Never A Dull Moment in the World of Foreign Exchange

Never A Dull Moment in the World of Foreign Exchange. 

As we move into the second trading week of 2017 two major macro narratives, continue to evolve, China FX policy & US interest rates. Moreover, for traders who were expecting a free lunch in early 2017, going long USD and short bonds, the market quickly reminded that nothing comes easy in the world of Foreign Exchange as early 2017 has been full of twists and turns. You know the old saying, there is no dull moment in the world of FX, and last week was the proof in the pudding.

I think the exaggerated moves in G-10 last week were more about heavily skewed short term long USD positioning jitters after a subtle shift in  Investor sentiment emerged suggesting the recent moves in US yield have run up far too quickly.  This notion could dampen USD bull’s short-term enthusiasm, and despite supportive US data, the USD may continue to consolidate before the anticipated resumptions of the USD uptrend, which should return full-bore post-Trump inauguration.

As for the near-term calendar, although not jam-packed, we may be in for some excitement none the less. Tuesday could be very engaging if Chinese CPI or PPI deviates from expectations and of course, the Aussie traders will dial in on domestic retail sales that same day.

With attention squarely on China this week, the Aussie could re-emerge as the quintessential China proxy trade.

However, I am focusing on Friday when Fed chair Janet Yellen is delivering a Thursday night EST speech, which will be available on webcast. Given the markets focus on all things Feds these days, we could be in for bustling APAC session to end the week. Also, China’s December trade report will be released that same day.

 

NFP

Traders were treating last Friday’s NFP with little importance ahead of President-Elect Trump’s inauguration and possible policy game changers.  While the 156 K rise in non-farm payrolls in December fell short of market expectations, However, the huge story that emerged was the sharp gain in average hourly earning ( AHE), which was the call to action for traders as the employment report was viewed in a positive light.   Keep in mind that both resurgent wage inflation coupled with buoyant oil prices have been supporting the reflation trade. So US bond yields rose on the  AHE headline and a stronger USD ensued. Despite the 10 Year UST yield moving higher to 2.42-3 %  after a holiday-induced position squaring rally, the S &P closed at a record higher while the Dow Jones closed at 19,963.8, just shy of the major psychological 20,000 mark

Non-aggressive USD buying mainly centred on USDJPY, EURUSD, and USDSGD

 

 AUD

While the Aussie dollar closed the year on an offered note, and the odds of that bias to re-emerge strong,  the recent sell-off in USDCNH  has permeated into strength in commodity currencies as Aussie remains tentatively perched just below the  .7300 level.

If you’re surprised by the uptick in volatility to start the year, you are not alone as the vicious wave of short CNH covering on the back of ridiculous funding costs has caught more than a few traders by surprise. Also, while the effects have spilt over to the G-10 basket as memories of the 2016 China Hysteria gripped the market. The fact is it appears to be more or less a CNH contained phenomenon and has not affected market sentiment anywhere near the panic levels of early 2016.

As the CNH effect begins to temper, the fact remains not a great deal has changed in the Aussie trade. The tug of war between commodity prices and rising US interest rates will continue to play out as will the possible trade disruption from the political uncertainty associated with the US Presidential transition and regional trade sanctions.

However, asset classes continue to trade favourably, and commodities trade bid on expectations of the massive US infrastructure spend.So if current price action is telling us anything, it’s that commodity currency should continue to hold up well even in the face of a continued USD uptrend

However, the commodity block remains intrinsically linked to the price of oil and with both OPEC and NON -OPEC member’s assurance to turn off the spigots, prices should rise. However, the fly in the ointment remains Shale producers as the latest data from Baker Hughes reveals that the number of active US rigs drilling for oil climbed by 4 to 529 rigs this week. That marks the tenth weekly rise in a row.  Also weighing on WTI prices, Via Reuters  that, ” Iran has sold more than 13 million barrels of oil that it had long held on tankers at sea, capitalizing on an OPEC output cut deal from which it is exempted to regain market share and court new buyers, according to industry sources and data.”

On the Diary, Tuesdays domestic retail sales report and Wednesdays quarterly ABS job vacancy data are the featured events on a relatively quiet local calendar, so look for the external factors to continue driving sentiment.

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CNH

It has been a tortuous start to the year on the CNH trading desk as funding conditions continue to wrong foot market participants, and despite some semblance of order emerging, we should expect volatility to remain high.  However, I also  expect the underlying Yuan depreciation pressures should return as fundamental reasons that are driving depreciation, such as capital outflows and concerns on Trump’s China policies, haven’t changed

Although the CNH moves have put traders on edge, the global impact is not in the same league as the turmoil created last year. Moreover,   as history so often repeats itself in the forex world, we should expect the Yuan to resume its course of depreciation post-Trump inauguration and at latest post-Lunar New Year

However, how to move forward and time the position entry is very tricky and open to much debate. While I suspect we are firmly entrenched in a longer-term USD bull rally, traders will tread lightly or remain sidelined in the CNH short trade likely until “Tom Next”  drops below 10 % implied.

Given the prohibitive CNH funding cost look for traders to continue expressing regional views via the  USDSGD mainland proxy as  Sing Dollar volumes continue to surge as cool heads viewing opportunity at current levels.

.After the recent Twitter tantrums direct at Tokyo from the man in high trump tower.   Senior Chinese officials have warned the US that Beijing is ready to retaliate if Donald Trump’s incoming administration imposes new tariffs.  Let us hope we do not go down this road as the last thing the Global Supply Chain and a recovering Global Economy needs is a reciprocation trade war between the market’s two biggest players.The Global economy can not run without China -US trading winds blowing China’s foreign-exchange reserves fell to the lowest level in nearly six years last month

China’s foreign-exchange reserves fell to the lowest level in almost six years last month falling  $41.08 billion in December to $3.011 trillion,  which marks the lowest level since March 2011 the lowest level since March 2011. While the print was in line with market expectations it none the less highlights the PBOC’s willingness to dip into the Reserve Cookie Jar while maintaining an Iron Fist on capital controls in an attempt to support the Yuan.

 

JPY

USDJPY continues to be the prime mover in the G10 space and the favoured pair for to express their USD bias. However, recent price action is primarily driven by news flow, and due to heavy weighted long USD bias, the market continues to show a gibbous response to data release. This bias leads me to believe the USDJPY could be extremely susceptible to weak US economic data over the short term. However, the long run paradigm continues to suggest that US fiscal infrastructure spend coupled with Tax reform will provide sufficient tailwind to break the 120 level for a possible test of 125.

 

EM APAC

Expect lots of racket in local EM space as there is no escaping the stronger dollar due to policy divergence and while I think capital market growth differential will certainly favour the region, managing the foreign exchange exposure is another question.

Global yield curves will continue to accelerate higher, and the omnipresent regional capital outflow will continue to be a major headache for local central banks.

With the ever present possibility for increased US trade protectionism, it paints a less than positive outlook for local currencies

The regional whipping boy the Malaysian Ringgit  other than relying on a wing and a prayer for higher oil prices  There seems to be no respite in sight, as are the currency  remains  Asia’s worst performer

 

Sydney Open v Fridays NY close

EUR 1.0535-50 (1.0530)

JPY 116.85-99 (117.02)

GBP 1.2261-1.2315 (1.2283)

CAD 1.3235-80 (1.3235)

CHF 1.0150-80 (1.0178)

AUD 0.7291-95 (0.7297)

NZD 0.6954-89  (0.6957)