Investors started to worry about the French election in Feb-17 – two months ahead of the vote. European parliamentary elections are up in May, while Spanish turbulence could start already next week. We opt for a more defensive short USD basket.
Table 1: Our current convictions
When could market participants start to care about the EU parliamentary elections?
In early 2018 we noted that no one cared about the Italian parliamentary election, but at the same time people were focusing quite a bit on a possible impeachment of President Trump. While the Italian parliamentary election in March did not cause investors to care much it, when it stood clear that the League and the Five Star Movement formed government they suddenly had to care quite a bit. While there are several political hurdles that must be passed before we get there (US debt ceiling, US shutdown, China/US trade negotiations, Brexit votes), we nonetheless wanted to remind clients about the European parliamentary elections. While the election might not prompt any market focus at all, investors might worry that a bad showing by establishment parties could make “needed” reforms less likely, possibly prompting doubts on the long-term viability of the EUR.
Judging by e.g. Japanese portfolio flows, investors started to worry about the French presidential election in February of 2017 – roughly two months ahead of the April-May votes. This indicates investors might want to front-run such a European Parliamentary worry in March. While the Italian parliamentary election of 2018 prompted no pre-worries at all, there was a ketchup effect in May of that year – as it stood clear that the League and the Five Star Movement were likely to form government.
While this data-set is limited it suggests market participants could start to pay attention to the EU parliamentary election in March, though we suspect the Brexit situation will need to be resolved first. Even before that the Spanish budget may be blocked by the Catalan PDeCAT party next week.Interestingly, the budget vote coincides with the beginning of the trials of 18 former Catalan leaders in the Spanish supreme court (Maybe one should care a little about Spain as well?). We book profit in our long EUR/GBP as a consequence.
Chart 1: Market participants could start to worry about the EU election in March
A big SOMA day is coming up on February 15. USD43.5bn of bonds and notes mature on the Fed’s balance sheet, and the Fed will allow excess liquidity to shrink by 23.3bn that day. Whether we have looked at it daily or weekly, it looks as if SOMA days can be good news for the USD. And the bigger the shrink, the larger the negative effect on equities and the greater positive effect on the USD. Of the seven weeks when the balance sheet has shrunk by more than 20bn, the dollar has weakened twice – but then by less than 0.1% on the week (Wednesday to Wednesday). The weekly QT patterns thus suggest a move higher in the USD between Wednesday February 13 and Wednesday February 20, given the hefty SOMA day on February 15..
We keep our short USD debt ceiling basket intact but opt for a slightly more defensive composition(33% NOK, 33% JPY and 33% CHF).
Chart 2: DXY vs the Fed’s balance sheet changes since October 1, 2017
On Swedish Surprises, Housing & Politics
Chart 3: A raft of weak Swedish data has dragged the surprise index massively lower
The extremely low Swedish economic surprise index has suggested a chunky move higher in EUR/SEK, just as has been realized since January 1. At its current super-depressed surprise index it hints at a further move to 10.60+ within one month. Maybe we should stop the analysis there… However, we’d like to highlight two potentially under-appreciated risks for the SEK in 2019.
The first pertains to the supply surge in Swedish home supply. A lot of supply is hitting the market, which may prompt weaker house price developments in coming months.
Chart 4: A lot of supply has been arriving to the Swedish housing market
The initial read to eg Stockholm apartment prices is also negative according to this proxy of house price developments. Stockholm apartment prices may have slumped 1% mom – in contrast to January of 2017 and 2018 when prices rose by 1.5% (quality-adjusted house prices will be unveiled by Valueguard/HOX on February 18).
Chart 5: Proxy for Stockholm apartment prices suggest a weak start to the year
Maybe what we are seeing, or are at risk of seeing, is that a weaker housing market prompts tighter lending standard which weaken growth and hence also weigh on the SEK?
Chart 6: Weaker SEK has gone hand in hand with weaker bank equities
Recently, the (formerly communist) Left party has signaled it will try to stop the S/Green-government from implementing the 73-point agreement between S/Greens and the Centre Party and the Liberals. It may thus be daring the “opposition” (C+L) to topple the government, with the help of M+Cd and SD. This week, the leader of the (L)iberals unveiled he will be stepping down in November. While political risks seldom matter for the SEK, these titbits do suggest a pick-up of just such risks.
For all that, most of the market participants who bought into the idea that the SEK could be a trade of the year for 2019 is likely stopped out by now, and as such the upside momentum in EUR/SEK may be about the cool it a notch (short AUD/SEK entry levels though look more interesting now).
NOK: CPI-ATE surprises on the cards?
There is blood on the streets from the stop-loss festival in short EUR/SEK bets, but it seems like NOK is now also suffering from spill-overs. Norge’s Bank though continue to be the odd one out amongst G10 central banks, as they prepare for a hike in March.
Next week the Norwegian CPI-ATE number will be more interesting than usual, as the January print surprised substantially on the downside in both 2017 and 2018. Will the consensus again conclude that the negative surprises were one-offs and therefore expect a rebound this year? Yes, the consensus looks for a jump to 2.3% from 2.1%. in the CPI-ATE measure. While a rebound is likely, we still see the best risk/reward in betting on a negative surprise.
Chart 7: Will CPI-ATE surprise on the downside again, as it did in 2017 and 2018?
The positive FX impulse is waning in the Norwegian inflation figure, which leaves the risk of negative surprises more elevated than usual in the months ahead. We took profit in our short EUR/NOK around 9.70, and we prefer to remain side-lined in that pair (we see risk of more upside pressure), though we remain short USD/NOK as part of our debt ceiling basket.
Chart 8: Imported prices will probably soon start to wane due to FX effects
DKK: An upwards level shift in excess DKK liquidity around the corner
As part of the financing strategy for 2019, the Danish issuance target remained constant from 2018 despite a larger financing requirement. A drawdown of DKK 48bn on the governmental cash account is hence to be expected to bridge that gap. (Unchanged target for issuance of Danish government bonds)
It is difficult to imagine that private sector liquidity can be increased by DKK 48bn (as it will be when the government draws down its cash balance), without continued upwards pressure on EUR/DKK spot, as DKK money market rates will likely drift (even) lower in this scenario.
In the EUR/DKK xCcy basis swap, an upwards level shift of 48bn DKK in the excess liquidity would suggest a 1yr (3m vs 3m) EUR/ DKK xCcy basis at -30bp (or slightly lower) compared to the current -20 (EUR/DKK: A tale of differing liquidity paths)
Chart 9: 1yr basis (3m vs 3m) in EUR/DKK versus the net position (excess liquidity) in DKK, bn
AUD and NZD: Which one is worst? We go long EUR/NZD
It’s not as if macro data have shown many comforting signs anywhere lately, but even in relative terms the news out of the Antipodes have been worse than in most other places (except for Swedish data. Sorry pals #1). The dramatic shift of momentum is though most visible in New Zealand, in particular if measured against expectations. The NZD (and New Zealand data) was the G10 darling towards the latter part of 2018. That is no longer the case.
The New Zealand surprise index is now consistent with a 5% quarterly drop in NZD in a month from now. We bemoan that the CESI (surprise index) analysis works as well as it does, but apparently the market is not as forward looking as one could have hoped for (we should admittedly have realized that when we entered a long SEK position a month ago. Sorry pals #2).
Chart 10: CESINZD (the NZD surprise index) points at a risk of much lower NZD a month from now
Even though the NZD took at joint blow with the AUD after Lowes speech Tuesday night, we still see a risk/scope of a dovish surprise from RBNZ. The unemployment rate jumped to 4.3% on Wednesday (a setback to the Philips curve apologists within RBNZ), and our most bearish indicators suggest that the trend could continue over the coming quarters. In case, it would be in sharp contrast to the current unemployment projections from RBNZ. The NZD is also still on the strong side of the latest RBNZ projection (1-1.5%), which is another argument in support of a dovish surprise.
Chart 11: Vehicle registrations point at rising unemployment in New Zealand
In the intra-Oceania space AUD/NZD tested 1.04 very briefly during the week, but it does admittedly look as if risks are mostly on the topside for the pair judged by technicals. News out of Australia also continues down a depressing road, this week exemplified by the weak retail sales and building approvals (by the way, don’t expect the building approvals to rebound – see chart below). The market though seems slightly better prepared for weak Australian data, we wonder if it is possible to find an Australian optimist at all at the moment?
We though continue to struggle to see why AUD should fare well (outside of the risk of an even more dovish Fed), both due to domestic data woes and due to the deteriorating Chinese/Australian relations (Beijing’s former top lobbyist in Australia just got his Australian citizenship rejected this week).
Technically our short AUD/SEK conviction now offer better entry levels, why we increase our conviction in that bet again. Also, we enter long EUR/NZD with an initial target of 1.70.
Chart 12: New orders on apartments point to even weaker Australian building approvals next month
JPY: BoJ forced into accepting higher real rates?
The global bond bullish bonanza continues with new lows in bund yields and e.g. USD and CAD yields close to early-January lows. In Japan, the 10yr bond yield has now reached the zero-mark, which limits the downside potential for JPY rates due to the yield curve control from Bank of Japan (-0.2 to +0.2 range, effectively probably even tighter). It is not even unthinkable that Bank of Japan will start selling bonds, if we get closer to the bottom of that range. After all the YCC was probably introduced, as Bank of Japan felt that it was running out of assets to buy.
Hence, if the inflation pressure abates further due to the slowing growth momentum worldwide, then Bank of Japan is likely to get higher real rates (also in relative terms) and there is not much they can do about it (lower inflation, but YCC keeps 10yr point at bay). This may implicitly lead JPY higher, if real rates matter (on charts it looks like they do).
Chart 13: Will Bank of Japan be forced into accepting higher real rates if inflation drops further?
Long real rates are already higher in Japan than in Germany and US, at least when one accounts for the cost of FX hedging the holdings of Bunds or Treasuries as a Japanese investor. It is visible from Japanese flow data that this equation matters. The accumulated Japanese bond flows into US or German bonds have halted, or even slowed after Japanese real rates outpaced the US and German peers (post FX hedging). We probably need lower EUR/JPY and USD/JPY levels to re-ignite those bond flows.
This leaves us with a slight JPY positive taste in our mouth unless Bank of Japan panics.
Chart 14: When Japanese real rates are higher than global peers after FX costs, then Japanese investors stay at home
A little down the line a scope for new policy easing / policy panicking from BoJ may arise, as wage growth looks set to slow. This comes on top of the already potentially rigged level for 2018 wage growth, that Shinzo Abe (partly) admitted to this week.
Chart 15: Wage growth is set to slow in Japan (from the already rigged levels from 2018)
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