It’s finally spring time in Scandinavia and the sun is shining (occasionally) again. Our longs in AUD/NZD have been catapulted higher, as Asian key figures have shown signs of recovery. Could an Asian rebound also save the ECB from complete misery?
Table 1: Our current convictions
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Green shoots in Asia
Asian PMIs offered signs of green shoots over the past week, with Chinese, Indonesian, Japanese, Korean and Taiwanese PMIs all rising. Why do we bring this up? Because Asian PMIs may point the way towards higher inflation expectations in the Euro-area (Fly inflation dragon, fly!)
Chart 1: If Asian PMIs can rise, so may EUR inflation expectations
This would naturally be good news for the ECB, who has seen e.g. 5y5y inflation expectations weaken precipitously this year. As long as growth keeps weakening, so will the market’s and ECB’s convictions that inflation will rise sustainably towards the target. But if global trade stabilises on the back of Chinese & Fed stimulus, Euro-area PMIs might stabilise too.
Chart 2: Industrial metals supporting green shoots narrative
Industrial metals also appear to be supporting a green shoots-interpretation.
Chart 3: Sweden PMI indicates a turn-around in EA PMI this summer
Sweden’s PMI also topped expectations in March, and since the Swedish PMI and its details have been leading the way for EA PMI over the past 2.5 years, we figure it’s worth mentioning that Sweden’s PMI indicates a stabilisation or even pick-up in EA growth this summer (a move by Trump to implement hefty tariffs on EU might stomp this green shoot back into the ground, however).
EURUSD “box” says buy, as does liquidity
Our latest weekly contained the below chart, which brought us plenty of client discussions. We also penned a piece on USD FX hedging costs, which we hope you have read by now: USD hedging costs may have peaked.
Chart 4: EUR/USD vs the box
The recent dovish repricing of the Fed does indicate EUR/USD upside – similar to its signal in 2016. In 2015/2016, EUR/USD also rose, but only temporarily. One important difference this time around is US/EA liquidity. In late 2016, liquidity momentum moved to the USD’s advantage, while in 2019 it will likely do the opposite.
Chart 5: At the end of 2016, liquidity favoured the downside in EUR/USD– not so today!
What’s more, the recent plunge in USD hedging costs on the back of Libor-OIS narrowing and the dovish repricing of the Fed, might also indicate USD downside. For some reason, it seems to take 2-3 months before changes to FX hedging costs impact spot developments.
Chart 6: Repricing of USD hedging costs could augur DXY downside
Is Trump Making America Great Again?
For all that, we wouldn’t be us without mentioning some “smoulder in the joybox”, as the Swedish saying goes. The USD has been well-behaved indeed recently. Perhaps this merely reflects i) strong data (ISM) being helpful for the notion of US outperformance, ii) presence of e.g. Brexit or trade war hedges (It’s also hard to see EA fixed income being markedly repriced with a hard Brexit threat still looming), or iii) (perhaps) signs of scarcity of bank reserves.
Chart 7: ISM model off by 3 points on average since 2017
On the ISM, let us note that one old model of ours have been underestimating ISM by on average 3.2 points since President Trump was inaugurated in 2017. In March, the model was off by 3.3 units. It could be that models such as these do not fully capture the impact from President Trump’s policies, such as his moves to deregulate the nation.
Chart 8: ISM model error vs regulation being perceived as the biggest problem
In the NFIB small business survey, respondents are asked about their “biggest problems”. After being increasingly dissatisfied with government regulation and red tape under President Obama, the election of Trump brought a trend change. The ISM model error we outlined above tracks falling dissatisfaction with regulation and red tape. Maybe we and others are underestimating the positive effects on “animal spirits” in the US from deregulation? That would be good news for global growth.
Chart 9: Is less US liquidity pushing the EFFR rate higher?
The Fed has already signalled a stop to QT, but this will not prevent bank reserves / excess liquidity from dwindling somewhat further in coming months. As bank reserves have dwindled, mostly because of Fed’s QT, the Effective Fed Funds Rate (EFFR) has seemingly been pressured higher. At the end of March, it rose 3bps above the IOER rate – a new high during the cycle. It has fallen back to a somewhat more normal spread since then. That said, if the EFFR rate is pressured higher in coming months, it could be a sign of scarce bank reserves (USD-positive) which could eventually prompt a Fed response (a start of reinvestments or a repo facility).
Chart 10: Asian green shoots good news for AUD against NZD
The green shoots narrative has also been helpful for our AUDNZD long, and further upside would appear to be beckoning. One reason is the difference in positioning in AUD and NZD. Until very recently the market was net long NZD versus USD, while the AUD is basically almost the most hated G10 currency positioning wise still.
Domestic data differences also continue to support a further AUD/NZD rally. Relative surprises suggest that further 2.5% upside is in the pipe for the pair, and this relative domestic story should be extra fuelled by the budget proposal from Scott Morrison’s administration last week. Estimates from ANZ Research suggest that the proposed tax cuts and cash payments could boost household income by 0.8ppt in H2 2019 (should Morrison win the election in May).
Chart 11: Domestic data Australia versus New Zealand also supports a further rebound in AUD/NZD
In the meanwhile, our long EUR/NZD position finally broke out of the downtrend on the topside. On charts EUR/NZD looks set to catapult higher – especially given the still (too) optimistic positioning in the NZD.
Chart 12: EUR/NZD ready to explode higher? The pair broke two important resistance lines this week
Another Swedish inflation disaster?
Turning to Sweden, we expect an inflation reading a full 0.6pp below the Riksbank’s forecast, which should fuel expectations of a dovish response by the Riksbank later in April and lead to a robust bounce in EURSEK from the 10.35-10.40 area. CPIF has furthermore tended to disappoint the consensus in March, undershooting expectations six times (sometimes substantially), while topping expectations only three times and then only modestly.
Chart 13: Swedish inflation has often disappointed in March
While comments from Riksbank officials on the SEK and on inflation may be indicative of some kind of hawkish shift, as was the February MPR, one cannot rule out that the mix of lower inflation, downside risks to growth (on our forecast), falling inflation expectations and Deputy Governor Jansson back in action brings the Riksbank back to its panic room, worrying about de-anchoring of inflation expectations. That said, if the green shoots narrative has legs, our official estimates on Swedish growth and the SEK may be too downbeat. Maybe the record-weak SEK will boost Swedish exports more than expected, should global trade stabilise – or even pick up?
NOK: CPI-ATE looks peakish.. We continue to like short CAD/NOK
Norge’s Bank is not faced with the same kind of inflation issues as the Riksbank, as CPI-ATE runs substantially above target (2.6% vs 2.0%). Judging from the FX impulse, the February print at 2.6% looks like a “one-off”. Inflation will though likely just return to levels around 2% over the next 3-4 months, if the NOK impulse is any guide (it usually is).
CPI-ATE may look “peakish”, but it’s not an issue for Norges Bank – and markets are still only pricing 30-35% probability of a June hike (compared to Norges Banks +50% probability in the latest rate path).
Chart 14: Houston is calling CPI-ATE. Please return to earth
It though seems as if the NOK momentum is slightly exhausted, and we don’t see a big scope for levels lower than 9.55 or so in EUR/NOK (we would take profit on short EUR/NOK positions around that area).
But why is NOK not performing better, even as Norge’s Bank is the hawkish one out in G10-space?Just a few weeks back it was decided that the Norwegian Oil Fund should get rid of its holdings of foreign Gas/Oil stocks. What if that decision is a good proxy of the investment policy trend globally?
The foreign ownership of Norwegian Oil/Gas equities has been on retreat since early 2018 (roughly a drop of 35-40bn NOKs). Could it be that NOK is structurally hit by a lack of appetite for Oil/Gas equities from foreign investors – and is that the reason why NOK is not performing better despite having the “backing” of the most aggressive G10 central bank currently?
It’s tricky to judge, but NOK-positive market participants who fear such equity flows may be able to shield themselves via short CAD/NOK, which is how we’ve expressed our NOK long.
Chart 15: Foreign ownership of NOK oil/gas companies could be an issue for NOK (note reversed left hand scale)
CAD: BoC could be the next central bank to throw in the towel completely
On March 6th Bank of Canada wrote that the outlook “continues to warrant a policy rate that is below the neutral range” (2.5-3.5%) and Poloz basically reiterated that view this week but refrained from referring to the direction of the next move. In March, “the timing was uncertain on the next hike”. Omitting the directional phrase is probably a most obvious hint ahead of the April meeting.
Is Poloz and BoC about to throw in the towel? We tend to think so (and so does the market). The unemployment trend has now reached policy-pause territory in Canada (see chart 16), and therefore the Philips curve apologists within BoC may be ready to at least signal 50/50 probability for the direction of the policy rate at the meeting later in April or maybe even highlight downside risks to the 50/50 view (remember RBNZ just recently).
Chart 16: BoC to admit to the downside risks to the policy rate later in April?
House price developments also suggest that CAD is far from being the best in class amongst the commodity currencies. CAD has basically NEVER picked up (versus USD) with house price trends as worrisome as currently.
Chart 17: House prices suggest even higher USD/CAD (note the reversed left hand scale)
GBP: Those suggesting a long Brexit extension don’t understand game theory
Theresa is doomed. That was the headline of our GBP analysis back in November-2018, when we wrote that “There is no majority in favour of anything in the House of Commons, meaning that it is ultimately very hard to imagine any progress being made without a shakeup of the current composition of mandates. New elections are eventually unavoidable.” Our view from then is basically 100% intact..
From a game-theoretical viewpoint it is still more than difficult to imagine a solution that untangles the Gordian knot. Jeremy Corbyn needs to have a different view from that of Theresa May, if he wants to conquer Downing Street after the next election, while Theresa May needs a solution that keeps DUP (and most Conservatives) happy, otherwise the government is dead. For May this implies leaving EU without a backstop, but with a deal.
Those aims have so far proven mutually exclusive, and what is even worse is that both May and Corbyn stand to lose from the deadlock (look at their approval ratings, the Brits hate both of them), even though they both act rational in terms of securing personal goals. This is almost a perfect prisoner’s dilemma, as neither May nor Corbyn have the incentives to back a decision that supports the common good.
Those suggesting a long extension probably don’t understand this (including Donald Tusk), as it would be wiser to force the “prisoners” to take a decision by not allowing the deadline to be extended. We don’t consider a potential long prolongation of the deadline a GBP positive scenario, as nothing will happen in the meanwhile. Low visibility, no investments and poor key figures – you name it.
The market may though decide to interpret a long extension as another sign that a “no-deal” cannot happen. The no deal risks are though already mostly, if not almost fully, priced out of markets (see chart 18).