Category Archives: Global FX

H2 2017: Something old, something new, something revisited

As we head towards the second half of 2017 and the one-year anniversary of the UK referendum on EU membership, many themes which have pre-occupied financial markets in the past 12 months are likely to continue dominating headlines.

These include Donald Trump’s US presidency and its longevity, merits and scope for tax reforms and infrastructural spending, Brexit negotiations which officially started on 19th June and the resilience of the ongoing recovery in global GDP growth.

Global GDP growth rose modestly in Q1 2017 to around 3.12% year-on-year from 3.06% in Q4 2016 and a multi-year low of 2.8% yoy in Q2 2016, according to my estimates.

But the global manufacturing PMI averaged 52.7 in April-May, down slightly from 52.9 in Q1 2017, suggesting global GDP growth may not have accelerated further in Q2. This could in turn, at the margin, delay or temper policy rate hikes and/or unwinding of QE programs.

Non-Japan Asian currencies have in the past month been even more stable than in the preceding month, in line with my expectations, but a more pronounced policy change – particularly in China – remains a possibility.

Other themes, such as the timing and magnitude of higher policy rates in developed economies and falling international oil prices, have recently come into clearer focus and will likely be of central importance in H2.

For the UK, I am sticking to my view that a 25bp policy rate hike this year is still a low probability event and I see little chance of an August hike.

The uncertainty over the MPC’s interest rate path and the government’s stance on Brexit complicate any forecast of Sterling near and medium-term but I continue to see the risks biased towards further depreciation.

In France, the hype surrounding Emmanuel Macron’s presidential and legislative election victories is already giving way to whether, when and how smoothly the LREM-MoDem rainbow government can push through its reformist agenda.

Finally, while most European elections are now thankfully behind us, European financial markets are likely to attach great importance to the outcome of Germany’s general election on 24th September.

Conversely, the burning topic of rising European nationalism and future of the eurozone/EU has lost traction following recent presidential and/or legislative elections in France, the UK, Netherlands and Austria. Read more

GBP – Hawkish Surprise Presents Selling Opportunity

Financial markets in the past week have had to contend with two UK-borne shocks: The ruling Conservative party’s loss of a majority in last Thursday’s general election and three MPC members voting in favour of a 25bp hike at today’s Bank of England policy meeting.

Sterling, which sold off sharply after the election result, has recovered this week and the more hawkish than expected MPC meeting has given the modest rally further impetus.

Confirmation of an alliance between the Conservatives and DUP, which is expected in coming days, may see Sterling strengthen further, particularly with markets digesting the implications of two further MPC members calling for higher rates.

This would, in my view, present an opportunity to short Sterling versus the dollar or euro, for five reasons:

  1. Conservative-DUP marriage is not one of choice and arguably not even one of convenience;
  2. Question of which type of Brexit is unlikely to be answered any time soon;
  3. MPC has become more hawkish but rate hike still unlikely near-term;
  4. Concerns over falling wages are at the heart of a UK economy which remains at best soft; and
  5. EU/eurozone growth slowly picking up and European nationalism on the back foot

Read more

UK General Election Scenario Analysis Impact on Policy, Theresa May and Sterling

In less than 24 hours the British electorate will start voting in the election for the 650-seat House of Commons with the result expected early in the morning of Friday 9th June.

While the last general election was only held two years ago, there is arguably as much if not more at stake this time round than in May 2015.

Opinion polls still point to the ruling Conservatives winning a record-high 44% of the national vote ahead of the opposition Labour Party, but polling agencies which in the past have misestimated true voting intentions still display great inconsistency.

Ultimately it is the number of seats which British parties command which matters and the UK’s first-past-the-post electoral system makes it difficult to predict.

You Gov’s constituency-specific model forecasts the Conservatives winning only 304 seats as a result of a record number of “wasted” votes, a 26-seat loss and well short of both a working and absolute majority. Labour would increase its seat numbers from 229 to 266.

This would result in a hung parliament and either a coalition or minority government.

My own model points to the Conservatives winning around 360 seats (55.4% of total) and Labour 212 seats. Admittedly, this prediction is based on a number of assumptions, namely the net share of votes which Conservatives gain from other parties as well as voter turnout.

Whether the Conservatives significantly improve on their current 330 seats or fail to secure a parliamentary majority remains a tough call and there is an almost infinite number of possible outcomes.

However, I have narrowed down in Figure 10 the number of seats the Conservatives could win to eight possible scenarios, in each case assessing i) Their probability; ii) Their numerical impact on the Conservatives’ majority (or lack thereof); and iii) The risk of opposition parties and/or Conservative backbenchers high-jacking the policy agenda.

Figure 11 assesses for each of the eight scenarios their likely impact on iv) Theresa May’s standing within the Conservative Party and v) Sterling and currency volatility.

Regardless of what happens tomorrow, two events beyond British shores also scheduled for 8th June – the ECB’s policy meeting and Former FBI Director James Comey’s testimony to the Senate Intelligence Committee – will conceivably exacerbate Sterling volatility.
Read more

Asian currencies keeping their head in a world losing its own

Financial markets have had much to digest in recent weeks and the calendar for the remainder of May and June is anything but light, with the Fed and ECB holding key policy meetings and legislative elections in both the UK and France.

Nevertheless, most major currencies have either been flat or appreciated against a slowly weakening Dollar in the past month, with only the high yielding Brazilian Real, Russian Rouble and Indian Rupee (INR) and Australian Dollar weakening by 0.5% or more.

Conversely, European currencies have outperformed, with in particular the Euro Nominal Effective Exchange Rate (NEER) up about 3.4% since mid-April – in line with my constructive near-term euro outlook.

Non-Japan Asian (NJA) NEERs have seen only very modest moves in the past month. Bar the Malaysian Ringgit NEER which is up about 1.1% and the INR NEER which is down about 1.7%, NJA NEERs have appreciated or depreciated by less than 1%.

The question is whether this relative calm in NJA currency markets is likely to become more entrenched or whether FX flows and/or central bank policy are likely to fuel greater volatility or see some currencies adopting a clearer direction.

As a starting point, I would again note that the pace of depreciation and appreciation in most NJA currencies tends to be confined to reasonably narrow ranges.

While this is partly a by-product of seasonal patterns in current account balances and the ebbs and flows in capital migrations, it also arguably reflects central banks’ desire and scope to control their currencies.

At this juncture I would conclude that few central banks – including the MAS and PBoC – face overwhelming economic reasons to markedly alter the paths of their currencies via the bias of FX intervention and/or interest rate policy.

There is however perhaps a case for Bank Negara Malaysia to favour a weaker or at least stable Ringgit NEER which has appreciated about 2.7% since mid-April.

Read more

Politics suspected of interfering with economics and markets

In the US, political intrigue, seemingly lifted straight out of a John Le Carré novel, has reached a crescendo and there are now multiple investigations running concurrently.

If we assume these investigations will run over weeks/months, the question is whether and to what extent this political backdrop is likely to impact financial markets, US government policy-making, the US and global economy and Federal Reserve monetary policy.

US equities have corrected lower, volatility has spiked and markets are seemingly ignoring positive data surprises

It has all been rather orderly so far but it is difficult to see how at this juncture, with major policy initiatives likely kicked down the road, US equities can launch another meaningful rally. If anything big data misses are likely to further pressure stocks. 

The Dollar’s performance has been mixed in the past month, posting its biggest loss against the euro in line with the fundamentally bullish euro view I expressed in December and April.

Capital inflows into the eurozone allied to a 2% of GDP current account surplus, a pick-up in economic activity and receding political risks following the French presidential elections are likely to extend the euro’s current rally near-term.

However, the ECB’s stance on its quantitative easing program will be key in shaping the euro’s medium-term path.

US economic indicators paint a blurry picture while solid global GDP growth is seemingly struggling to make further gains.

The Fed and US rates market have the unenviable task of making sense of these macro trends and a quickly changing political landscape.

The apolitical Fed will of course stay above the political fray, even if markets do not with pricing for the probability of a 25bp hike at the 14th June policy meeting continuing to oscillate between 60% and 75%.

My core scenario is that the Fed will hike rates only once more in 2017 although I acknowledge that this is not a high conviction call. The market seems still on the fence, pricing in a further 32bp of hikes in the remainder of the year.
Read more

The A-Team had a plan, the British government has a nebulous goal

The UK has its own eclectic A-Team led by Prime Minister May, tasked with getting the UK out of the EU and securing a more beneficial relationship with trading partners.

Theresa May, David Davis, Liam Fox and Boris Johnson have been dealt a tough hand and unsurprisingly have so far refused to reveal the intricate details of their daring plan.

But voters, businesses, parliament, EU leaders and foreign trading partners are pressing the government to elaborate on its tactics and strategies for Brexit.

There was break-through of sorts on 7th December, with the 650 members of the House of Commons (MPs) voting overwhelmingly to allow the government to trigger Article 50 by end-March in exchange for publishing the details of its Brexit plan.

But the devil is in the detail – or lack thereof. This parliamentary vote is not binding and the government has only agreed in the vaguest of terms to publish its plan for Brexit.

If MPs receive the plan late in the game and/or it is insufficiently detailed and assuming the Supreme Court rules that government has no prerogative to trigger Article 50, parliament may decide to delay or even scupper the process by which Article 50 is triggered.

Moreover, this likely vote in the House of Commons and House of Lords may well be only one of multiple votes which parliament has to hold between now and the approval of a final treaty between the UK and the EU.

In addition to these possible parliamentary hurdles, the government may also have to navigate a number of pending legal cases.

Some of these parliamentary votes may not take place and these legal actions may fail. There is certainly scope for further compromise between Theresa May’s government and parliament.

But the risk is that this reputation-sapping cat-and-mouse game extends beyond March, in turn making it far more difficult to predict the end-outcome – which ranges from the UK reverting to WTO rules (the “hardest” form of Brexit) to the UK staying in the EU.

Given the uncertain path which British executive and legislative bodies will take to reach a difficult-to-predict outcome at an unidentifiable point in the future, forecasting Sterling remains fraught with difficulty.

In this context I would expect Sterling to continue lacking direction near-term, particularly as the FX market has, it would seem, already priced out the more negative scenarios for the UK economy. Mixed UK data may not provide Sterling with much direction either way.

Read more

What will Asian central banks do?

Global risk appetite nudges higher as “West Wing” versus “Yes Minister” plays out

Cinemagoers have in recent years been treated to the daft yet watchable Alien vs Predator and Superman vs Batman movie franchises but nothing compares to the Frankenstein-esque beasts of US and UK politics which have been thrust on voters both sides of the pond – a tragi-comic blend of “the West Wing” versus “Yes Minister” with more twists and sub-plots than a John le Carré novel. Read more

Barbarians at the Sterling Gate

Sterling’s collapse overnight has eclipsed somewhat tepid US labour market data.

The net result is that the Sterling NEER has weakened a further 2% since yesterday and is now down about 20% since November 2015.

While trading desks will have a far better grasp of how risk management systems and liquidity contributed to sterling’s drop, recent political decisions and UK data clearly helped set the scene and will leave the currency vulnerable going forward.

Theresa May’s government and EU leaders have in recent weeks successively dismantled the raft of hopeful predictions which had helped Sterling stabilise over the summer.

Moreover, there is growing evidence that a more competitive Sterling has not translated into materially stronger UK industrial output or exports, with the UK’s trade deficit in goods and services widening in recent months

I would reiterate my view, expressed in early July, that the uncertainty associated with the UK’s possible exit from the EU will likely continue to weigh on the UK economy and currency.

This week’s fall in sterling, if anything, has reinforced my view that the Bank of England will maintain a dovish rhetoric but for now refrain from cutting its policy rate to zero or expanding its current QE program.

Moreover I would not expect the BoE to intervene in the FX market to support sterling at this stage. Read more

Federal Reserve – the Father Christmas of central banks

Thursday’s Fed policy meeting contained few major surprises, even if the divide amongst FOMC members has received much attention.

The bottom line is that 14 out of the 17 FOMC members, and at a minimum 7 of the 10 voting members, estimate that at least one 25bp rate hike before year-end would be appropriate.

Should the Fed hike in December – currently my core scenario – this almost unprecedented glacial pace of hikes would be in line with my January forecast of only 1-2 hikes in 2016.

The Fed’s accompanying statement and Yellen’s press conference were, if anything, reasonably upbeat. There were no direct allusions to the dollar, property, equity and bond markets or to global factors, with some justification (for now at least).

The Fed’s two main concerns are squarely centred on sub-target inflation and areas of weakness in the labour market.

It will thus be paying particular attention (and so should markets) to evidence of slack in the US labour market, with the unemployment rate becoming a less useful measure per se of labour market strength and potential wage/price pressures, in my view.

The Fed is clearly giving weight to the historically low neutral Fed funds rate. Even so FOMC members may have to further tone down their 2017-2018 estimates of the appropriate policy rate in relation to realistic (if still a little optimistic) economic forecasts.

Financial markets’ reaction has so far been mostly text-book: a jump in market pricing for a December hike to 16bp, a bull-flattening of the US yield curve, a slightly weaker dollar, a rally in EM and commodity currencies and stronger global equities.

But now comes the hard part. Volatility in Fed fund futures is likely to remain fluid in coming weeks, with financial markets increasingly sensitive to key US data, particularly on inflation and labour markets, speeches by FOMC members and presidential opinion polls.

Should Clinton win the US elections, US data improve and the Fed hike in December, I would expect the dollar to end the year stronger, EM currencies and global equities to struggle to hold onto post-US election gains and major currencies to underperform.

The more problematic scenario for the Fed (and its credibility) is one whereby Donald Trump wins and/or US economic activity slows down.  

This would likely cause a sharp sell-off in global equities while safe-haven assets (e.g. gold, Swiss Franc) would outperform the dollar and in particular EM currencies. Moreover, these moves could struggle to reverse even if the Fed decided to pause in December. Read more

Sticking to forecasts: Fed summer hike, Dollar hat-trick still on the cards, Modestly weaker EM currencies, UK to stay in EU and Sterling to appreciate

The Federal Reserve’s minutes of its 27th April policy meeting released last week set the tone for a possible June or July rate hike. On balance, recent US and global data are unlikely to have fundamentally changed the Federal Reserve’s view that a summer hike may be appropriate.

This is in line with my long-held forecast that the Federal Reserve would likely hike once or twice this year, with the first hike in June. I recently updated my forecast to a July hike as it gives the Fed more time to assess US and global data and the result of the UK referendum on 23rd June. The risk is that the very threat of a hike derails financial markets sufficiently for the Federal Reserve to postpone its second-hike-in-a-decade to later this year. Read more

1 2