'EURUSD to challenge 1.0458, will probably attempt 1.000 after New Year' - Marshall Gittler, FX Primus

MARSHALL GITTLER
PROFILE
• Current Job: Head of Investment Research at FX Primus
• Career: More than 30 years researching the markets. Has worked for UBS, Merrill Lynch, Bank of America and Deutsche Bank among others.

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Marshall Gittler is a renowned expert in the field of fundamental analysis, with over 30 years’ experience researching the markets. His career spans a range of elite investment banks and international securities firms including UBS, Merrill Lynch, Bank of America and Deutsche Bank.

Marshall has established himself as global thought leader for clients of FXPRIMUS – a global provider of online trading – educating and delivering high level FX research, helping traders to make the best trading decisions.

What kind of central bank action are you expecting on December? Do you believe the ECB will extend the QE program? Will the Fed finally hike interest rates?

I expect action from both the ECB and the Fed next month. ECB President Draghi for example dropped several hints in his recent presentation to the European Parliament that indicate the Council’s view is less sanguine than it was back in March, when the ECB staff first made its inflation forecasts incorporating the impact of the ECB’s QE program. Recent comments from senior ECB members suggest that Governing Council is likely to follow the lead of Switzerland, Denmark and Sweden and cut its deposit rate further into negative territory. This would be a large-scale experiment in monetary policy as it would be the first major central bank to try such a move.

As for whether they increase the amount of their QE program or extend its duration, it’s clear that they have been laying the groundwork for such a move by increasing the limit of how much of each bond issue they can buy and expanding the range of bonds. However, given the success that the ECB has had so far in boosting bank lending, I think they might be content to hold fire on this point at the December meeting in case they need to make further moves later on. 

By contrast, the Fed is likely to hike rates two weeks later. The Fed surprised the market by holding fire in September despite many hints that it would move, but it kept alive the possibility of a rate hike in December. Having successfully pushed market expectations for the December meeting back up, the Fed will not want to reverse course yet again; that would make a joke of its “transparency” and make it look more like a day trader than a body focused on the medium term. I expect that they will raise the Fed funds rate back up to 25 bps, albeit with numerous caveats about how future hikes will be slower than in the future, this does not portend an immediate series of hikes, the terminal rate will be lower than in the past, etc. etc.

What is your year-end forecast for the EUR/USD? 

Negative short-term rates have a more direct impact on the exchange rate than bond purchases do, because FX speculation is generally more related to short-term rates than to long-term rates. Hence I expect that a cut by the ECB deeper into negative territory would be likely to push EUR/USD down further. The market is already discounting a 10 bp cut in the depo rate by the December meeting and a total of around 16 bps in cuts by Q3, but I think there is still room for expectations to be lowered further. If the ECB gives the impression that further cuts are in store, the market could lower its expectations for the terminal rate. 

Meanwhile, there is a huge gap between the FOMC’s expectations for rates at end-2016 (1.46%) and the market’s (0.80%). As the Fed starts hiking rates, investors are likely to reconsider their forecasts and revise their expectations upwards. 

The combination of these two forces – one pushing EUR down, the other pushing USD up – are likely to cause EUR/USD to challenge and break through the previous 2015 low of 1.0458, in my view. If that happens, the market will probably make an attempt at the 1.000 line, although that might not happen until in the New Year.. 

Can the JPY lose its safe-haven value if the BoJ extends the QE program?

First, I don’t expect the BoJ to extend its QE program, because it is already buying up so much of the Japanese Government Bond (JGB) market that it is causing problems for financial institutions that need to hold bonds, such as banks and insurance companies. Rather, I think they are likely to follow the ECB and institute negative interest rates, which seems to be the latest fashion among central banks. That would be a new and dramatic move for the BoJ.

Secondly, we have to look at exactly why the JPY has a safe-haven function. It’s certainly not because the Japanese currency is particularly sound. On the contrary, the country’s gross debt/GDP ratio is the worst in the world, far worse than even Greece (although the net debt story is different). Rather, research suggests that the safe-haven effect comes from the fact that Japanese investors hold massive positions in overseas assets and tend to adjust their currency hedges rapidly when there is a change in the global situation or in their risk appetite. 

So we have to ask: will negative interest rates change their risk appetite or their behavior? If negative interest rates extend to retail accounts, then there would probably be a massive outflow of funds from Japan, because Japanese companies hold considerable liquidity. So far though Switzerland and other countries with negative rates have managed to insulate their account holders from the effect. My discussions with officials at the Bank of Japan some time ago left me with the impression that Japan would try to do so as well. Japanese citizens are already comfortable holding considerable cash, they are afraid that if retail accounts imposed negative rates, people would simply withdraw all their money from the banks, causing the banking system to collapse. Corporate accounts may be a different story, however. 

But in any event, if negative rates send the yen lower – as I expect they would do -- and create the expectation that the yen is likely to continue to depreciate, then investors would probably be less anxious about responding quickly to short-term changes in the risk environment. They might also lift their currency hedges. In that case, yes I think we could see less of a response in the yen whenever global risk appetite declined. .

Do you think China will need to continue loosening its monetary policy in order to reach their 7% growth target?

It looks to me like China has given up on its 7% growth target and is likely to lower the target further next year. At the same time, the economy is clearly slowing and I expect the authorities to continue to loosen monetary policy to prevent growth from slowing too quickly. Exports are falling. Many companies are saddled with debts and having difficulty meeting payments. For example, just last week the nation saw its largest-ever bond default. The move is a harbinger of more defaults to come, which is bound to push up the risk premium on corporate bonds. To offset this market-created tightening, the authorities will have to continue to loosen policy in order to support companies that are struggling to pay back their loans and thereby soften the transition from export-led growth to domestic-demand-led growth. I think some further weakening of the CNY could be part of this looser monetary policy.

Do we have an ongoing currency war?

I think we have an inadvertent currency war. Most countries are worried about either deflation (G10) or sluggish exports (EM). The countries worried about deflation are cutting interest rates (or at least keeping them at historically low levels) and in some cases increasing their QE programs. This naturally depresses their currencies, which further depresses the exports of the EM countries. That encourages the EM countries to prevent their currencies from appreciating in order to defend their share of a shrinking market. We saw the results most markedly when China devalued the CNY in August and Vietnam and Kazakhstan quickly responded in kind, while the Fed held off from a widely anticipated rate hike in September. I don’t see any way out of this problem so long as monetary policy is one of the major drivers of currency rates and is also the major policy tool used to fight deflation.   

What about oil? On the long-term, where do you think WTI barrels can find their bottom?

Former Saudi Arabian oil minister Sheik Ahmed Zaki Yamani famously said, “The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.” In the long term, I expect renewable power, particularly solar, to provide the bulk of the world’s energy needs and the demand for oil to drop dramatically – perhaps it will be used mostly for its use as a lubricant, for asphalt, and for energy where electricity is impractical, such as ships and airplanes (although the solar-powered plane Solar Impulse, which managed to fly around the world on solar power alone, may prove even that prediction wrong). Even gloomy Germany produces 7% of its total electricity consumption from solar power, while oil-producing Texas generates so much power from wind farms that many power companies give electricity away for free at night. Given the accelerating pace at which the technology is improving, I expect that 10 years from now the world’s energy mix will be totally different than it is now. 

However, that probably is a longer-term prediction than you are asking about. For the moment we are caught in a trap similar to the “currency wars” mentioned above. Many of the major oil producers are in financial difficulty – Venezuela, Libya, Iraq, Russia, even rich Saudi Arabia, and soon Iran – and so are fighting to maintain their market share. They had hoped that low oil prices would knock out the US shale oil production, but this hasn’t gone exactly to plan as US production has remained relatively robust. 

Meanwhile, lower prices have caused an increase in gasoline demand, but not enough to reduce US oil inventories, which are still about 25% higher than usual at this time. At the same time, the slowing Chinese economy means demand for oil there is likely to slow too. 

On top of which, this year we are seeing one of the strongest strong El Niño events ever recorded. That will result in unusually warm weather in many places. Canada for example expects one of the warmest winters on record, and the US may see less snow than normal. Europe is less affected by the El Niño and temperatures here are expected to be close to normal. 

To make matters worse, storage tanks are filling up and even ships to store oil are getting in short supply. 

It was notable too that the Paris bombings and French retaliation caused only a temporary blip in the oil price and did not prevent the price falling from the previous day. That speaks volumes about the market’s total lack of fear about future availability. 

In sum, I think the supply/demand balance is still tilted solidly in oversupply and I expect oil prices to continue to decline, perhaps even into the $20/bbl region. At that point I think the US shale production would be hit hard enough to rectify the balance somewhat.