The Week Ahead: Fading Immunity

Foreign Exchange: The Week Ahead
Fading Immunity
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Risk markets around the world have moved higher as headlines continue to support the global reflation narrative.  Case in point, there are growing expectations that the US and China could roll back existing tariffs as part of a Phase 1 deal despite conflicting headlines.  Should this actually come to fruition, it would be a significant positive surprise and provide material support to the narrative that the worst could be over for the global economy. 

Truth be told, even before a potential truce between the US and China is signed, the trade war’s impact on the US has been relatively modest.  A key reason for this is China’s limited scope for retaliation given China’s trade surplus with the US and the limited impact of those retaliatory tariffs.  Thus far, China’s retaliatory tariffs have been focused on US commodities which includes an element of self-harm due to high price elasticity. 

This dynamic could change should the US-EU trade conflict escalate.  For starters, the trade balance between the two economies is more balanced and includes mainly services and manufactured goods, with commodities amounting to small portion of trade.  In other words, a trade war would be a battle of two fighters in the same weight class.    

This matters because around the same time that the US and China are expected to reach a truce, the WTO is expected to rule in the EU’s favor on its claim against Boeing.  Given that the US chose to impose tariffs after winning a WTO ruling on Airbus earlier this year, the expectation is that the EU will use its ruling to retaliate.     

All of this comes at a time when auto trade tensions remain unresolved.  At present the US has a 2.5% tax on passenger cars but a 25% tax on light trucks with the EU taxing both at 10%.  The EU recently agreed to phase out auto tariffs as part of its free trade deal with Japan and Korea.  As a result, should the US choose to escalate trade pressure, the EU would be unable to quickly lower these tariffs on most-favored nation grounds. 


Certainly this isn’t to predict the US and EU will escalate to a full blown trade war.  If anything, the looming impeachment threat and upcoming election incentivizes Trump to make deals.  However, history has shown it is dangerous to assume this administration will follow conventional thinking.  So while things look positive and markets have become cautiously bullish, we certainly aren’t in the clear. 

FORECASTS

EUR

November has brought a change in trend for both the EUR and GBP after a strong performance in October centered on improving Brexit expectations as both currencies moved higher in tandem. Both currencies have declined by ~1.25% due to the markets pricing in good news as well as rising U.S. interest rates.  Continue to expect the EUR to shadow and be hinged to the GBP and Brexit volatility as the U.K. election approaches. Expect a steady to slightly weaker EUR this week.

GBP

The GBP had a spectacular October resurgence on the back of a sharp reduction in the likelihood of a hard Brexit and PM Boris Johnson’s positive political maneuvering in Parliament. Polls still favor a Tory majority but the situation is very fluid and there is a long ways to go to December 12th.  Tory political campaigning/posturing prior to previous elections since 2015 has been humbling. The Bank of England kept rates unchanged last week but downgraded future growth and inflation. Expect a steady to slightly weaker GBP this week.

JPY

The JPY has been on a weakening trend over the past two months. Risk sentiment has improved and U.S. interest rates have been on the rise as positive sentiment builds towards a U.S. – China trade break through. Markets seem to have priced in a Phase 1 deal but volatility will remain as the White House has not given the green light to a mutual tariff reduction program nor has a date/location been set for a signing of the Phase 1 document. Expect further consolidation this week. 

CAD

The Canadian dollar has followed a similar path to other major currencies transitioning from October to November where strength has been followed by weakness. Overall, Canadian economic fundamentals remain in good shape relative to its peer group. Friday’s jobs report was a disappointment but that followed two months of spectacular gains. Expect a steady to slightly weaker CAD this week.

CNY

As optimism continues to build for a mini-breakthrough on the U.S. – China trade talks, the CNY has continued to surge and most recently  broken back through the key psychological level of 7.00/$. The market has now confidently priced in a Phase 1 deal despite a lack of clarity on the mutual reduction of tariffs or definitive signing date or location. Expect some consolidation this week.

AUD

The Aussie mirrors much of the recent developments of other key major and commodity linked currencies piggybacking the positive developments  regarding U.S. – China trade prospects. November has brought a change in direction as the market takes stock of recent trade developments and a lack of clarity on key issues as we hopefully approach the finish line. The RBA maintained its slightly dovish bias last week; there is a 15% probability of a rate cut in December and 41% in February.

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

11/12 New Zealand Expectations for rates to be cut by 25 bps to 0.75%
11/14 Mexico Expectations for rates to be cut by 25 bps to 7.50%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

11/13 CPI Expectations for a gain of 0.3%; YoY at 1.7%
11/14 PPI Expectations for a gain of 0.3%; YoY at 0.9%
11/15 Retail Sales Expectations for a gain of 0.1% following a -0.3% print
11/15 Industrial Production Expectations for a decline of 0.4% following a -0.4% print

Europe/Eurozone 

11/14 EZ Q3 GDP Expectations for a gain of 0.2% following a 0.2% print
11/12 German ZEW Survey Expectations for a slight improvement in the survey
11/13 German Q3 GDP Expectations for a -0.1% print following a -0.1% print in Q2
11/11 U.K.Q3 GDP Expectations for a gain of 0.4% following a -0.2% print in Q2
11/11 U.K. Indust. Product. Expectations for a -0.1% print following a -0.6% print
11/11 U.K. Trade Balance Expectations for an increase in the trade deficit
11/12 U.K. Jobs Report Expectations for a decline in employment; UR at 3.9%

Asia/Japan, and New Zealand 

11/13 Chinese Ind. Product. Expectations for a decline from 5.8% to 5.4%
11/13 Japan Q3 GDP Expectations for a gain of 0.2% following a 0.3% print
11/13 Aussie Jobs Report Expectations for a gain of 16k; UR remains at 5.2%
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