FP Markets Weekly Insight – Tuesday 21st February
- Interpreting USD’s sharp pullback
- Opportunities in a risk supportive trade environment
- Key data events
- Developing tech set-ups
Last weeks USD price action has given us understanding of how the consensus view of a stronger USD is developing. The USD made a significant rally in response to Fed Chair Janet Yellen’s hawkish tilt and US CPI figures beating. However the USD struggled reversing most of its gains ending the week vs JPY(-0.35%), AUD(0.16%), CAD(0.2%), EUR(0.2%) and GBP(0.48%).
So much is currently priced into the dollar and we shift our stance to neutral until we gain further insight from the Administration in regards to their infrastructure spending and planned tax cuts which may provide the stimulus for the next leg in the USD trend.
We assess the USD framework and positioning in the following questions:
1) What caused the USD to reverse past week’s gains?
Low real yields caused the USD to underperform. From face value it would seem Fed Chair Yellen’s stance was hawkish however the status of the Fed’s monetary policy is still highly accommodative as the real Fed Funds rate remains restrained allowing US markets to continue their pro-cyclical nature with equity markets reaching new highs and the USD rallying in reaction to a hawkish Yellen.
Inflation breakevens continue to rise while the US 10y Treasury rate struggles to break through 2.5% and has been range bound since reaching a high of 2.64% in December 2016. Figure 1 highlights the nature of low US real yields while the US 10y Treasury yield continues to drift lower.
2) What trading opportunities does this provide?
The outcome for markets is risk is being supported on the back of low US real yields, higher commodity prices, Trump’s rhetoric shifting away from trade, potential tax reforms and the PBOC maintaining a stable CNY. The foundation for a stronger USD remains but until we gain more clarity from the Administration we shift to being neutral the USD. We see more upside being long EM (Emerging Markets) and commodity currencies vs EUR and JPY. We see CAD outperforming AUD and NZD in the DM (Developed MarketS) commodity space driven by oil prices remaining around current levels and yield differentials favouring CAD longs.
Figure 2 highlights that, although an important driver of USDJPY, US 10y yields and 2y yield differentials are taking a back seat to risk sentiment as relative equity exhibits a higher correlation to JPY futures.
Figure 2: 1m rolling correlation
3) What are the risks?
There are a large number of risk events that will drive markets throughout 2017 each of which has a broad range of outcomes. The administration have not delivered a clear vision on trade policy as of yet but this may change now that Treasury Secretary Steve Mnuchin has been approved. If the administration do go through with their inward looking protectionist trade policy the result would be an inefficient allocation of capital and further inflationary pressures which would support a higher USD as the Fed will have to adopt a more hawkish stance while the trade policy would be a significant drag on global growth. If protectionist rhetoric shifts back into focus then AxJ (Asia excluding Japan) trade based economies will be most affected. We would use that as an opportunity to short SGD and KRW.
Key Data Events
|USD||· FOMC minutes (Thursday 23rd, 6:00am)
· New Home Sales (Saturday 25th 2:00am)
|EUR||· German PMI (Tuesday 21st 7:30pm)
· CPI (Wednesday 22nd 9:00pm)
· German GDP (Thursday 23rd 6:00pm)
|JPY||· Trade (Monday 20th 10:50am)
· PMI (Tuesday 21st 11:30am)
|CHF||· Trade (Tuesday 21st 6:00pm)|
|GBP||· BoE Gov Carney Speaks (Tuesday 21st 9:00pm)
· GDP (Wednesday 22nd 8:30pm)
|CAD||· Retail Sales (Thursday 21st 00:30am)
· CPI (Saturday 25th 00:30am)
|AUD||· RBA Minutes (Tuesday 21st 11:30am)
· Wages (Wednesday 22nd 11:30am)
· Capex (Thursday 23rd 11:30am)
|NZD||· PPI (Monday 20th 8:45am)|
Times are AEDT
1. GBPJPY has found strong demand at lows which should see the multi-month downtrend be tested
2. EURGBP has formed a head and shoulders