G10 FX week ahead: Out of sight, out of mind

Markets shrugged off the events at Capitol Hill and are focusing on fiscal prospects under a Blue Senate. Despite having found some support on rising US Treasury yields, we expect the USD to resume its downtrend this week. Keep an eye on the ECB minutes on Thursday, while grim UK GDP may have a limited impact on GBP.

USD: Fed seeks to curb bond market’s enthusiasm

The first week of the new year has seen much focus on the US Treasury market. Here the rise in ten-year US Treasury yields to 1.10% has provided the dollar with a little support. Indeed, the US Treasury sell-off paid little heed to the soft December jobs report. The week ahead should also see more soft US data in the form of retail sales and consumer confidence – weighed by lockdowns, particularly on the West Coast. We will also see quite a few Fed speakers, probably delivering a message that US$120bn of monthly bond buying will last all year. That might be enough to slow some of the rise in US yields and take any sting out of a corrective $ rally.

The unedifying events on Capitol Hill have not really impacted FX markets. Instead, the focus rightly has been on the prospect for stimulus and reform under a Democrat-controlled Congress. This should be good news for US and global growth and as long as the Fed doesn’t take away the punchbowl, the dollar should stay offered. The week ahead will also see the first look at 4Q results from the US banks. Here the focus will be on the size of 4Q20 provisioning (more/less?), but the steeper US yield curve provides a good tailwind to the banking sector.     

EUR: ECB minutes and 4Q20 German GDP in focus

A little consolidation looks no bad thing for EUR/USD after a strong advance since November. And arguably it has held up quite well despite broadening lockdowns in Europe and criticism over a slow roll-out of vaccines. This week the focus will be on the minutes of the European Central Bank December meeting (much opposition to the larger QE programme) as well as the first look at 4Q20 German GDP. Our team feel it might be slightly better than expected at -0.5% quarter-on-quarter.

In reality none of the big global trends that have driven EUR/USD to 1.23 have changed. A Fed keeping the liquidity tap open and policy rates on the floor, plus strong inflows into EM and hopes for a 2H21 recovery are all largely intact. For the time being, then, we would expect to see good demand for EUR/$ below 1.22.

JPY: All about US yields

The yen’s short-term faith remains strictly connected to the volatile UST, with developments in US politics likely to stay in focus this week. On the domestic side, the decision to impose fresh containment measures in Tokyo and some surrounding prefectures appeared unavoidable, and this will inevitably take a toll on Japan’s recovery prospects and has possibly endorsed JPY weak momentum on the back of rising yields.

This week, Japan’s machine orders figures and the Tertiary Industry Index for November are set to look rather grim, but that may have limited implications for the yen.

GBP: Brexit risk out of the way and the USD weakness is to dominate

The positive impact from the UK-EU trade deal on GBP was short-lived and offset by the emergence of the new Covid variant, new restrictions and associated rise in expectations of Bank of England cuts. However, we expect the BoE to avoid bringing rates into negative. With plenty of bad news priced in and the vaccination under way (with the UK being ahead of the most of EU countries), downside risks to GBP should be fairly muted. Given the broad-based USD weakness in place, we are looking for more GBP/USD upside over the coming months and quarters, particularly when the speculative GBP/USD positioning remains neutral (as per the CFTC data).

On the domestic data front, the focus will be on the November monthly GDP number (Friday). It will reveal the scale of the negative effect of the November lockdown, which should help to gauge the severity of the current lockdown. But as per above, with plenty of bad news priced in, its effect on sterling should be limited.

AUD: Still buoyed by iron ore

The Aussie dollar continues to benefit from the extraordinary performance of iron ore, which moved back above $160/MT after a correction in late December. This is likely the key market to monitor for idiosyncratic outperformance of AUD against other pro-cyclicals as the global reflationary narrative appears to be consolidating after the Democrats gained control of the US Senate. 

Data-wise, there are no stand-outs this week in Australia. The China-Australia trade dispute remains another thread to follow, but AUD has so far not been impacted as the intense Chinese buying of iron ore has been perceived as offsetting the bans on coal and duties on other Australian exports.

NZD: Waiting for a sign from the RBNZ

NZD is set to continue following the general risk dynamics but, differently from AUD with iron ore, it appears to lack an idiosyncratic catalyst for the moment. Markets will likely await some comments by the Reserve Bank of New Zealand in the new year to gauge whether some fresh policy actions are on the cards after having fully priced out negative rates.

In particular, it will be key to gauge whether the RBNZ will more explicitly address its concerns around a strong NZD. In that sense, however, it must be noted that the NZD has appreciated to a smaller extent on a trade-weighted basis considering the currencies of its two main trading partners (China and Australia) have also appreciated recently. This week is scarce of data releases or central bank activity in New Zealand, but a continuation of the risk-on/USD-off narrative may continue to offer support to NZD/USD.

CAD: Staying supported

Canada saw a contraction in hiring for the first time since April as fresh virus-containment restrictions started to hinder the otherwise strong recovery in the jobs market. Despite the drop in employment in December exceeded expectations, there are some silver linings. The fall was all attributable to part-time workers as full-time employment actually rose. Incidentally, the unemployment rate rose by only 0.1%, to 8.6%.

This week, the only stand-out in Canada data-wise is the Bank of Canada Business Outlook, which will help gauge the pace of the economic recovery in 4Q. Any developments in US politics and stimulus-related news are set to keep playing a role for the highly exposed CAD. Also, keep an eye on the OPEC’s release of the supply and demand projections this week. Overall, we expect USD/CAD to remain under some mild pressure next week.

CHF: Keep an eye on Italian politics

Despite markets not showing any reactiveness so far, the Italian political situation is raising some concerns. The ruling coalition has experienced intense disagreement on the EU Recovery Plan and whether to activate the ESM for health-related expenses. Former PM Matteo Renzi’s party has been threatening to pull their support to the government, which may cause either a reshuffle (which might involve a change of PM) in the cabinet or, in the worst case, early elections.

We are reluctant to think Italy is heading to early election in the current emergency situation, especially considering the ruling parties would have no benefit from a vote now, according to all opinion polls. If anything, a cabinet reshuffle looks more likely. CHF is the quintessential safe-haven when it comes to European political turmoil, and tends to have strong correlations with the BTP-Bund spread when markets feel the Italian political risk is rising. It’s worth monitoring the situation as markets may start to react to the news-flow if the prospect of a government crisis rises in the coming days. Elsewhere, no data releases worth mentioning in Switzerland and other significant moves in EUR/CHF this week will likely depend on any surprise from the ECB minutes.

NOK: The usual meaningful gains in the seasonally strong January

Seasonally, January is the strongest month for NOK and reflects the current krone outperformance. We expect the pace of NOK gains to slow from February onwards, but EUR/NOK should continue to dip lower, helped by the supportive external environment. With general risk environment remaining benign, the near-term bias remains for lower EUR/NOK, with the pair moving towards 10.20 next week.

On the data front, the underlying Dec CPI has risen to 3%YoY. The underlying CPI is set to rise above 3%. Although the new wave of Covid restrictions reduced the scope for imminent hawkish Norges Bank bias, the rising prices and the eventual post winter economic recovery will allow the NB to move towards tightening. While we don’t expect a NB rate hike this year, we see it as likely that the central bank will bring forward expectations of the first rate hike (to be delivered in 2022).

SEK: More gains ahead

SEK outlook continues to look bright. Despite the rising Covid cases globally, the market is focused on the post winter rebound which should benefit currencies of small open economies levered to global growth such as SEK. Further gains in EUR/USD are also adding to SEK attractiveness and helping EUR/SEK in its grind lower. Next week should be no different, with a modest downside to the cross. EUR/SEK to test the psychological 10.00 level.

December inflation is published on Friday with both CPI and CPIF expected to increase modestly. Still, compared to Norway, Swedish inflation pressures remain very muted, reiterating the divergence between the two central banks (the NB moving towards signalling an earlier rate hike this year vs the Riksbank remaining on hold and possibly trying to lean against SEK strength should the currency gains be excessive).

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