Just like Goldman top ticked the EURUSD trade to within a few hours of the multiyear low of the pair when it issued its downgrade from 1.35 to 1.15, so today's notice that Goldman is now bearish on the dollar should be enough reason for everyone to short the living daylight out of the euro. Amusingly even as the GS Global Market team sees a major slowdown in the US, somehow the rest of the world (BRICs) is supposed to pick up the slack, even as Jim O'Neill himself has now said he expects China to decelerate materially. Also, according to Goldman's "GS Bond Sudoku Model" the fair value on the 10 Year is at 3.1%, "with a very grim macro backdrop needed to justify yields at 2.5% or below." Well if the Sudoku says so... Altogether confusion is rampant, but the only thing that matters is that Goldman is now buying dollars and selling euros.
From Goldman's Mark Tan
- We are seeing greater signs of a US slowing below trend in the 2nd Half of 2010…
- …but likely relatively stronger growth elsewhere
- We expect broad moderate Dollar weakness in this mild decoupling baseline scenario
- Growth differentiation is still a key theme
- We opened a long AUD/CAD trade recommendation along these lines
- EUR/$ direction less clear, and hinges on political risk premia
- GS Banks Research issued a note on the assumptions underlying the European Stress Tests yesterday
1. Market Overview
Yesterday saw a broad risk bounce with the SPX up over +3%, along with notable gains in commodities and a broadly weaker Dollar. The FX moves were sharpest in ‘risky’ FX crosses with AUD leading the moves. The moves in EUR/$ were muted by comparison.
We opened a long AUD/CAD trade overnight to take advantage of the differential exposure to a 2H US slowdown, a related topic that we discuss in today’s Daily. The cross has been on the move recently, especially on the back of the stronger than expected Australian jobs data overnight, but we still think there is further differentiation to go. We have a target of 0.9500 for the trade and stops at 0.8850.
German IP numbers for May are key today, following yesterday’s disappointing manufacturing orders which can be notably volatile. We continue to expect German industrial sector momentum to hold up and are forecasting a +1% mom gain for the IP print. For the ECB meeting later today, we are expecting no major policy changes. Bank Negara Malaysia also meets later today. We are expecting a 25bps hike while consensus is roughly evenly split between a 25bps hike and no change. In the US, we have the weekly jobless claims numbers where consensus is expecting a moderation to 460,000 in initial claims after the surprise rise to 472,000 last week.
Our GS Banks Research Team also released an update on the European Stress Tests yesterday, which outlined some of the assumptions that are likely to be used in the tests, and how they will differ from country to country.
2. Baseline Scenario—US Slowing Below Trend…
Our baseline forecast for the US economy is clear and is one which our US economics team has been holding on to for some time. They have been highlighting both the correction in temporary boosts from the inventory cycle and the fade in fiscal stimulus boosts, which will eventually result in headline GDP growth converging to final demand growth, which has been tracking around 1.5% annualised over the last few quarters.
What is less clear though is how much of this is priced in. Consensus is around 3% annualised for headline GDP in 2H 2010, a good deal above our 1.5% forecast. However, there is likely to be some downward revisions over the next few months in light of the weaker data that we have seen recently, which should also continue to come through over the next few months. For instance, our US economists expect the US ISM to head back down to 50 over the next several months. Looking at the move in US rates, we have also seen a pretty large move--as Mike Vaknin discussed in yesterday’s Daily, fair value according to our GS Bond Sudoku model is around 3.1%, with a very grim macro backdrop needed to justify yields at 2.5% or below.
At this juncture, with the uncertainty that has arisen from markets repricing and digesting the changing growth views, we take a look at certain scenarios and what they imply for our USD outlook. Generally speaking, implications for the broad Dollar trend largely depend on the extent of the US slowdown and are also a function of what is going on elsewhere in the world.
3. …But Stronger Growth Elsewhere Means Broad Moderate Dollar Weakness
The US slowing below trend during the remainder of 2010, while avoiding a ‘double dip’ slowdown, remains our baseline forecast. At the same time, we expect moderation in growth momentum elsewhere, which will hold up largely relatively well, especially in the stronger-growing emerging markets. Our global GDP forecast currently stands at 4.8% for 2010. A large part of the global outlook rests on China, where we see near term sequential slowing. However, a rebound is possible as early as year-end with sequential FCI easing, as Mike Buchanan, Yu Song and Helen Qiao in our Asia Economics Team have discussed in their recent China growth revisions.
This is essentially a mild decoupling scenario which should be supportive of a broad moderate Dollar weakening trend. We are likely to see most of this Dollar weakness come through in areas with endogenous domestic demand strength, for example, against the stronger growing NJA and commodity currencies. We may see currencies with closer links to the US fare relatively worse though, especially if a slowdown is not sufficiently priced—one of the reasons why we have just recommended long AUD/CAD positions for their differential exposure to a US slowdown.
An additional factor supporting our broad moderate Dollar weakness view that we have been consistently highlighting, is the structural argument of the lack of fundamental Dollar support in terms of the BBoP outlook. The US BBoP deficit while narrowing in the last quarter to -2.8% of GDP, is still below the -1.5% threshold which we view to be supportive for persistent Dollar strength. In addition, the composition of portfolio inflows are also not broad-based and still very much concentrated in Treasuries. The fact that we have not seen broad-based inflows thus far is also arguably reflective of the view that the US had been at the core of the recent crisis and was always facing a challenging recovery process with a need for large structural adjustments.
4. More CNY Appreciation, Not Less
Under our baseline scenario, moderating China growth momentum in the interim is not necessarily a case against further CNY appreciation over the medium-term. A large part of the decision to allow more CNY flexibility has arguably been to alleviate pressure on the political front. The political focus from the US will likely not fade with US unemployment staying close to the 10% level, as we expect to be the case over an extended horizon.
From China’s perspective, it is likely that exchange rate policy and the decision to allow further flexibility is a decision taken with the longer-term outlook very much in mind (they were obviously aware of the near term cyclical downside risks when they allowed the move recently). This is a beneficial adjustment that aids further domestic rebalancing over time (which in-turn helps reduce global imbalances) and continues the process towards enhancing the role of the CNY on the global stage over the longer-term. (See Mike Buchanan and Jim O’Neill’s recent Global Paper on ‘Global Reserve Currencies and the SDR’ for a thorough discussion of this topic).
As such, we hold on to our current trade recommendation to be short $/CNY via 1-year NDFs with a target of 6.50, a trade that we opened on June 10, before the recent announcement to allow more CNY flexibility.
5. Growth Differentiation Still a Key Theme
Overall, this backdrop continues to allow for opportunities on a relative basis. Growth differentiation strategies that pit faster-growing economies against slower-growing ones should continue to do well in a moderate slowdown scenario and this remains a guiding theme for us in identifying trade opportunities going forward.
Broad-based relative value strategies such as our Growth Current, which remains on our Top Trades list this year, should also outperform. The Current is basically flat over the last 2 months of jittery markets, after an almost uninterrupted +7% run since the middle of last year.
6. Downside Scenario—If ‘Double Dip’ Fears Take Hold
A much sharper slowdown than what we currently envision in our baseline scenario will likely herald a more indiscriminate reaction in FX markets, i.e., one of broad Dollar strength resulting from significant ‘risk-off’ and safe haven flows. Return correlations between risk and the Dollar still remains strongly negative and we expect this to persist.
Along these lines, the CHF would no doubt be well-supported as well. But regardless of the downside scenarios, there are sound reasons for Swiss franc appreciation too. As Robin Brooks highlighted in a recent Daily, CHF continues to be well supported by a good domestic fundamental story as well as a reduced threat of FX intervention, following the SNB’s unusually large interventions in May.
Another possible implication of a sharper risk sell-off would be the prospect of sharper EM FX depreciation and the impact on inflation, which would limit EM central banks’ flexibility on monetary policy. This is something that Themos Fiotakis discussed in a recent daily on July 1st.
7. EUR/$ Direction Less Clear and Hinges on Political Risk Premia
The EUR/$ direction though is less clear, in our baseline scenario of moderate broad Dollar weakness. Our fundamental view of the EUR has not changed despite the shift in our forecasts over the last few months. We largely see fundamentals as supportive but endogenous political risk premia will likely continue to exert a greater influence in driving the EUR, as we explained in June’s FX monthly.
If the political risk premia recedes, then the EUR/$ rally will have more room to extend and move more in line with Euro-zone-US growth differentials. But the jury is still out on this issue and it is too soon to sound the all clear. As Robin Brooks reiterated in Tuesday’s Daily, the main issue is that the EUR/$ still has potential political issues to contend with in the near-term. We would highlight the fact that we have only just seen the initial stages of the fiscal adjustment process in the Euro-zone and there is still the potential for heightened tension linked to unpopular policy and reform measures further down the road.
8. Current Trading Views
The following trading ideas from the Global Markets Group reflect shorter-term views, which may differ from the longer-term "structural" positions included in our "Top Trades" list further below.