The Week Ahead: What Goes Down, Must Come Up

Foreign Exchange: The Week Ahead
What Goes Down, Must Come Up 
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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
There are times when market sentiment and psychology become so entrenched and pervasive that it is nearly impossible to change the market's tone and direction. The escalation of the U.S.-China trade war and the continued use of higher and higher tariffs set in motion a full-risk off sentiment with forecasts for continued declines in world growth and a corresponding decline in interest rates; this has been the mantra for the markets for weeks and months now. All the negativity helped tilt forward expectations to weaker U.S. growth, further sharp declines in U.S. interest rates and the increased probability of a recession.

But in early September, there was a thawing in the U.S.-China trade war that changed the one-sided market dynamics. The promise of a meeting in October in Washington between the two superpowers and concessions on both sides have rapidly changed the market dynamics. G7 interest rates, and in particular U.S. interest rates, have been on a steady march higher reflecting the new optimism. The U.S. yield curve inversion is retreating with the 3-month versus 10-year spread moving from -54 bps on September 3 to only -8 bps on Friday.

What does all this mean for the U.S. dollar? Currencies that are export sensitive (EUR, AUD, MXN etc.) and that have been particularly beaten down by the sharp decline in global trade volumes and lower respective domestic interest rates are being revived and correcting higher. The U.S. dollar, which has been seen as a safe haven due to its steady growth relative to its peer group, is losing some luster as investors shift portfolios to reflect the current wave of optimism.

This trend should remain in place, but we have a big hurdle to get over on Wednesday when the FOMC meets. Market expectations remain at nearly 100% for another 25 bps rate cut, but everything will ride on the Fed’s language and Chairman Powell’s press conference. Language, tone and forward guidance will mean everything and could cause the DXY to strengthen again or resume its weakening.  


9/18 United States Expectations for rates to be cut by 25 bps to 2.00%
9/18 Japan Expectations for rates to remain unchanged at -0.10%
9/18 Brazil Expectations for rates to be cut by 50 bps to 5.50%
9/19 Switzerland Expectations for rates to remain unchanged at -0.75%
9/19 South Africa Expectations for rates to remain unchanged at 6.50%


United States and Canada 

9/17 Industrial Production Expectations for a gain of 0.2% after a -0.2% print
9/18 Housing Starts Expectations for a solid gain to 1,250,000 starts
9/18 Canadian CPI Expectations for a decline of 0.2% after a 0.5% print


9/17 Germany ZEW survey Expectations for another fall to -15.0
9/18 U.K. CPI Expectations for an increase of 0.5%; YoY falls to 1.9%
9/19 U.K. Retail Sales YoY Expectations for a decline from 2.9% to 2.3%

Asia/Japan, and New Zealand 

9/19 Japan Nat'l. CPI YoY Expectations for a decline from 0.5% to 0.3%
9/18 Aussie Jobs Report Expectations for a gain of 15k; UR remains at 5.2%
9/18 NZ Q2 GDP Expectations for a decline from 2.5% to 2.0%



The hope and promise of compromise regarding the U.S.-China trade war and Brexit has changed some of the overly negative short-term sentiment regarding the EUR and EZ economies. EZ interest rates rallied sharply higher late last week allowing the EUR to correct higher and diffuse some of the safe haven status of the U.S. dollar. Expect a steady to higher EUR heading into the FOMC meeting. 


The British pound was the top performing major currency today up 1.40% in the past week. The fuel for this appreciation is centered on the fact that Parliament is in recess and the story on Friday in the London Times that the DUP party of Northern Ireland is shifting its red line positions regarding Brexit. Short-covering is keeping the GBP elevated to its best weekly performance since May. A key meeting between Boris Johnson and EU’s Juncker takes place on Monday. Like the EUR, we anticipate the GBP to be steady to higher heading into the FOMC meeting next week.


The JPY continues to be undermined by the positive shift in risk sentiment as G7 interest rates rise and this currency's safe haven status declines. The correlation between the JPY and the near term direction of U.S. interest rate yields remains strong at nearly 0.73% for both U.S. 10-year and 2-year yields. Expect some consolidation heading into next week with the JPY remaining vulnerable to cross rate activity and to further spikes higher in U.S. interest rates.


The CAD has been underperforming like many other commodity-linked currencies despite the positive shift in risk sentiment over the past week. Uncertainty surrounding the upcoming Canadian election on October 21 appears to be at the root of this underperformance. With nearly 100% certainty of a Fed rate cut this week and 93% probability of the Bank of Canada standing pat on October 30, interest rate fundamentals should help stabilize the CAD in the medium term.


September 3 was a key day for the markets as a thawing of the U.S.-China trade war commenced and further gestures and concessions by both sides continue to create optimism for a trade break through. Risk sentiment has improved globally and the CNY has reflected the overall improvement in tone. The CNY has appreciated in eight of the past ten sessions and is up by nearly 1.50% against the U.S. dollar. Expect a steady to improving CNY this week.


The Aussie is up in seven of the past nine sessions as this currency pair benefits from the improvement in the outlook regarding U.S.-China trade as both sides make concessions and gestures ahead of the key October meeting. Coinciding with the improvement in the Aussie has been a rapid rise in iron ore prices (a key export for Australia) reflecting the renewed optimism. The Aussie jobs report comes out on Wednesday and will be a key focus on the state of the Aussie economy. Expect the Aussie to correlate with the risk-on or risk-off environment heading into the FOMC meeting.
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