FX and Gold Weekly: Selective dollar selling maintains appeal, gold uptrend remains firm

With many countries in the West attempting to reopen their economies, attention has turned to whether new infection rates will remain low as mobility picks up. Even if the reopening momentum takes risk assets broadly higher over the near term, it might still be too early to sell the dollar with reckless abandonment. But selectively? Yes.

The Chinese Yuan 

Despite the improved tone on trade via a planned US-China trade chiefs call this week. Most Yuan watchers believe the latest trade calming comments will fall well short of settling the bilateral and what could soon emerge as multi-pronged disputes more generally – particularly in light of the upcoming US presidential election, which will see both parties charging the election stage with trade war playbooks in hand. Notwithstanding the difficulty China may face in meeting the $200bn purchase agreement.

This noise is causing much bidirectional risk for the Yuan, despite the market sidestepping and placing on the backburner President Trump's first significant trade salvo in a while. But history reminds us that trade war news flow usually recycles in fits and starts.

On the one hand, it’s not in China's best interest to weaken the Yuan and fan the global trade war flames. Assuming both parties confirm the modest tariff reduction under the 'Phase one' agreement after this week's phone call, the Yuan could move back down to 7.05 level, which then brings the year-end 6.95 back into play. 

President Trump indicated on Wednesday that he would report on China's progress buying US imports "in about a week or two." Rising US-China tensions can affect Yuan negatively – and quickly – by reducing cross-border portfolio inflows flows.

So, until President Trump gives the all-clear signal that China intends to honor their trade commitments, we could see traders enter long USDCNH hedges on dips as a trade war insurance hedge.

If you believe that we’re rotating from the equity rebound / Flattening the Curve / Fed Largesse to a more sinister Blame Game increasing the risk of China repatriations, then long USDCNH is the easy way to play it.

The Euro 

On a narrow reading, the German Constitutional Court's request for the ECB to show that its first sovereign QE program (PSPP) was "proportional" doesn't look like a bridge too far to cross. But the broader implications for markets are more worrisome, in part because it reinforces the view that ECB is operating under certain limitations and remain bridled to antiquated policy constraints ill-suited for this current crisis. So, it may mean market pressure, equity market rout, or the EURUSD trading considerably lower to be the compelling mechanism for any further steps toward fiscal risk-sharing. So, amid the Eurozone legal squabbling, there could remain downside pressure on the EURUSD at least until the debt mutualization issues are resolved.

The Norwegian Krone

Norges Bank surprised the market by cutting its policy rate to zero last week. However, the Executive Committee made clear that it does not plan to cut rates into negative territory and revealed that it intervened to support the currency to the tune of NOK 3.5bn in late March. 

Interest rate policy transmission via a one-off rate cut does not change the fundamental picture for the currency (or any currency for that matter), given depressed front-end rates across the G10. Moreover, the country stands to benefit from the rebound in oil prices, reiterating my positive outlook.

The Japanese Yen 

The Yen has a favorable balance between a currency that’s cheap on most metrics but doesn’t have a cost of carry as a disadvantage and acting as an anvil on its back. 

And although there have been numerous stops and starts in Japan's attempt to exit from the virus, it’s certainly one of the more advanced North Asia countries and is leaps and bounds ahead of the EUR area and North America. 

With the Eurozone trials and tribulations over providing a unified policy response to the crisis, it’s tending to highlight the Yen as a significant currency alternative. That’s reflected being in downward pressure on EURJPY.

Generally during a recessionary time it’s higher oil price shocks that result in terms of trade imbalances for the Yen. This time around, with oil prices languishing, it will be a boost to terms of trade from the start of the recovery. While positioning is starting to lean long Yen (mostly via EURJPY), it’s far from overextended outside the bump up seen in CFTC asset manager positions; equivalent leverage positioning is very modest.

With the GPIF is finishing off its global bond-buying splurge, there are positive signs that Japanese real money is starting to shift their flows and, more importantly, their hedge ratios on the outstanding stock of foreign assets. 

Since 2018 Japanese life insurers have been running low hedge ratios on their USD assets, due to the stronger dollar. If the Yen veers below Y105 and lurks there for a while – which is widely viewed as the trough in the long term rage trade play – it may trigger Japanese lifers into action, then higher Japanese hedge ratios on USD assets will drive the USD/JPY lower in a cascading effect. We’re not there yet, but the markets are moving in that direction and could be worth putting a few bob or two on the stronger Yen narrative as the currency hasn’t been this captivating in years.

The Malaysian Ringgit 

The Ringgit should trade on more stable footing, supported by rising Brent crude oil prices. However, regional optimism remains slightly tarnished by the coronavirus blame-game and a looming US Presidential election which could prove to be a toxic recipe for US-China relations, with  Politics, Trade, Technology and Capital markets again the critical fissure points.

Short term currency trades 

The US dollar can selectively sell-off if investors differentiate those economies returning to social normalcy sooner; Australia, China, New Zealand, South Korea, Sweden and Taiwan are out in front on this metric. Although, worries about another wave of coronavirus infections could complicate these trades.

Gold market 

The US jobs report tarnished gold’s lustre as focus shifted from the headline data to the positive rebound in hourly earning. Before NFP, gold traded up, building on substantial gains made the previous day. Firm prices in Europe and Asia lasted into early US trading. Gold rallied despite the broader financial markets adopting a mild "risk-on" tone, which is usually unfavorable for gold. But that correlation has broken down of late as equity market "risk-on "appetite is primarily driven by central bank largesse, which is equally supportive for gold. 

Gold took a knock, but the uptrend remains firm since it has a plethora of factors in its favor –none more so than the latest Eurozone legal imbroglio. Germany's former finance minister, Wolfgang Schaeuble, said the German constitutional court's ruling means "the existence of the Euro may be now put into question in other European Union member states" (Redaktionsnetzwerk Deutschland). This is the kind of comment that can add jet fuel to the gold rally.

While the trade war flames eased into the weekend, based on telephone talks between US and Chinese officials this week, it’s far too early to put these frictions to bed .

Even herd immunity may not mean the end to the gold rally, while debt increases will play a key in the background and will eventually lead to the dollar demise.

On the surface, the USD seems destined not to crack, not because it’s stable but because there remain few alternatives. Once investors find a non-US investment alternative that’s attractive, perhaps the worm then turns on the Greenback. In the meantime it’s going to be a grind being short US dollars, but not extremely attractive to own them either with little carry to show. 

The first signs of a crack in the US dollar dominance could occur via the Yen, so USDJPY 106-105.50 could be a significant signpost for gold traders. Still, you probably want to back up the truck on dips before that Yen trade eventuates as you might be looking back at XAUUSD $1,700 with nostalgic longing.