Guest post by Nordea Macro team

All the sudden three Fed officials in a row sounded downbeat on the global macro picture. What is up? Risks are on the upside for EUR/USD, as we interpret recent events as signs that the dollar-o-meter is starting to turn cold.

Table 1: Our current list of convictions

Before we enact in more esoteric stuff, here are some FX quickies for those of tactical persuasion…

EUR/USD: The 1.13 anchor seems re-installed and with the sudden concerns about the global macro momentum amongst Fed members risks are on the upside for the pair. We though find it hard to get really excited about the upside in EUR/USD on this side of New Year.

EUR/SEK: A weak Swedish macro momentum, upcoming PPM-flows and uncertain Swedish politics all suggest upside risks to EUR/SEK in late November / early December. We stay long aiming for a break of 10.30 short-term.

EUR/NOK: Things are heating up for the NOK. Another break of 9.62 on the topside in EUR/NOK may lead to a rapid move towards 9.80. We are long EUR/NOK into year-end (and close our long NOK/SEK).

EUR/GBP: Theresa May is a “walking dead” in UK politics. Stay long EUR/GBP, as the options market skew now indicates topside risks all the way up to 0.91-0.92.

Oil down the slump

The recent oil price slump may carry with it plenty of interesting effects. First of which is that weaker oil prices may rewrite the outlook for headline inflation across the world. A simple CPI vs energy price chart suggests that US CPI might plunge to 1% next year. While not necessarily a game-changer for hawkish central banks such as the Fed, it does become tougher to tighten policy in the face of a significant inflation undershot. Especially if GDP growth also slows, as we think will be the case. Can the Fed keep hiking 25bp/quarter in such a milieu?

Chart 1: US CPI to collapse to 1% next year?

We’ve been arguing for some while that the delayed effects from earlier Fed tightening is ripe to show up in (weaker) US sentiment indicators. Now we wonder if it’s not also time to talk about the negative effects from oil prices on fixed investments. Oil prices at these levels suggest downside risks to US energy capex sometime in early 2019.

Chart 2: Oil price slump might be posing risks to US capex in 2019

Fed Powell has taken a small step in acknowledging that everything may not be all right across the globe, saying last Wednesday that “[y]ou still see solid growth, but you see growing signs of a bit of a slowdown. And it is concerning”. Fed’s Clarida also said on Friday that slowing global growth is relevant to the US outlook, as did Fed’s Kaplan. Moreover, in its latest loan officer survey the Fed also asked how respondents would respond “to a prolonged hypothetical moderate inversion of the yield curve”. They do seem to be getting worried. Our leading indicators suggests plenty of more downside for global growth, and hence the Fed’s worries may intensify…

We argued this summer that global weakness could trigger a Buenos Aires accord, in which the powers that be eventually try to undermine the dollar so as to help bring back global “reflation”. Recent Fed remarks point in this direction, as do Fed’s nervousness on the curve, while (maybe) progress on the trade war front (as in a cease-fire) could help do the trick. We interpret recent events as signs that the dollar-o-meter is starting to turn cold.

Weaker oil prices also prompt questions relating to petrodollar flows. Oil producers will have fewer excess dollars to invest as a result of getting paid less for their oil exports. Back in 2014-2015 some market participants argued that the lack of such flows could represent a Quantitative Tightening of sorts. While we prefer to use that specific moniker for the shrinking of central bank balance sheets or to the sterilisation of excess liquidity, smaller petrodollar flows can’t be good news for risky assets. If oil prices weaken further, we can’t rule out questions relating to public finances as well as pressures on dollar pegs in for instance the gulf. Long USDSAR forwards?

Chart 4: Saudi Arabia FX reserves vs oil prices – entering the bad quadrant?

SEK is doing fine – but should it?

Despite an inflation disappointment in Sweden in the past week, the SEK has fared well. Usually, when CPIF inflation disappoints by 0.2pp on the month it causes or coincides with a ~4% weakening of the trade-weighted SEK. On our forecast, the Riksbank could face inflation at 1.1% in roughly one year’s time as the fall in oil prices will bring deflationary consequences (assuming it persists).

Chart 5: The Riksbank could face inflation close to 1% next year

Moreover, the Swedish economic surprise index is firmly in negative territory. This usually indicates that a weaker SEK is on the cards.

Sell-on-rallies does however seem to be the name of the game for the EUR/SEK though. Why? Maybe market participants have concluded that the worse the outlook, the more likely a December hike becomes as it’s now or never!

Chart 6: Inflation disappointments usually trigger a weaker krona

Aside from weaker inflation, weaker macro, downside risks to domestic and global growth, the risks for greater volatility, risks (chances?) of a new election, ongoing QE-flows (while ECB is set to stop QE), an already well-priced December rate hike (16/25bp), we can add PPM flows as a SEK-negative in coming weeks. More often than not EUR/SEK tends to glide higher ahead of the start of the PPM flows (which we have assumed to be December 10 for now).

Chart 7: PPM flows a potential SEK-negative in late November / early December

NOK: In line to be hammered into year-end

Things are heating up for the NOK. A plummeting oil price and weakening consumption growth suddenly speaks in favour of a downwards revision of the rate path by Norges Bank in December. Just a month ago several factors argued in favour of a hawkish December path.

The list of potential NOK negatives has though started to evolve at a worrisome speed in recent weeks. The oil price now indicates as much as 10% downside risk for the NOK (see chart x), but the plummeting oil price is not the only factor weighing on the NOK short term (NOK: That time of the year)

Usually the structural liquidity tide turns right about now, meaning that the Norwegian commercial banking system will be flooded with cheap NOK liquidity over year-turn (this year at least 10bn NOK will flow in to the system from now and until New Year). Norge’s Bank allows cheap NOK liquidity to prevent a skyrocketing NIBOR/OIS spread due to an expensive USD over year-turn. This is an underappreciated driver of the sluggish December NOK seasonality (FX weekly: The debt ceiling is a USD celling)

Chart 8: Mind the gap. Oil now indicates 9-10% higher EUR/NOK (note reversed right axis)

The housing market is another renewed concern for the NOK. The inventory-to-sales ratio on the Norwegian housing market has rolled over recently, which usually hints at an upcoming weaker trend in the yearly house price trend. Currently the inventory-to-sales ratio points to roughly unchanged house prices year on year (compared to the current 2.5% pace).

Broader trends in EUR/NOK and Norwegian house prices usually go hand in hand (likely driven by an exogenous factor). The NOK has recently traded slightly on the expensive side of the housing market developments. A recoupling of trends should lead EUR/NOK higher.

We go long EUR/NOK and target at least a move to 9.80 before year-end but don’t rule out a move of >5% over the next 1-1.5 months.

Chart 9: EUR/NOK versus house prices. Trends broadly follow each other

GBP: Theresa is doomed

We opted to go long EUR/GBP last week, as we found the market optimism surrounding a Brexit deal too stretched. Here we are a week later with a “walking dead” Theresa May. To put it blunt, there is no whatsoever majority in favour of Mays Brexit draft deal (Week ahead: Will November the end of May?).

Judged by the risk reversal, EUR/GBP could be headed as high as 0.91-0.92, if the full risk of a new Brexiteer-PM is priced in. We stay long EUR/GBP, as we consider Theresa May doomed.

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 unavoidable.

Chart 10: EUR/GBP could be headed as high as 0.91-0.92, if Brexiteer risks are fully priced in

CAD: No pay, no cure

What’s up with Canadian wage growth? Despite a continuously dropping unemployment rate the monthly wage growth figure has disappointed for five straight months. The yearly wage growth now yields 1.9% compared to 4% in May. For the records, this is the exact opposite trend of what is recorded elsewhere across G10. It wouldn’t be a big issue for the BoC if it wasn’t for the fact that wage growth has been an increasingly important explanatory factor for core inflation trends over the past years. Wage growth + FX effects now suggest a Canadian core inflation at 1.2-1.3% early 2019.

This is bad news for Bank of Canada bulls, as Stephen Poloz seems more obsessed with wage inflation than the combo of falling equity prices, lukewarm growth perspectives and lower oil prices. “Higher volatility and a re-calibration of equity prices do not point to a gloomy economic outlook by any means – rather, they are welcome symptoms of normalization.” Poloz is probably the most “Borio’ed” central banker out there.

But, Poloz recently also said that: “Given our outlook for growth and inflation, the Bank’s policy rate will need to rise to a neutral stance to achieve our inflation target.” Inflation hence matters way more than equity or market volatility and with the recent renewed wage growth disappointments in mind, it is hard to see any “upside risks” to that statement.

Chart 11: Wage growth points to substantial downside risks for Canadian core inflation

As is the case with NOK, the list of downside risks to the CAD has emerged swiftly in recent weeks. Looking at EUR/CAD versus the Crude oil 1 month earlier it looks tempting to long EUR/CAD into-year end. We though opt for the long EUR/NOK bet for now but close our short AUD/CAD position, as a consequence of the increased CAD risk picture.

Chart 12: Mind the gap part 2. Oil points at much higher EUR/CAD

AUD: Too early for a rebound

It is still too early to expect a further rebound in the AUD (technically, an AUD/USD short looks compelling from just below 0.73).

The AUD has been a lagged “slave” of the fortunes of the Asian currencies for a while and while both AUD and NZD could prove to be solid bets versus the USD in case the wobblier Fed comments continue, we choose to bet on further AUD downside versus NZD.

Even in a reflationary comeback scenario, driven by a widespread undermined USD, we argue that NZD will outpace AUD due to squaring of the current positioning (NZD more hated than AUD by spec-accounts).

Chart 13: It is too early to expect an AUD comeback. It is a story for 2019.