Submitted by By Shant Movsesian and Rajan Dhall MSTA of FXdailyterminal.com
At the very start of the year, we recall the chorus of projections for EUR/USD to fall below parity, warranted by the euphoria over the Trump administration's plans for a tax overhaul alongside the reform plans for healthcare, and allied to the assumption that Europe had too many headwinds to negotiate in order for underlying growth to impact significantly on the region. Some were even calling for levels as low as 0.9500 and 0.9000. Five months into the year and with the French elections voting in Emmanuel Macron, there was renewed confidence, and with recovery still pushing ahead, the shift in sentiment was near tidal as outside calls for 1.2000 became the consensus and hedge funds and money managers poured into the EUR across the board. We saw EUR/CHF shaken out of its coma, with the SNB naturally welcoming the move back above 1.1000 and later 1.1500 - though as an aside, the Swiss central bank still believes the EUR is overvalued - the ECB are more worried about the speed of appreciation in the USD rate.
1.2000 achieved, it was not long before momentum kicked in and all and sundry were then looking for 1.2500, but all the while paying scant attention to time-frame, which is an all too forgotten metric in the markets these days. The correction was due, and as we cited a few weeks back, it was a matter of where we based out, and this ranged from 1.1700 down to 1.1200 (ish) based on technical factors which we have tried to align with the US yield curve. The Fed's dot plot has eased off a touch, but the market has been significantly more downbeat, not least of all due to the multitude of obstacles standing in the way of tax reform first and foremost. We will ignore the US equity markets, which seem to be running on their own rules at the present time, but the USD has naturally suffered, and by the sheer weighting in the USD index, the EUR has benefited the most.
Looking at the Euro wide data on the leading economies, few can argue with the numbers, and with the likelihood of some of the key financial business migrating away from London, the prospects continue to look good for the continent. Even so, the undercurrent of political fragmentation, which - let's not forget - brought Marine Le Pen into the final vote, and the latest collapse in German coalition talks are all a recipe for potential instability, which at the very least should see an element of 'discount' in the EUR rate to some degree. We also have the Italian elections next which are also a cause for some concern, as are those on NPLs within in a number of notable banks - not just in Italy.
If we do push past 1.2000 next week, sellers will be looking to fade this on some of these factors, and we also have to factor in the Dec Fed hike, which is an opportunity for the FOMC not to miss as normalisation is still very much on the agenda, albeit slightly more gradual than before.
Inflation is a worry across the globe, and we await the time when this near obsessive focus in the market fades away. For not though, we get the latest CPI rate (Nov) on Thursday, with Germany and Spain releasing their prelim numbers the day before. French, Spanish and Italian Q3 GDP numbers are also due out in the latter half of the week - all EU wide manufacturing PMIs on Friday.
In the US, standout is the Q3 GDP release on Wednesday with its latest revisions, and on Thursday, the core PCE index is expected to tick up, and is released at the same time as personal income and spending data. US payrolls is released on Friday the week after, but the Nov manufacturing ISM is out at the end of next week, with the employment index having shown a healthy correlation to job numbers.
Key data in Japan next week; not least of all the inflation numbers on Thursday, but the BoJ will be watching the core rates given the strong rise in Oil prices which should lift the headline. As such, the JPY will stick to its funding status, and despite rumblings over persistent negative rates hurting banks as well as the huge asset buying fuelling an inflationary surge down the line, the price action suggests the market is not taking notice for now. We can see this in evidence in the way EUR/JPY keeps bouncing back, while losses in USD/JPY have been pretty orderly.
Good times for Sterling as the recent data run shows the economy is holding up. No one - certainly not us - is suggesting a complete break down in EU talks will mean an outright collapse in the UK economy, but pushing GBP higher from current levels on an eventual stabilisation in Brexit and the consequent developments looks premature as yet. Those buying the Pound on the interest rate perspective would also do well to book profits now, as this seems to be fading with the BoE looking for 2 more rate hikes in the next 3 years. This looks to have been a clever communication 'hedge' of sorts, with Brexit to and fros always on hand to vindicate a change of heart within the MPC.
On Brexit - the only driver of trade next week with no data on the schedule of note - the leading obstacle now standing in the way of progress to phase 2 talks on trade is the hard border issue in Ireland. Northern Ireland will not entertain any differentiation in the agreement with the rest of Britain; more specifically the customs union. With the Irish government itself dealing with internal issues which will dilute the decision making process, the deadline of the EU summit will be seriously tested - and we are being conservative here. The divorce bill is still also an issue as the increased offer from PM May will likely be subject to concessions on trade - something which the EU have been not committal on so far, so there there is every reason to believe the optimism based rise in GBP could start to fade soon. 1.3400 and 1.3460 are key technical levels in Cable to watch out for, but in EUR/GBP we are already looking to the upper end of the range. Clear 0.9050, and we could see some fresh upside traction developing.
Trade negotiations for Canada - with the US and Mexico - are also hitting road-blocs, with the hard line drive by the US to implement measures to reduce their trade deficit the focal point for talks. Naturally this would come up against resistance, and Canada's Freeland was sanguine in her expectations as a result. This does not seem to be having much of an impact on CAD, though nor is Oil price as it continues to try and push on to new highs. Rather the spot rate is now settling into a near term range with a slight skew to the upside based on fair value, which we continue to see in the 1.2500-1.2700 area. The BoC have successfully reined in the hawkish market view on interest rates, so we are now back to data watching, and next week, we have Sep GDP and Nov payrolls to look to in Friday's trading session. USD sentiment will dictate until then, with support against the USD see at 1.2670. Price action suggests a breach of this level will not yield much momentum just yet.
Rate rises in Australia have also been priced out, but these were more so over the medium term. 2018 expectations were centred around the mid point of the year when the RBA would add another 25bps on rates, but slow wage growth and the CPI rate falling out of the central bank range have all but erased these projections. The RBA ares still confident of economic pick up, but the market needs a little more to push AUD/USD materially higher from its recent lows, having based out ahead of 0.7500. Next week we get some CapEx data on Thursday as well as credit numbers, which in the current light are attracting plenty of attention as does high household debt levels - a key concern in Canada also.
Less focus on this in NZ, where private debt to GDP is less than 100% compared to 233% in Australia and 267% in Canada. For comparison, the US is 200%. Liquidity issues as well as economies to scale have been bypassed in the recent upside seen, which saw the spot rate breaching 0.7500, but we still have to look forward to the Labour led coalition policy intent, to see whether the NZD can outperform from current levels. AUD/NZD is looking more intent on the downside these days. Sub 1.0900 here could spark a return to much lower levels, which in turn could finally push NZD/USD back through 0.7000.