The Week Ahead: Muddied Waters

Foreign Exchange: The Week Ahead
Muddied Waters
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Over the last 5 years, the UK has had 3 PMs, two referendums (if you count the Scottish vote on independence) and three general elections.  Depending on the result of the upcoming election, there could be a 4th PM and potentially two more referendums (a redo of the Brexit and Scottish independence votes).

Uncertainty surrounding how the election impacts the GBP is centered on a couple factors:
  • The actual election results.
  • The balance between the new government’s impact on Brexit and its broader economic policies.  Between the Conservatives and Labor, the party with the most conventional economic policies it the one that has the greatest risk of a hard Brexit and vice versa. 
Starting with the election results, polls show that this election is PM Johnson’s to lose but the same was said 2017 for the election that PM May lost.  Broadly, there are three reasons why this election is difficult to call.  The first is the wide variance in results across different polls.  The second has to do with the UK’s election system that makes it difficult to translate national polls into the number of seats in parliament.  Finally, with ~6 weeks to go there remains event risk as developments between now and the election can swing voter sentiment.  While there are many moving parts, a large Conservative majority is likely the most GBP positive result.  Conversely, a narrow Conservative majority or a Labor majority are likely the most GBP negative.   

From an economic perspective, a Brexit deal actually doesn’t provide much clarity.  All it means is the UK will exit the EU and transition to something that has yet to be defined.  All options, from a hard Brexit to a soft Brexit, still remain on the table.  What this means is that the chronic uncertainty that has plagued the UK economy will still persist even after a deal is struck.    

The weight of this chronic uncertainty should lead to two things—monetary and fiscal stimulus.  Fiscal policy is pretty straight forward as both leading political parties support increased spending.  Monetary policy is a bit more nuanced.  The BoE meets this week and will remain on hold.  However, over a longer horizon the bank is more likely than not to ease in 2020 as economic headwind persist.  Until then, expect GBP volatility to continue.   

FORECASTS

EUR

The euro continues to be lifted by improved trade and Brexit sentiment.  While recent price action has been for EURUSD higher in October, reservations still remain behind the stainability of this move.  Overall, the European economy remains challenged but its increasingly strong balance of payment position does provide a cushion for these economic headwinds.   

GBP

With the date of the UK’s next election finally set for December 12 and public opinion polls should gain increasing importance as we get closer to election day.  Ultimately it is hard to have conviction on a GBP view without further clarity on the many variables involved.  Please see the main write up above for a more detailed discussion on how the election impacts the GBP. 

JPY

The BoJ left its interest rates unchanged last week but made changes that continue to signal the possibility of easing down the road.  Positive market sentiment has helped USDJPY move up to levels not seen since early August.  Eventually USDJPY gave up those gains on headlines questioning the prospects of a long term US-China trade deal.  This, in a nutshell, illustrates the concern with the market’s current direction.  Certainly the developments on US-China trade and Brexit are positive but, in the end, they are sentiment factors and still remain unresolved.  Additionally, structural issues remain and without exiting tariffs rolled back, it’s hard to see global growth staging a sustained recovery.   

CAD

The BoC surprised markets last week by delivering a dovish hold.  The bank downgraded its domestic forecast and discussed insurance cuts for the first time.  Given this, the bank still remains hesitant to take near term action.  With this dovish shift, incoming economic data takes on increased importance.  Expect continued range trading.

CNY

The yuan has continued to strengthen due to increased hopes for a finalization of the Phase 1 deal between the US and China.  While headlines remain positive on Phase 1, a Phase 2 deal will be much more difficult to achieve.  China’s economy continues to be weak and existing tariffs are still high.  As such expect the CNY to continue to be pressured with China aiming for currency stability as talks continue.    

AUD

The AUD finally moved above .69 on the interbank market as currencies exposed to international trade have been supported by positive trade developments.  However, as previously discussed, the AUD is vulnerable to a market rethink of the positive news that has pushed risk assets higher. Neither Brexit nor US-China trade are set to be resolve in the near term and, with regards to US-China trade, lack substance.  Without a rollback in existing tariffs, it’s hard to see a recovery in global growth and the AUD continuing to stay at these levels.   

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

11/4 Australia Expectations for rates to be unchanged at 0.75%
11/6 Poland Expectations for rates to be unchanged at 2.00%
11/7 United Kingdom Expectations for rates to be unchanged at 0.75%
11/7 Czech Republic Expectations for rates to be unchanged at 2.00%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

11/4 Factory Orders Expectations for a decline of 0.4% following a -0.1% print
11/5 Trade Balance Expectations for an improvement in the trade deficit
11/8 Michigan Sentiment Expectations for a gain from 95.5 to 96.0
11/5 Canadian Trade Rep. Expectations for a smaller trade deficit
11/8 Canadian Jobs Rep. Expectations for a small gain after a large gain in Sept.

Europe/Eurozone 

11/5 German Factory Ords. Expectations for a gain of 0.1% following a -0.6% print
11/6 German Indust. Prod. Expectations for a decline of 0.3% after a gain of 0.3%

Asia/Japan, and New Zealand 

11/7 Chinese Trade Report Expectations for another large trade surplus
11/8 Chinese Inflation Data Expectations for CPI to rise to 3.2%; PPI to decline 1.5%
11/6 Aussie Trade Report Expectations for a smaller trade surplus
11/5 New Zealand Jobs Expectations for the UR to rise from 3.9% to 4.1%
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