That didn’t go according to plan and we are stopped out at 1.1187 in our EUR/USD longs. We see three reasons why we were wrongfooted in our USD view. Trump, growth and liquidity. Liquidity will work against the USD in May, but what about growth?
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That didn’t go as planned. We had hoped the 1.1187 level in EURUSD would hold, and that some green shoots would soon start to show up also in Euro-area data. Instead, the USD has been resurgent, causing plenty of technical damage both in EURUSD and the broader DXY index. We are hence stopped out of our EUR/USD short @ 1.1187 (and close our USD basket) but opt to hold on to our CAD/NOK shorts which could be seen as a less carry expensive medium-term proxy for higher EUR/USD.
We still hold relatively high hopes of Asian green shoot spill-overs on to e.g. the Australian and German economies and accordingly like to buy the dip in AUD/USD targeting 0.7225 (or pay front-end AUD rates. E.g. versus NZD rates). In Scandinavia we feel temped to go short NOK/SEK after the Riksbank killed the Krona again but have decided to save our ammunition another week or two.
Table 1: Our current convictions
Three reasons why the USD has been resurgent
We can identify three main reasons why we’ve been wrong-footed in our USD view: Trump, growth and liquidity. Trump threatened tariffs against EU this week. This could stomp out any green shoots in Europe and may be one reason causing PMIs and IFO to remain more depressed than we have expected, though timing is extremely uncertain.
Chart 1: US tax payments = an underappreciated driver of the strong USD?
Second, it could be that we have underappreciated the USD positive effect from the tighter USD liquidity owing to incoming US tax receipts. US households tax payments have comprised roughly 200bn worth of Quantitative Tightening since April 4. This is also likely one reason why the Effective Fed Funds Rate has been pushed higher over the IOER rate recently, and the situation might worsen due to the SOMA day on April 30 before USD liquidity becomes ampler in May (those of a very short-term nature could hold onto USD longs until after Apr 30).
Table 2: USD liquidity will shrink by 28.1bn on April 30 (table includes SOMA-days with a liquidity drop of more than 20bn USD)
Third, instead of signs that the rest of the world will gradually be picking up vs the US, growth-wise, economists are if anything now hiking US growth forecasts for 2019 while other growth forecasts are flat or being lowered (especially for the Euro-area). The better-than-expected US Q1 GDP figure underpins this idea for now.
Chart 2: US growth still outperforming, and few signs of ROW picking up as of now
Moving left in the dollar smile?
The dollar smile is a framework through which to understand the direction of the dollar. In the leftmost part of the smile, the US outperforms the rest of the world. The Fed is relatively hawkish, which reduces global USD liquidity. This is bad news for risk appetite but good news for the USD. In the rightmost part of the smile, global growth is slowing. Risk appetite weakens, USD liquidity becomes increasingly scarce. This is good news for safe-havens (USD, JPY, CHF). In the lowest part, global growth is more evenly distributed and robust, risk appetite is solid and global USD liquidity is rising because of improving global trade. This is bad news for the dollar but good news for riskier currencies.
Chart 3: The dollar smile – moving left, not down
We have lately been in the top-right part of the smile, but had hoped we would move towards a lower quadrant due to green shoots in China and eventually also a pick-up in the Euro-area. Alas, there are yet no clear signs that a weaker EUR is paving the way for improving Euro-area growth. We do still remain hopeful that we will see such signs in coming months, however.
Chart 4: Strong USD ought to weigh on ISM right about now
In the near term, the USD break-out could spell trouble for risky assets. If DXY is now resurgent, it could severely dent the revenue outlook for the S&P500, some 50% of its revenues does stem from abroad, after all. A stronger USD also potentially spells trouble for emerging market currencies, should the nascent rally have more legs. Volatility is furthermore at risk of picking up. Not since 2012 has the open interest been this short in VIX.
You should though don’t rule out that e.g. AUD and EUR could perform oddly decent during a volatility squeeze due to squaring of shorts in both vs. USD.
Chart 5: Spec accounts are super short VIX
Could Fed provide precautionistic cuts?
The USD is not without risks however, especially not in the week to come. We and others have been worrying that weak growth or tighter financial conditions (weaker equities) could prompt the Fed into cutting rates at some juncture. Recent remarks however indicate that the Fed could ease for even more reasons! Fed officials have started to talk up the prospects of cutting rates if inflation or inflation expectations weaken.
Fed officials have also talked about the Fed’s experiences in 1998. Back then, the Fed lowered rates by 50bp to keep growth humming along in face of risks due to the EM turmoil at the time… Precautionary cuts! Yes, we know precautionistic ain’t a word, but it could be! That the Fed helped build the dotcom bubble, which burst in 2000, is a fact now conveniently forgotten.
We suspect we will see weaker core PCE inflation next week – which could prompt further rate-cutting speculation, as could the next FOMC meeting. Maybe the below “fractal” shows the near-term way?
Chart 6: EUR/USD – bouncing about in a downtrend, bounce is due based on recent fractals
Riksbank – masters of accidental deceit
Dear Mr Ingves,
We have been trying (and failing) to write this letter to you for the last three months. But I keep getting stuck after the first two to three sentences. Then I sit for hours staring at the skyline outside my office window, trying to figure out how I could ever articulate the praise you deserve.
The Riksbank delivered an easing package broadly as we expected in April, but we were VERY uncertain about our call (Riksbank review: Going Japanese). The Riksbank is now at risk of becoming quite surprised by SEK weakness again this year, if the Riksbank’s QE flows was a driver of the surprising weakness since 2018 as we think. The Riksbank has decided to expand its balance sheet at a rapid pace once more starting in August, and its bond holdings will surpass the previous peak towards the end of 2020. This is one reason we have had EURSEK heading to 10.70-10.80 in our forecast.
Chart 7: Riksbank’s krona-killing machine starts up in August. Bond holdings will surpass the 2019 peak in late 2020
The intraday move in EUR/SEK on the day was among the 20 largest ones over the past decade, and the Riksbank clearly blames the market for the volatility. However, the fault lies clearly with the Riksbank.
Thou hypocrite, first cast out the beam out of thine own eye; and then shalt thou see clearly to cast out the mote out of thy brother’s eye. – Matthew 7:5
Market participants have been spoon-fed comments from various officials throughout Q1. They have downplayed recent low inflation outcomes as well as expressed surprise about the weak SEK, not to mention the hawkish tinge to the February meeting. As a result, it has been rational to doubt the Riksbank’s reaction function, even though in retrospect it was just a truckload of “fake news”. The Riksbank remains worst in class when it comes to its communication “strategies”.
EURSEK well above 12 in 2024?
As a thought experiment, we below assume that (i) the Riksbank means business with bringing inflation to the 2% target, (ii) underlying inflation in Sweden is equal to that of the Euro-area, (iii) EUR inflation swaps are telling the correct story for EA inflation and (iv) the import-content in Swedish CPI is ~30%. From this we can calculate the implied EURSEK levels needed to get Swedish inflation to the 2% target over time. It follows that EURSEK needs to rise ~3% per year and end up well above 12.00 in 2024. – contrary to the Riksbank’s (always-wrong) forecast of a decline towards ~9.60. This would suggest that the SEK can only gain if EA inflation expectations start to rise – bad news for the SEK…
Chart 8: EURSEK above 12 in 2024?
While clearly possible, we think it’s pure madness. What the Riksbank (& many others) are missing is, for instance that i) a weak SEK depresses household sentiment (empirically), ii) households save more (empirically), iii) a weak SEK hits profitability of already-stressed retailers & wholesalers, iv) the positive effects on local currency profits does not lead to as large of a rise in local capex (because of globalisation), and v) low rates make “financialization” easier, such as share buybacks, this means firms can deliver solid returns without taking economic risks. Zombification!
To us it’s far from clear that monetary stimulus is productive at this juncture, but as Hegel said, “the owl of Minerva spreads its wings only with the falling of the dusk”, meaning that the Riksbank will only realise what it has done on the eve of the next crisis.
NOK: The Riksbank is killing kroners
The Riksbank is not only killing the Krona, it also partly kills the Krone along its way. The NOK is hit by the “Swedish disease” and EUR/NOK now trades substantially above our earlier mentioned take-profit zone around 9.55 (for EUR/NOK shorts). The super-dovish Riksbank has probably wrongfooted a few NOK believers as well, as the market entered the Riksbank meeting very long NOKs (owing to the June hiking prospects from Norges Bank) – see chart 9.
Even as the divergence between Norway and Sweden seems to be growing by the minute these days, it is not completely out of this world to pour a little of the Riksbank dovishness on to the NOK. When the Riksbank cuts the long-end of the rate-path by 39 bps (and inaugurates a SEK receiver party) it will have a non-neglectable dovish bearing on the long end of the rate path from Norges Bank in June.
Chart 9: The market entered the Riksbank meeting more than 1 z-score long in NOKs
Despite the Krona-killing machine by the Riksbank we are actually mulling a tactical short position in NOK/SEK due to three reasons. I) Positioning is super long NOK – maybe in particular versus SEK, ii) the NOK dividend season will hit its peak during May (while the Swedish ends) and iii) Norwegian excess bank liquidity will increase rapidly from mid-May and over the summer owing to the budget deficit in Norway (tax refunds) – see chart 10.
If we are right on this bet on a tactical short in NOK/SEK over the course of May/June, it will likely wrongfoot a truck-load of investors.
Chart 10: NOK liquidity will increase rapidly in May/June. Usually it coincides with higher SEK/NOK
AUD: Yes, domestically it looks really bad, but we fancy buying the dip
Another week, another weak domestic data print from Australia. Calls for imminent rate cuts escalated quickly after last week’s CPI disappointment and almost all IBs now project 2 or 3 cuts from the RBA this year, while the market prices almost two full cuts for the remainder of 2019 (47 bps).
Judged from our favourite tracker of unemployment trends in Australia (see chart 11), the Philips curve apologists within the RBA will face a plethora of obstacles over the next 6 months, as unemployment could even pick up by as much as 1 ppt. So why on earth do we suggest buying AUD anyway? Due to non-domestic factors.
Chart 11: Australian vehicle sales point to higher unemployment in Australia
A weaker CPI trend in Australia is mostly a lagged consequence of the tighter financial conditions in Asia in 2018. The softer financial conditions seen throughout 2019 will likely soon spill-over to a re-increase in the Australian CPI. Easier conditions in Asia lead to a slight rebound in metal prices, which shows up in the domestic price pressure in Australia with a lag. We bet that the Q2 inflation report will be more upbeat than the Q1 report that we received last week. The highly certain influx of USD liquidity in May is another reason to expect AUD/USD to bounce higher within the 2019 range.
Chart 12: Asian financial conditions lead Australian CPI developments by roughly a quarter
Accordingly, we even see a decent risk/reward of a hawkish re-pricing of the RBA compared to the current gloomy outlook. Current financial conditions point to a stabilization of the 9×12 FRA 2-3 months from now. Yes, the RBA will likely cut once or twice this year, but that is already in the price. The best risk/reward is likely to pay the front now or else buy the AUD versus either NZD or USD.
Chart 13: Asian financial conditions point to a stabilization or even a slight pickup in 9X12 AUD FRA
CAD: BoC lags Fed and house prices are still struggling
Bank of Canada lags the Fed. This still seems to be the case, as Poloz followed in the footsteps of Powell and announced an “indefinite” pause in Canadian rate hikes. If the Fed should enact in precautionary cuts (as discussed in the section above), then BoC is still well too aggressively priced. On top of that USD/CAD has never dropped with house price trends as weak as current in Canada.
Chart 14: USD/CAD has NEVER dropped with as weak Canadian housing trends as currently (note the reversed left-hand axis)
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