FX Focus: Confusion and uncertainty reigns

There is a mixture of confusion and uncertainty in the market currently, with the traditional correlations having seemingly broken down as the escalation of a trade war looms on the horizon.  

President Trump is showing no signs of holding back on his trade offensive with the rest of the world, as he seeks to rectify the imbalances (injustices) which have seen the US deficit (on trade) balloon over years and decades.  His crusade is relentless, and it is fair to say that risk assets are sitting uncomfortably at the present time.  

That said, notable is the sell-off in gold, which continues to come under pressure into the mid $1,200's, but we can only assume that central bank selling is largely behind this at a time when safe havens would be expected to be in demand.  

Some will say, and have said, that the trade tensions are being overstated and this is borne out through the resilience seen in the equity markets, where we have seen the NASDAQ hitting new record highs in the past week.  

No surprise then that the FX market is holding off a wholesale flight to safety into the likes of the Japanese yen (JPY) and Swiss franc (CHF), where both spot rates remain close to their respective highs.  

The US dollar (USD) is enjoying a dual status of both a rates (risk) play and that of investor (safe) haven at the present time, but the upside momentum in the greenback has started to fade and we saw a clear sign of this at the end of last week. 

In the latter half of this week we get some fresh US data, chief being the May core PCE data as one of the key Fed metrics.  Even if we get a continuation of the pace of 0.2%, the market has now effectively priced in four interest rate hikes in 2018. 

So, only a major acceleration in consumption expenditure will reinforce the steeper rate profile in the short end of the curve, and even then, we have to wait and see what impact this has on long end yields.  

Curve flattening may well be one of the key factors in the restraint in the USD at current levels, as well as the fact that the turnaround in bearish sentiment at the start of the year has been very aggressive. 

US durable goods for May are also out this week and can be pretty volatile, especially in the current tense environment.  Q1 GDP is also out, but this is the final reading and the market has already switched its focus onto Q2. 

Consequently, buyers of USD/JPY have struggled when the price has neared the 111.00 level.  More recently, selling through 110.50 has been resolute, but, as long as we hold above the 107.90-108.20 area, we are in a consolidation phase here for now.  

Trade tensions seem to be having a marginal impact on the pair and more on the cross rates, but this is largely down to familiar defiance, if not complacency which threatens to unravel at any time, so investors will be ever mindful of this.  

Technically, there is strong resistance into the 111.70-112.00 area higher up, but, as we have already noted, it will take a much more congenial mood among the major trading nations to encourage traders to test these levels, so focus remains more to the downside. 

Past performance is not a guide to future performance

Aussie dollar (AUD)/JPY is a traditionally highly correlated pair with global risk sentiment, and despite the low volatility seen lately, the cross rate is hovering ominously above the recent base seen in the mid 80.00's.  

We have a similar situation in New Zealand dollar (NZD)/JPY where the mid 75.00's and 74.00's are in the spotlight, but it is worth noting that both the AUD and NZD spot rates have lost considerable ground against the USD in recent months, and have recovered ground against the Euro (EUR) and GBP which have caught up with the rest of the pack vs the USD. 

EUR/USD losses have taken us to lows seen just ahead of 1.1500.  Last week we tested this level for the second time, but demand was too strong to breach, and largely on the over-extension in the USD we have already touched on.  

It was only 10 weeks ago we were trading highs around 1.2400, so this puts the 'readjustment' in the exchange rate into perspective, though the political backdrop in Italy - and also Germany - has added to the negative bias over this time.  

On Friday we saw the recovery extending into the mid to upper 1.1600's before we ran out of steam, and starting off the week again, there seems to be a little indecision into the 1.1600 level, which suggests the correction higher may have been prematurely curtailed.

Past performance is not a guide to future performance

On Friday, we get the June reading of EU CPI which should see another rise based on the sharp drop in the EUR, but energy prices have dropped significantly also, so this prompts modest expectations of a headline rise to 2.0%, which, although in line with ECB targets, is somewhat redundant given the core rate is barely holding above the 1.0% mark.  

The European Central Bank (ECB) has set out its framework on how it will exit the asset purchase programme, and has made it clear that rates will not be moving (up) until after mid-2019.  This seems to have been questioned by some members of the governing council according to source reports, but we have to look to the next tranche of growth stats, where the manufacturing PMIs show limited promise as yet.  

EU-wide sentiment indices are due out later in the week as well as German employment and consumer stats, but the current negative tone is having limited impact over real money flow it seems.  At this point it time, it would be very hard to suggest that the EUR will gain any favour during times of risk off, as it has done in previous episodes seen last year. 

Tough times for the pound again as Theresa May is getting pulled left and right from pro-EU and hard-line MPs on how the government should approach the EU talks.  Over the weekend we saw a march in London protesting for closer alignment with Europe, but along with the warnings from UK-based enterprises over continued uncertainty and lack of progress, Brexiteers continue to dig their heels in and are now urging the PM to underline the fact that the UK is ready to walk away without a trade deal.  

The EU summit meets this week where immigration will be top of the agenda given the political ramifications in Germany and Italy, but there will no doubt be discussions on the collective stance towards the UK.  

On the domestic front, the Bank of England (BoE) split may be moving the way of the hawks with Andy Haldane voting for a hike last week.  Markets are clearly sceptical in the current climate, but some of the more recent data keeps hopes alive that Q1 weakness was temporary, which was indeed the major factor in Haldane's dissent.  

McCafferty is set to resign his position on the Monetary Policy Committee later this year, so we have to watch out for potential candidates for his replacement and naturally their prospective (economic) bias.  

Past performance is not a guide to future performance

The 1.3480 level was very strong when challenged nearly two weeks ago, but the post BoE rally petered out above the 1.3300 mark, and we are now looking at a potential return to sub 1.3200 levels.  

The lack of conviction, however, suggests 1.3100 may not be tested quite yet, but if so, faces strong demand at this level and into 1.3040-50 below here. EUR/GBP gains have the added support from central bank demand usually seen towards the end of the month, but heavy offers either side of 0.8800 are going nowhere, and it will need a strong catalyst to push the cross rate to the next key levels on the upside just above 0.8900.  

At the end of the week, we get the final reading of Q1 GDP, where some have suggested that this may be marked down yet again.  This will have been largely priced in, and the focus is on growth and data going forward, though the market could be sensitive to the business investment data in light of the comments from Airbus and BMW last week.  

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