Safe haven appeal key to dollar’s revival
Swiss International Financial Brokerage Co
Aretreat through Friday left the US Dollar with limited gains on the week. Nevertheless, the Greenback will head into the new trading week with tangible gains against the Euro and Pound – two of its most liquid counterparts. To revive momentum behind the currency waylaid by nearly 10 months of congestion we need clarity on a key theme. Though the Dollar is still imbued with the characteristics of a last resort safe haven, that role isn’t revived until we hit extreme levels of risk aversion. Short of such that speculative degree, sentiment will be a slow but persistent burden. The ready and prevailing fundamentals winds will once again reside in rate speculation.
Through this past week, interest rate expectations have shown a little resurgence – though emphasis needs to be on ‘a little’. Fed Fund futures lifted the implied probability of a hike in six months from zero to 24 percent and the two-year Treasury yield advanced from four-month lows. Meanwhile, overnight swaps are still not showing the follow up to December’s liftoff over the coming year. And, the contrast to the FOMC’s forecast from that meeting (100 basis points — or 4 standard hikes — in 2016) is exceptionally large regardless of what market metric we use. In the convergence of these views, we are likely to find the Dollar’s next move.
The fundamental updates through the past week that speak to rate speculation trimmed both the market’s exaggerated pessimism and the FOMC’s inflated optimism. Taking the top off hawkish ambitions, we had a well-known hawk (San Francisco President John Williams) notably soften his tone and the FOMC minutes reinforce concerns. A trimmed view of inflation pressure from the group’s evaluation takes the most productive wind out of the sails of the tightening bias, but it was the reiteration of global concerns that look more like appeasement for investors that are over-exposed on the market.
Alternatively, the January consumer inflation report (CPI) is slowly shoring up the most unstable corner of the central bank’s mandate. While the headline reading only ticked higher on an annual basis to 1.4 percent, the core figure would also nudge up to 2.2 percent – further above the 2.0 percent target. These figures increasingly highlight commodity prices as the limiting factor for this facet of policy making. That group also happens to be incredibly volatile, meaning they could rise much faster than policy officials usually act.
Establishing a firm read on the forecast of price pressures ahead will be key for Fed official and Dollar traders alike. Through the coming week, there are a few important statistics to mark. The Conference Board’s US consumer confidence survey offers up a wage expectations component which is about as close to the virtuous wellspring of infla- tion that we can come. There are also measures of employment, inflation and economic forecasts worth keeping tabs on. Friday’s PCE deflator will carry more of an air of authority though. The Fed’s favored inflation gauge is still well below pace on both a headline and core basis.
Outside of the influence of Fed timing, Dollar traders should also keep track of the other major central banks as well as the G-20 meeting Thursday and Friday. ECB officials have threatened to escalate their accommodative effort while the BoJ is seen as being pressured to upgrade as its currency gains and economy stumbles. China and the PBoC are unpredictable but cracks are showing again in their effort at control. As for the G-20, it is one of the few outlets to answer the major concerns listed by world authorities.
Dominating the headlines for the foreseeable future in the UK will be the prospect of a ‘Brexit,’ or a British exit from the European Union. This has been over three years in the making. In 2013, the Prime Minster of the UK, Mr. David Cameron, pledged that should conservatives take a parliamentary majority in the 2015 elections, the UK government would negotiate more favorable terms for continued EU-membership before holding a referendum in which residents of the UK could vote on the matter. Conservatives took a majority in those elections and Mr. Cameron reiterated his pledge to hold an ‘in-out’ referendum before the end of 2017, and here we are.
Mr. Cameron and the British government are in the process of trying to negotiate those more favorable terms right now. The UK government wants concessions for continued membership in the EU and it makes sense, given the unique geographic disposition and economic influence for/of the United Kingdom; but member states of the European Union are balking at the idea of giving special treatment to any individual member, arguing that it negates the veracity of the union to allow for special treatment to any individual nation.
Once those more favorable terms are agreed upon (or even if they’re not), a referendum will be held in which the British citizens get to vote on the matter and this is likely where the major volatility will emanate from. For right now we’re merely discerning probabilities of continued membership based upon the negotiations taking place between the UK and European governments.
There are numerous issues at bay. Key of which is the topic of migration, which is somewhat of a sore spot in Europe right now. The UK has 3 million EU nationals in-country with roughly 2/3rds employed, while having only 1.3 million expats living in the EU. While this deviation of approximately 1.7 million people might sound small when compared to American or Chinese populations, we have to keep in mind that this constitutes approximately 2.65% of the UK population.
This topic is being addressed in the negotiations through an extension of in-work benefits to European migrants, referred to as the ‘emergency brake.’ Mr. Cameron wants a four-year ban (which isn’t even really a full ban, as benefits would be incrementally earned based on taxes paid), and much of Europe considers this discrimination against European nationals. Given the current migrant crisis raging throughout Europe, threatening the very same Schengen agreement that provides the glue of the union, thinking this through on the part of the UK is probably pretty timely. Former Soviet Countries of Poland, Hungary and the Czech Republic all argue that this type of ban could be further applied to Germany and Austria, and if that happens, what is the point of having a union at all?
On the other hand, the trade ties between the UK and EU are significant and severing or ‘modifying’ this relationship could have a negative impact. Roughly 45% of exports and 53% of UK imports transact with Europe. Roughly 3.4 million British jobs are supported by this industry; and for a country with a population of 64.1 million people, again, this is significant; approximately 5.3% of the British population.
In the near-term, this could be GBP positive as fears of a Brexit on the back of stalled negotiations had driven the Sterling lower. Longer-term will depend on British voters. For now, we take a bullish forecast on GBP moving into next week, and will review as more information on negotiations and a potential Brexit become available.
The Japanese Yen finished the week marginally higher despite a clear disappointment in economic growth figures, and two key themes will likely determine whether the JPY resumes its impressive year-to-date uptrend. First up: will the Japanese Nikkei 225 and US S&P 500 continue their very recent recovery?
The USD/JPY and other JPY exchange rates remain strongly correlated to the performance of global equities, and recent signs of life in global equities suggest that recent fear-driven USD/JPY tumbles could at least slow. A relatively quiet week of global economic event risk could allow markets to continue to stabilize, and this in of itself could keep the Yen lower.
The major exception is an upcoming G20 economic summit on February 25; all eyes turn to the world’s top leaders and central bank governors as they respond to global financial market turmoil. Concrete actions to counteract asset price volatility seems especially unlikely, but some claim that excessive exchange rate swings could elicit a strong policy response from the Group of 20. Any references to joint efforts to stabilize FX rates could spark major market moves.
The second key theme for the Yen is likewise straightforward: will Bank of Japan monetary policy and the Japanese government’s actions be enough to protect against further Yen gains? Large speculative traders have rushed into bets on further JPY gains (USD/JPY losses), and this in itself tells us many expect that answer will be “no”. And indeed the controversial move to enact negative interest rates has not been enough to forestall a substantial Yen rally—it now trades six percent above where it stood before the January, 29 BOJ decision.
Impressive Yen appreciation leaves momentum firmly in its favor, and however much they try Japanese officials seem unlikely to reverse the trend. Absent a substantive improvement in global financial market conditions and/ or aggressive rhetoric from the upcoming G20 meeting, we think the USD/JPY will trade to further lows through the coming week of trading.
The preliminary 4Q U.S. Gross Domestic Product (GDP) report may produce near-term headwinds for the greenback and spur a near-term decline in USD/CAD should the data print show a meaningful downward revision in the growth rate. Even though the advance print highlighted an annualized 0.7% rate of growth for the last three-months of 2015, the updated figures are expected to show the economy growing a marginal 0.4%, and the ongoing slack in private-sector activity may encourage the Federal Open Market Committee (FOMC) to endorse a wait-and-see approach at the March 16 interest rate decision amid the uncertainty clouding the economic outlook.
With Fed Vice-Chair Stanley Fischer, Governor Jerome Powell and Governor Lael Brainard on tap to speak next week, the fresh batch of central bank rhetoric may also spur increased volatility in the exchange rate as market participants speculate the timing of the next rate-hike. However, the central banks officials may refrain from saying anything new as the FOMC is scheduled to release its updated forecasts next month, and a more of the same from the Fed officials may produce a limited market reaction ahead of the GDP report as USD/CAD retains the range-bound price action from earlier this month.
In turn, the failed attempt to test the opening monthly range may keep USD/CAD confined within 1.3638 to 1.4102 as market participants continue to weigh the next move by the FOMC, but the near-term holding pattern in the exchange rate may give way should the key event risks spark a material shift in the monetary policy outlook.
Gold prices snapped a 4-week winning streak this week with the precious metal off 0.84% to trade at 1227 ahead of the New York close on Friday. The pullback comes amid a rebound in broader equity markets U.S. Dollar Index staging a near-term recovery on the back of a sharp two-week sell-off earlier in the month. Nevertheless, bullion is on course to set its best yearly start in more than 30 as weakness in global equity markets and plummeting commodity prices continue to fuel demand for the perceived safety of the yellow metal.
Looking ahead to next week, traders will be closely eyeing U.S. housing data, durable goods orders and the second read on 4Q GDP. Of particular interest will be the Core Personal Consumption Expenditure (PCE), the Fed’s preferred gauge of inflation. With central banks around the world now facing the prospects of negative interest rates (something Japan, Denmark, Sweden & Switzerland have already done), a weak read on US inflation would further dampen expectations for a Fed rate hike this year and in turn gold is likely to remain well supported as investors seek alternative stores of wealth.
Aside from the economic docket, be on the lookout for a host of Fed speakers next week with Vice Chair Stanley Fisher, St Louis President James Bullard, Atlanta President Dennis Lockhart and San Francisco President John Williams slated for speeches next week. Traders will be attempting to ascertain the timing & willingness of the central bank (or if there even is a willingness) to further normalize monetary policy amid the ongoing turmoil in broader financial markets.