The Week Ahead: Down the Homestretch

Down the Homestretch Share this story: Andrew Kositkun Foreign Exchange Head Trader This week marks the start of the final quarter of the year.  Looking at the event calendar, Q4 is shaping up to be an eventful one with markets expecting additional insights on US-China and US-EU trade negotiations, Brexit and whether or not the Fed justifies the market’s aggressive rate cut pricing.  Related to the last point is the question about the effectiveness of monetary policy.  Specifically, the FX markets are starting to show signs that monetary policy has become ineffective as the correlation between policy rate changes and G10 FX has dropped to near zero.  This is significant because foreign exchange rates are an important, if not the most important, mechanism through which monetary policy easing is supposed to affect inflation and inflation expectations.    Two of the more convincing reasons why this has happened are as follows.  Firstly, the broad nature of central bank easing has led to actions that have offset each other.  Without a change in relative interest rates, the markets lack a catalyst for FX rates to move.  This results in looser monetary policy that supports asset prices (i.e. stocks etc.) but not the real economy, making economies more vulnerable to asset bubbles.  The second reason relates to the market’s belief that monetary policy won’t improve the real economy.  Monetary policy is already very loose.  Real policy rates are currently negative in many of the G10 economies and policy rates are below what the Taylor rule would suggest in all G10 economies.  As a result it is difficult to argue that lower rates are what is needed to address the current issues.  Ultimately the reasons above are both symptoms of monetary policy that has been overburdened.  Central banks have been tasked with addressing problems beyond their control with limited and experimental tools.  While markets are calm now, FX’s increased insensitivity to central bank actions raises the risk that markets could be in for a rude awakening.      FORECASTS EUR Last week, the euro dropped down to its lowest level since 2017.  Catalysts for the move include a continuation of poor European data and USD strength.  Over the longer term, the bias remains for further euro weakness as the global economy remains under pressure, however the euro’s cheap valuation and current account surplus does provide support.         GBP Brexit remains the key driver for the currency.  Parliament is back in session so expect continued headline and political risk.  The Benn bill requires the government to seek an extension by October 19 if a deal with the EU is not struck by then.  However, PM Johnson has indicated he won’t abide by this.  Expect this to be a continued point of contention.  With hard Brexit risks delayed and not eliminated, the bias remains for the GBP to move lower. JPY Strong demand for foreign assets from Japanese investors continues to be a theme and the BoJ looks increasingly likely to ease at its next meeting.  These two factors, combined with more positive US-China trade headlines, have helped USDJPY move higher on the month.  However, with global growth slowing and trade sentiment exhibiting a history of sharp reversals, the bias remains to sell into USDJPY rallies. CAD Data risk picks up this week with Canada’s GDP release on Tuesday.  The expectation is that growth will return to about trend growth.  BoC resistance to the global wave of dovish central bank pivots has allowed the CAD to become the G10’s top performing currency YTD.  The CAD should remain in the range it has been over the past two weeks. CNY US-China relations had a bit of a push and pull dynamic last week with the yuan strengthening off news China will increase agricultural purchases and weakening off news that the US is considering delisting Chinese companies in America and limiting investment into China.  Expect headlines surrounding trade talks to continue to drive the currency.  The next round of talks are scheduled for October 10-11.  Should progress stall and tariffs are raised again on October 15, as scheduled, further CNY weakness would be the natural response.      AUD The RBA meets this week and markets are assigning a roughly 50% chance that it cuts rates again.  Ultimately it is more a question of when, not if, the RBA cuts rates again this year as the domestic economy continues to face headwinds and global growth concerns persists.  There are risks that the AUD strengthens should the RBA decline to cut rates this week, but the longer term bias still remains for a lower AUD. MAJOR CENTRAL BANK ACTIVITY THIS WEEK 10/1 Australia Expectations for rates to be cut by 25 bps to 0.75% 10/2 Poland Expectations for rates to remain unchanged at 1.50% 10/3 India Expectations for rates to be cut by 25 bps to 5.15% KEY MARKET MOVING ECONOMIC RELEASES United States and Canada 10/1 ISM Manufacturing Expectations for an increase from 49.1 to 50.3 10/2 ADP Employ. Report Expectations for a gain of 140k following a gain of 195k 10/4 Jobs Report Expectations for a gain of 140k; UR remains at 3.7% 10/4 Trade Report Expectations for another large trade deficit 10/1 Canada GDP Expectations for a gain of 0.1%; YoY at 1.4% 10/4 Canadian Trade Expectations for a similar trade deficit as in July Europe/Eurozone  9/30 EZ UR Report Expectations for UR to remain unchanged at 7.5% 9/30 German UR Report Expectations for employment gains to be flat; UR at 5.0% 9/30 U.K. Q2 GDP Final Expectations for a final print of -0.2%; YoY at 1.2% Asia/Japan, and New Zealand  9/30 Japanese Jobs Report Expectations for the UR rate to remain at 2.3% 9/30 Jap. Tankan Biz Rep. Expectations for a sharp decline from 7 to 1 10/2 Aussie Trade Report Expectations for another large trade surplus If we can help you with any Foreign Exchange needs, please email foreignexchange@cnb.com or call (800) 447‑4133. 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