The G3 currencies (USD, EUR, JPY) have been stuck in historically narrow ranges. In fact, over the past 6 months, EURUSD has been stuck in a ~3.4% range, one of the tightest ranges in history.
Certainly this inertia is partially due to a lack of direction with the USD and the EUR. Growth in the U.S. economy isn't robust enough nor is the Fed hawkish enough to support further gains for an expensive USD. However, Eurozone growth remains too soft and the ECB is too dovish to support euro appreciation, leaving the currency pair's volatility suppressed.
But this suppressed volatility is most likely due to more than economic factors, a narrative that is supported by the IMF's report on central bank reserve holdings. In the IMF's most recent report, USD reserve levels dropped to $337 billion in 2018 from $778 billion in 2017, a 57% drop. Conversely, euro reserves increased $311 billion, or 70%, over the same period. Beyond the change in absolute levels of USD and EUR reserves is the fact that central banks are simultaneously reducing USD holds while adding EUR holdings.
While these numbers are a bit muddied by how China reports its reserves, the take away remains unchanged. Central bank diversification from the USD into the EUR has helped support the euro during a time of persistent Eurozone economic underperformance.
The reasons for this move in diversification are less clear as market participants can only surmise the rationales. Some have suggested a drop in credibility of U.S. policy-making or the increased manner in which the USD has been weaponized to achieve U.S. foreign policy goals. However, the GBP hasn't really suffered its second-tier reserve currency status despite all the Brexit chaos. This suggest that a currency's reserve status is more resilient than a country's reputation for political propriety.
This then leaves valuation and positioning. Central banks are the ultimate long-term investor and as such, are not constrained by short term considerations, affording them the luxury to allocate reserves towards undervalued currencies such as the EUR, GBP and JPY. As a final note, central bank holdings of the Chinese yuan are disproportionately small to China's economic weight, lending scope for an increased move into the yuan.
MAJOR CENTRAL BANK ACTIVITY THIS WEEK
KEY MARKET MOVING ECONOMIC RELEASES
Expectations for rates to remain unchanged at 0.25%
Expectations for rates to remain at 0.00%
United States and Canada
Expectations for a decline of 0.5% after a 0.1% print
Expectations for a gain of 0.3%; YoY gain of 1.8%
Expectations for a gain of 0.3%; YoY remains at 1.9%
EZ Industrial Prod.
Expectations for a decline of 0.6%; YoY declines 1.0%
Expectations for a gain of 0.4%;YoY remains at 1.3%
U.K Trade Balance
Expectations for a 3.9 billion GBP deficit
U.K. Industrial Prod.
Expectations for a 0.1% gain
Asia/Japan, and New Zealand
Expectations for a gain of 2.3% YoY
China Trade Balance
Expectations for another large surplus
Expectations for the YoY to rise from 0.8% to 1.1%
The EUR remained range bound last week as it traded within a 1 cent range. This bullish/bearish trading pattern was driven by conflicting economic data which pushed the euro up and down and then ultimately left it broadly unchanged for the week. While there are signs that we could be near a bottoming of poor European data, it will take a series of positive data surprises to convince the markets and the ECB of a creditable recovery. Until then, we remain neutral on the euro and expect further consolidation with headlines moving the single currency. As such, the ECB will be on hold this week.
Like the euro, the GBP was broadly unchanged for the week, but unlike the euro, the GBP was much more volatile. Ultimately, the only thing that seems to matter for the sterling is Brexit, and as such, expect headlines to continue to dictate the direction of the currency. The most recent developments for cross party talks and a request for a longer extension all point to a softer Brexit and a decline in the risk for a no-deal exit. Additional indicative votes are expected this week and the EU meeting on April 10 is important as to the evolution of the EU's stance. Recent developments appear to have put a base under the GBP, but future uncertainties, including the possibility of a general election, also caps gains. Continue to expect further volatility based on individual headlines.
The JPY weakened this past week as U.S. 10 year yields recovered from lows last seen in 2017. Additionally, Japanese investor demand for foreign assets remains strong, supporting JPY outflows. While U.S. rates have recovered, a consistently dovish Fed should put a cap on U.S. rates and JPY depreciation. Additionally, political tensions remain high in Washington with the debt ceiling debate pending and could weigh on market confidence and the USD.
Canadian jobs data pulled back from its strong 6 month run with a somewhat expected soft jobs print as the strong jobs market came against a weakening GDP picture. The silver lining comes through an increase in wages but, net on net, the BoC shouldn't be impacted by this as it is more concerned with stabilizing growth than inflation. Looking forward, domestic factors should continue to pressure the CAD.
The CNY has been benefiting from a number of fronts since the beginning of the year. The Chinese government and central bank have been using all monetary and fiscal means possible to keep the economy liquid and afloat. Signs are emerging that the Chinese economy has started responding to this stimulus. Additionally, continued positive expectations surrounding a successful conclusion to the U.S. – China trade deal also spurred demand for the CNY. Over the past weeks, the CNY has consolidated its gains as the trade negotiations drag on; expect more sideways trading until more news is known about the trade negotiations.
The AUD is another currency that is broadly unchanged on a weekly basis but did experience sharp drops and rises on a daily basis. This past week, Chinese economic data as well as headlines on U.S.-China trade talks moved the currency. On a domestic front, Australian retail sales beat expectations, however this is unlikely to signal a material change in the outlook for household consumption. Expect sideways trading until the market gets more clarity on domestic consumption. As a final note, market pricing still heavily favors a rate cut this year.
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