A monthly commentary/summary that discusses our broader, long-term currency analysis.
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Alan Rose Head Trader - Foreign Exchange
U.S. economic data was on the mend in November with a better-than-expected employment report and an ISM non-manufacturing report that both widely beat expectations. With the better-than-expected economic data, the U.S. dollar (DXY) rebounded off its sharp losses in October as the market lowered expectations for another Fed rate cut in December from nearly 53% in early November to nearly 15% at the end of the month.
But despite all the short term swings in the DXY index this year, the DXY has been largely in the doldrums in 2019. Notwithstanding the remainder of the year, the U.S. dollar has experienced the tightest trading range in more than four decades (1976) going back almost to the inception of floating exchange rates in 1973. The range so far this year has been less than 5% from the low to the high.
Foreign exchange market volatility remains near historic lows and there appears to be no near term catalyst to spark a change. Much of the good news regarding the conclusion of Phase 1 of a trade deal and negative news regarding the impeachment inquiry are largely priced in at this time. Continue to expect more sideways trading over the next few weeks and months with short term bullish and bearish mini-cycles until the market dynamics shift dramatically. Market expectations and forecasts are for a rebound in global growth which should cause a slight reversal of flows against the U.S. dollar in 2020.
The euro benefited from the rapid rise of the British pound in October as the market began to price out a "hard" Brexit as PM Boris Johnson made significant political progress with both the EC and the U.K. Parliament. November has brought back some economic reality to the euro once again. There remains a clear market psychology and dynamic where the market remains biased for good things to happen in the U.S. and for general negativity toward the EZ preventing the euro from gaining any upward traction despite some signs that small "green shoots" are beginning to emerge in Germany.
The euro is the second most important currency to the U.S. dollar in terms of total central bank reserves and total global trading volume. But, the euro reflects and mirrors the lack of volatility that is impacting the U.S. dollar's range this year. The euro has been locked in its tightest trading range on record trading between $1.0879 and $1.1570 in 2019. One possible catalyst for change going forward is the fact that Christine Lagarde has replaced Mario Draghi as head of the ECB in November. In her first major speech, she emphasized the use of more fiscal policy to help promote EZ growth as a compliment to ECB monetary policy. If that should occur, we could see a stronger euro than economists have forecast.
The USD/JPY has been on a steady and methodical rise since the beginning of September coinciding with the restarting of the U.S. – China trade talks. "Risk-on" market psychology has largely been prevalent with equities outperforming while G7 interest rates and inverted yield curves have all improved allowing for the slow but steady weakness of the JPY as safe haven assets have lost some of their luster.
Even as progress appears to be made in the U.S. – China trade talks toward a minimalist Phase 1 document, markets have recently succumbed to fatigue and lethargy as much of this good news is priced in. As U.S. interest rates have been largely range bound over the past weeks, the JPY has also mirrored that move with a tight consolidation pattern largely between 108/$ and 109.75/$ in November.
While the correlation between the JPY and U.S. interest rates movement is strong and will continue, forecasting this currency can be an enigma depending on market psychology and other dynamics. On January 2, 2019, U.S. 10-year yields sat at 2.56%; today 10-year yields are at 1.76% inclusive of three Fed rate cuts. Surprisingly the JPY closed on January 2, 2019 at 108.71 and today we are 109.45. As with many of our forecasts, we are slightly biased toward a gradual weakening of the U.S. dollar and a strengthening of the JPY going forward.
The GBP soared in October by over 5% as PM Boris Johnson achieved what many thought was near impossible. He got the EU to sign a revised Withdrawal Agreement and was able to bring together his fractured Tory party to largely coalesce behind his agreement. Markets priced out the worst case scenario of a hard Brexit and short positions got covered. While much of the negativity from a "hard" Brexit has been priced out, there are still many hurdles over many months before we can cross the finish line.
As we conclude November, the GBP has reverted to a consolidation pattern largely between $1.2800 and $1.3000. Debates and polling will govern the near term direction of the GBP as we approach the December 12 election day. Polling and political campaigning have been an Achilles heel for the Tory party going back to 2015. It is the Tory party's election to lose between now and December 12. Despite the recent up and downs of the polls, the betting odds still favor a small Tory majority on election night. Part of the conclusion rests with overall Brexit fatigue after nearly 3.5 years since the initial vote and that the Boris Johnson deal is the best deal that can be gotten at this time. We remain cautiously optimistic going forward.
As was mentioned in last month's forecast, the CAD has been the top performing major currency in 2019 up by nearly 2.75%. This compares to declines for the SEK (-7.70%), EUR (-3.89%) and the AUD (-3.72%). The Canadian economy has clearly outperformed its peer group (AUD and NZD) and remains surprisingly resilient. This has allowed the Bank of Canada (BoC) to keep interest rates unchanged while other countries have consistently tilted to the dovish side. The key overnight rate has been unchanged at 1.75% since October 2018.
The Canadian jobs report released in early November was disappointing and, combined with a slightly dovish tilt from the BoC, set the stage for the CAD to correct lower as the market had been long of the CAD. That being said, the CAD has traded in a narrow range from 1.3400/$ to 1.3100/$ since September. U.S. 2-year yields reside at 1.62% and 2-year Canadian interest rates are at 1.59%... the second highest of any other G7 country. Overall, the combination of the BoC's neutral stance, relatively solid economic data and relatively high yields should make this currency an attractive investment.
The AUD has remained pressured almost all year long and the main driving forces remain nearly unchanged. A combination of slowing global trade volumes, a slowing Chinese economy creating less demand for Aussie exports, and three Reserve Bank of Australia interest rate cuts has undermined sentiment. The cash rate is sitting at 0.75% which is at an all-time low and the unemployment rate is sitting at a yearly high of 5.3% on the back of disappointing employment data in mid-November. The currency has depreciated against the U.S. dollar by nearly 3.86% so far this year.
Despite all this negativity and expectations for another interest rate cut in early 2020, the currency has remained resilient over the past few months. The prospect of the signing of a Phase 1 trade agreement between the U.S. and China in the near term including some reduction in tariffs is a promising start for a bottoming of the Aussie economy down the road. But for the short term, continue to expect more range trading. The market will remain very Aussie data dependent; we are looking for the economy to bottom and see some improvement which should allow for stabilization or slight improvement in the exchange rate.
Prior to the restarting of the U.S. – China trade talks in early September, the CNY was at its lowest levels of the year piercing the key psychological level of 7.00/$ and was hovering near 7.20/$. Since the announcement of the resumption of the trade talks, the CNY has been on a slow and erratic path of appreciation. Ping-pong headlines regarding the state of the talks have played havoc with intraday price action but overall the market has priced in a limited Phase 1 accord that has allowed the CNY to stabilize between 7.00/$ to 7.05/$. Headline fatigue has set in as the market awaits the contents of Phase 1 and a signing date.
While the reduction of tensions is a welcome event and has buoyed the markets, moving forward to Phase 2 and beyond will be more difficult. This is more than a trade dispute but is a clash of two very different national ideologies regarding the intersection of capitalism and free and open markets versus government distrust of markets and state intervention in achieving economic outcomes. This will be all the more complicated by the 2020 Presidential election year process and perhaps by the impeachment inquiry. Markets have price in a limited Phase 1 deal and we anticipate the CNY to stabilize near term but remain skeptical about further appreciation.
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