call saying it’s down largely to India’s rural markets, although these are expected to bounce back in the second half of next year. Meanwhile management says trading conditions in West Africa remain difficult. Developed markets continue to be challenging, but management did point to ‘early signs’ of improvement in North America as it picks up ice cream market share.

Earnings, margin and cash are not expected to be impacted. Weaker sales growth is a problem, but lately we have been encouraged that earnings growth is being driven by price rather than volume. However, the problem for fast-moving consumer goods giants with the big brand names is that consumers have a lot more choice and are more discerning than ever.

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