USD is always the King

Thks to HEAT for his comments....

USD strikes back

After some months of rangebound trading US dollar finally managed to break higher, although it has been quite rapid we can´t take this move as a big surprise since it has been supported by stronger economic data in the US (in fact is the only Advanced Economy providing positive economic surprises) which ultimately is driving US yields at years highs (USt 10Y >3.1%, 2011). Speculative position against the greenback played its role also and some sort of relief on the trade wars saga did the rest.  Once EurUsd broke the key 1.2150 support level the pair was one way traffic below 1.1800 where the pair has found some support but we are targeting for lower levels around 1.1600.

eurusd

As mentioned there are some signs of slowdown mostly in the EU and UK which has been reflected in latest Central Bank appearances, EU inflation in April came much lower than expected and despite being affected by transitory factors it doesn’t support a hawkish stance by the ECB , manufacturing sectors in Germany and France looked weaker also and 1QGDP for Germany was the lowest since 2016. There are some rumours that the ECB could leave the Bond Purchase Program as open-ended, for the time being they are reluctant to  come up with a date for stopping the program, taking into account that they will wait a considerable period after finisihing the program to hike I still believe that there are great odds Draghi will leave office without hiking the depo rate. On the UK front BoE remained on hold, don´t forget that May hike was fully priced by the market just two weeks ahead of the meeting (expectations driven by Carney) which in my opinion seemed (another) policy communication mistake by the governor, UK economy is clearly decelerating and there are still lots of Brexit uncertainties ahead so they should remain on a cautious approach. The pound has been sold of the back of it and eurgbp traded >0.8800 and 1st hike market pricing has been pushed back to the end of year, we seriously doubt there will be any in 2018.

The recent collapse of the Argentinian peso and other EM  currencies is a warning sign, those countries with weak fiscal positions, i.e. Argentina,Turkey and Russia are suffering the most but we can say that the whole EM spectrum is under heavy pressure. EM countries have benefited from the central bank “carry trade” of low interest rates and abundant liquidity which flooded markets with cheap usd used to buy “growth” and “inflation-linked” assets in EM, when that extraordinary and excessive flow of US dollars into EM suddenly reverses and funds return to the U.S. looking for safer assets and higher returns (yields+tax)the exit door is considerably smaller and the currency market collapses, this capital flow dynamic is called “sudden stop”. Since the bubble was used to increase their imbalances rather than strengthen their economies,  I think more pain is to come if US yields continue to grind higher. However in just purely technical terms LACI index (Latam currencies) trades at lowest levels since 2016 so we could find some support here.

LACI index (Latam ccies)

What really  amazes me is how well Risk Assets (mainly stocks) are performing in this context of higher Oil,rates and EM selloff, S&P500 tested a few times the 200MA level but held it quite well and managed to bounce back higher. I´ve mentioned in previous notes that I expect a decent correction in equities which ultimately would bring more volatility to market but it has simply not happened yet. There are some  other potential risks out there such the geopolitical situation in the Middle East once US has left the nuclear deal with Iran (oil up to 80$), US yields seems to have broken key resistance levels so more pain in that front could be expected… so the question here is what level of 10y UST yield would cause investors to rotate from equities into bonds?.

US 10Y Positioning at extreme SHORT

Xccy basis market keeps tightening across the curve, this move can be linked to tax reform, specifically by BEAT which punishes American corporates for maintaining overseas balance sheets so the need for issuance has clearly diminished. US corporates now prefer to use the domestic market and then use FX forward market to refinance their subsidiaries. On the back of that we are seeing a rapid move against the USD in front end g10 forwards fueled by poorer liquidity.

XCCY Basis Swap 1year

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria

Why do I think the EURUSD is a sell...??

Why do I think the EURUSD is a sell??

I do understand it is a non-consensus trade against all the big players of the FX market which their objectives vary between 1.25 and 1.30 for Q4, (yes, it could be the same situation as the beginning of 2017, when the majority thought we were going to parity in EURUSD….)

I also acknowledge the European economy has improved substantially in the last few years, due to the ultra-expansive monetary policy that the ECB has put in place at the beginning of 2015.

I also know that the American politics have strongly broken into the currency markets since Trump arrived to the White House, in order to counteract the American trade deficit with the rest of the world, especially with China and Europe. Therefore the US needs a weak USD (in my opinion it may work in the short term but, I disagree this strategy will benefit the US in the long term considering we are in a global economy)

Despite these arguments, I think that the appreciation of 20% experienced by the EURUSD in the last year deserves more than a small correction.

As an example, I remember perfectly the day of the American elections and the victory of the always controversial Donald Trump. His victory was going to be a blow to the world markets and the USD would suffer like never before (the end of the world was coming!). Indeed the USD was heavily punished after knowing the election result, but little by little it recovered ground to finish the day above where it had begun!! 
The rest of the story is already well known, an USD Index rise of just over 7% in just two months (USDJPY + 17.25% from the lows, from 101 to 118 ...). At that time, I also argued that the spectacular rise in the USDJPY was unsustainable, against the opinion of the big banks with 125 objectives at that time.

We are in changing markets and what seems clear today, tomorrow is not so.

The arguments that support my view are the following:

1) Macro Data: Recent data shows a weakness of macroeconomics in the Eurozone. Compared to other periods, this time we have seen a bigger decrease in the Economic Surprise Index.

Citi Economic Surprise Index – Eurozone (white) Vx EURUSD (orange)

)      2) Positioning: Long speculative positions in euros are at historical highs. The market is much more long positioned than when the EURUSD traded close to 1.60 in 2008.

This position will suffer if EURUSD drops below important support levels (1.2210 and 1.2150) leading to close positions, profit taking by investors accelerating the downward move.

This type of adjustment takes time, so patience is needed. 

CFTC EUR Non Comercial net position (white) Vs EURUSD (orange)

     3) Reserve diversification: Much has been said during this year about the diversification of the Central Banks reserves (especially Asian CB) are doing buying EUR and selling USD. Surprisingly, the last report published by the IMF (COFER) with information from the last quarter of 2017, shows how the reserves in euros have grown much less than estimated (from 20.05% to 20.15%). The main reason comes from the appreciation experienced since last year, which means that the reserves are increasing only by valuation.

So one of the arguments by which the speculators have positioned themselves in favor of the Euro seems to have lost weight.

   4) Oil: EURUSD and Oil have a positive correlation (please see graph underneath), losing strength at the beginning of 2017 and correlating positively again from the second quarter. Recently, Saudi Arabia has communicated that they would like to see the price of oil around 100 USD per barrel. It seems that we have already forgotten the American fracking sector and its ability to increase the offer (one of the factors why the Saudies knocked down the price in 2014).

In my opinion the fundamentals of the oil are not supporting such high prices. 
The risk is that, in an intervened market as the “black gold” is, OPEC couuld cut the production further shooting the price up.
The consequences in the medium term would be negative for the global economy, questioning the monetary policy normalitation being carried out by central banks.

EURUSD Vs Oil daily chart

And, what about the USD??

     5) FED: The Federal Reserve is on its course of interest rates normalization. Market, as the dots, discount two more increases from here to the end of 2018. But if inflationary pressure increases, we should probably see an additional one, with an important impact in the USD.

US CPI inflation

More interesting to analyze is the decoupling between US and Germany rate differential. That correlation was clearly broken by mid 2017 after French elections.

Last time we had this situation, it took EURUSD 10 months to converge again with rates.

DEUSD10Y (whithe) Vs EURUSD (inverse/orange)

DEUSD2Y (whithe) Vs EURUSD (inverse/orange)

 5)      USD Repatriation: Tax reform in the US will lead to a repatriation of 3.5$Trn foreign earnings, part of these are in USD assets and other in different currencies, so we will start to see some FX hedging by companies in the next months.

     6) Technical Analisys: A close below 1.2330 will be a bearish signal. Levels to have an eye are 1.2210 and most important 1.2150. If both are broken, 1.19/1.20 could be easily seen without discarding 1.18ish.

 EURUSD Daily Chart

EURUSD Daily Ichimoku Chart. A close below the cloud (1.2240) would be a bearish

EURUSD Weekly chart. Upside move stopped near the 61.8% Fibonacci retracement with bearish divergence in the RSI

EURUSD Monthly Chart. A close above the 200MA (1.25 now) would be a bullish signal

All this analysis makes me think that we are close to a greater correction in the single currency. 

A risk to take into account will be the verbal declarations from American authorities if the USD appreciates so quick (only a remind to Trump and Mnuchin: DXY has seen a fall of 12% in little more than a year).

As I said, only a close above the high seen in January would change my vision.

Any comment will be welcome

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria

Daily Comment

Thks to “Heat” for his thoughts…

Q1 is behind us and we can confirm that it has been one of the least volatile quarters ever in foreign exchange markets (February and March arguably boring), after a surprising initial USD selloff in January based on US deficit expansion and most likely reserves portfolio reallocation from Central Banks, Dollar index DXY has been trading sideways in a narrow range (88.50-90.50). Conversely EurUsd traded between 1.2250-1.25, UsdJpy 107.5-105, sterling 1.39-1.42 on the wide…  even Latam currencies remained pretty stable despite USD yields going higher (10Y UST reached 2.94%) and stocks drifting lower which both are good drivers for EM currencies, however we are seeing historic correlations performing poorly in recent months.

Does this lack of volatility makes sense? I´m prone to think that yes it does, seems that we´ve reached an equilibrium point where the synchronized growth is on track with low inflation levels so in everyone’s interest we´ve been in “don´t hurt ourserlves” mode and Central Bankers messages have been neutral. Looking at the Euro,  there is a quite positive sentiment in markets regarding Eurozone economy and the structural CA Eurozone surplus should support the common currency over the medium term, however total absence of inflation pressures (lower inflation set of data in recent weeks) will make any eurusd rally short lived (disinflationary effect of strong currency). Everyday I find it more difficult to believe that Draghi will be able to make any rate hike before he leaves the office by December 2019.

Do I expect to have similar level of volatility in Q2? I don´t think so (being honest I hope not either) thanks to the US stocks market which in my opinion will be the main market driver in coming months. There are several factors which are spooking investors and could lead to a deeper selloff:

·         Trade Wars between Trump and China, at the time of writing China has imposed tariffs on 106 new products including cars or tobacco (Trump´s twitter account followers will love his next entries). The total sum of tariffs imposed to each other is close to 50bn usd, still modest figure given the size of trade between the two but if conflict worsened this would massively erode both economies.

·         Tech companies valuations seems “high” (Amazon P/E ratio >300) and reputational risks are arising (Facebook & Tesla). Don´t forget that top5 US companies by Market Cap belong to IT sector.

·         Pure technical levels. Monday´s close below DMA200 level has taken market attention, additionally S&P is struggling to keep the long term uptrend, clear break of 2550 in s&p500 would leave an ugly scenario ahead of us for risk assets.

It´s true that there never was a clear bear market without the economy entering in a recession (not likely now), however it´s true also that there never was a bull market (almost ten years now) driven by such an extraordinary expansion of Central Banks balance sheet. Said that it´s reasonable to think that once that free liquidity start to vanish risk assets should retrace somewhat.

If that scenario materialized I would expect safe haven currencies such jpy or chf perform well, Latam currencies would suffer and US dollar should be supported, however protectionist rhetoric from US administration could offset buying forces, being honest I think eurusd will trade range bound for the remainder of the year. Treasuries would rally on first place as usual but we are waiting for lower levels for entry short again (2.55%-2.60% target). New Fed Chair Powell showed strong confidence in the US economy  on his first appearance in the March FOMC, Fed members projections were revised up also, makes me think that unless a strong correction in stocks starts to erode consumer confidence and consumption rapidly; the gradual path of rate hikes will continue, so given current market pricing of less than 3hikes until Dec2020 there isn´t too much room for US yields to go lower.

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria

Daily Comment

Thks to "HEAT" for his thoughts, my friend and mentor...

This week  we´ve had the new Fed Chair Jerome Powell premiere at the US senate, in his testimony he expressed confidence in the economic Outlook ( it has improved since December in his opinion), he was optimistic on wages and inflation while lacking concern about market volatility and the recent US equity market correction. Powell suggested that as long as “outlook remains strong” rate hikes will continue, however he was reluctant to endorse to 4 hikes for 2018.

Market is now close to fully pricing in 3 hikes and around 20% chance of 4, however in my opinion there is still a gap between market pricing and Fed Dots for 2019 and 2020, I will pay great attention to next week´s US wages data, a strong number could strengthen Fed message at March FOMC and eventually we could see their fed funds rate projections moving even higher in the back end which in current environment would drive yields higher and provide temporary support to the USD. Everyone´s eyes in the market is looking at 3% level in 10 US Treasury so I think we will need stronger evidence via data (it´s all about inflation) or Fed message before we manage to break it, in fact we are seeing a retracement from last weeks highs lead by lower US equities where technical aspect isn´t precisely good. We are constructive on usd yields so we would see Risk Off episodes that led UST treasuries market higher as an entry opportunity thinking over the medium term.

Green line= Fed Median projections  White line= Market pricing

On the back of what we could say was a  “hawkish” Powell, USD strengthened across the board, EurUsd reached 1.2160 but it bounced back strongly above 1.2200 again,lead by Trump´s protectionist comments (tariffs on steel and aluminium). Italian elections will be held this weekend,  which could add selling pressure on the Euro depending on the results. Sterling seems weaker and trades above 0.8900 vs eur which is the top of the last 6 month range, while EM currencies (mainly Latam and Chinese RMB)  remain sidelined, which given recent rally in US yields is weird in my opinion. Japanese yen trades strong and last night´s governor Kuroda comments hinted that they could exit their extraordinary monetary policy before than anticipated, when I look to the usdjpy chart 100 level comes right away to my mind. In Sweden, inflation continues to fall below expectations (Jan print 1.7% vs 1.9% exp); EUR/SEK trading above 10 for first time in over eight years, continued weak data (GDP missed) has put further pressure on the krone. The next hike has been pushed back from mid-2018 to much later in the year.  

Euro selling in the last few days was fueled by lower than expected inflation data in several countries (Germany,France, Italy), disinflationary effects of a strong currency are well known and given Euro strength in past months the absence of inflationary pressures makes sense to me. As commented in my previous note; if USD weakness persists, and ECB can’t downplay  current bullish expectations about the Euro, I will find it difficult to believe that we will see prices and wages picking up (impacted by the hit on exports) and which will impact the pace of rate hikes since the ECB will stick  to its inflation mandate ( at least whilst Draghi is the sheriff in town).  

This is the logic that makes me think that in spite of market positioning remaining at extreme short USD levels (what we hear from customers, colleagues and other participants points in that direction also) and taking into account that there are factors that play in favor of that vision  i.e. massive soar in US fiscal deficit, secular Eurozone Current Account surplus or forward GDP growth differential (playing now in Eur favor), I believe some sort of coordination amongst CBs will undermine potential USD weakness. Moreover the weaker the usd the more inflation the US will import (massive trade deficit) and faster the Fed will be tempted to hike in order to get more room from the next slowdown in the economy. So in my opinion there will be offsetting forces working at the same time that will lead us to trade rangebounds (likely skewed to usd weak) at least till enough inflation allows other CBs to normalize monetary policy more vigorously.

EurUsd speculative positioning, higher=short usd

Meanwhile we keep seeing USD funding stress, Libor3M has reached 2% for the first time in 10 years (before what market had anticipated) and the spread OIS-LIBOR which is a good indicator of usd liquidity conditions (and Risk, watch sp500 carefully) reached 40bps, level not seen since European debt crisis and beginning of 2016 (China stock market collapse). There could be a couple of reasons for this tightening in USD financial conditions:

1.       Fears that repatriation flows will soak up much of the excess liquidity on the front end.

2.       Surge in T-Bill and Treasuries  issuance by US government ( 200bn $ last week). It will be interesting to watch the experiment of Fed buying less paper whilst government issuance skyrocketing this year.

This lack of USD on the front end is driving Xccy basis in G10 space wider (mainly Eur and Jpy) and we expect this to continue as we get closer to FOMC and quarter end. On the back of this interest in g10  FX Swaps markets is in buying and selling usd. Those clients running long usd cash positions could benefit of this move swapping them into their local currency. EurUsd fx forward points in the front end are at highest levels in the last 20 years, so customers trying to protect themselves downside (buying eurusd puts i.e) can take advantage of this also.

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria

Daily Comment

Trying to understand FX markets....

These are not being easy days for Fx Trading ....... In terms of assets pricing everything looks awesome,  bond yields up, equities up, commodities up, bitcoin up, and usd.....DOWN!. This move has perplexed markets (myself included) and we are racking our brains trying to understand why.

Yesterday's price action is  a great example to (not) understand this uncorrelated USD behavior, after stronger US inflation numbers were released we saw the expected price action, yields up, s&P500 down 1% and USD slightly stronger vs G10 currencies. In the afternoon stocks bounced back strongly and managed to end up positive  on the day, yields continued rallying but UsdJpy surprisingly sold off from 107.40 to 106.5 which is a quite unusual price action for this pair given its high correlation with yields and stocks.

S&P / US 10Y  / USDJPY

The fast rise in Bond yields makes sense to me given the pickup saw in recent inflation figures, Trump`s fiscal expansion and Fed balance sheet reduction program. Market consensus forecast for 10Y for 2018 was 3%; in my opinion it is probable that we get overheating and break higher on these levels if we keep seeing strong US data mainly on wage growth. Fed Funds market has now almost fully priced 3hikes by the end of 2018 and there are considerable risks in my opinion that we move towards 4 hikes, so there is still room for rates going even higher.

In this environment of selling bonds, dollars and an increasingly less liquid market I expect US equities to adjust lower adding more volatility (opportunity) to markets, which ultimately in my opinion should give some support to the greenback, additionally interest rates differentials should play in favour of the usd also.

However as it´s said the trend is your friend and USD remains under heavy pressure, USD index trades close to 4 year lows and breaking 88.50 support area could trigger another selloff up to 85 (-4% ). From a pure interest rate differential this USD weakness seems irrational but there could be some reasons behind:

*         Investors fears regarding the huge increase in US budget deficit and erosion of US creditworthiness and ultimately a loss of real yield. Shorting the usd is a safety trade against that risk.

*         Central Banks reserve portfolio adjustments. There have been rumours regarding China selling UST in the past and given political tensions between Trump and China, this could be a possibility.

*         White House seems a much bigger factor in Fed and Treasury policy making that at any time in the past years. There are concerns regarding Trump interfering in Fed´s independency. Some interpreted Mnuchin´s comments as indicating that the Trump administration wants a weak DXY as a boost to export competitiveness.

We must take into account that recent selloff in usd is affecting the rest of the Central Banks within G10 space, those would have expected ( like me) that higher US yields would lead to a stronger usd helping them to create inflation given that their respective currencies would weaken vs the USD. That's not happening and this will  make their monetary policy actions more challenging and maybe they will have to lean to a more dovish approach ( ECB and BoJ main suspects).

On the contrary of what we are seeing on Spot markets,  FxSwap (Cash) markets remain strong USD buyers  vs G10 currencies, the extreme volatility we experienced back in December for year turn has spooked markets and everyone wants to hoard dollars mainly over turn periods. There is less liquidity available from US lenders and I expect this move and volatility to continue over the next months.

So far eurusd FxForward market has been one way traffic being driven by higher usd yields which I expect to continue. If USD weakness persists in the coming weeks (spot is 5 figures up YtD)  I think there could be a potential window opportunity for importers to hedge their exposure at even longer periods. For instance at the time of writing 5Y eurusd fx forward trades at 1.4260, which given the interest rate differential dynamics between both currencies and expansionary monetary policy from ECB ( I don´t expect any hike before 2020) with ample liquidity buffers makes those levels attractive to me thinking over the medium term.

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria

Daily Comment

Daily Comment,

The dollar liquidation continues without firms arguments to see a correction.

An already touched greenback did not favor the statements from the US Treasury Secretary Steven Mnuchin, confirming that a weak dollar is good for the American economy. This has been the edge that was missing the greenback to further deepen the freefall that accumulates about 4% so far this year, surprising even the most bearish, in a scenario where the currencies have decoupled from the monetary policies and the political factors are now influencing moves in currency markets.

The 1.2350 break in the EURUSD has accelerated the movement in an exaggerated way, trading this morning above 1.2450, levels not seen for three years, also highlight the spectacular rise of the GBPUSD that in almost 10 sessions has appreciated close to 6.5%

We think that these exaggerated movements may bring be a good oporunity to accumulate USD longs waiting to see a correction in the next sessions.

Today all eyes in the European Central Bank meeting. No significant change is expected in the current monetary policy and a direct message to the European currency, wich appreciation further complicates the achievement ot the inflation target. We will see if Mario Draghi is able to stop this upward movement that responds more to a fall in the USD than to an appreciation of the EUR.
We also have today the first meeting of the year of the Central Bank of Norway where no changes are expected and which keeps the tone of the December meeting.

In terms of data, the German IFO and the new housing data in the USA. the macro references to watch.

Watching carefully the USDCNH Vs EURUSD, highly correlated

A weekly close in USDJPY below the Ichimoku cloud (109.10) would be a bearish signal

Stop loss in long USDCAD position at 1.2350 opened at 1.2450

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria

Daily Comment

Daily Comment,

Impressive round-trip movement of the USD during the Asian session.

The Steve Bannon subpoena by Attorney General Mueller and the fears of a possible "shutdown" due to the lack of agreement of the American Congress, caused a new wave of sales of the USD that has led to mark new highs in the EURUSD at 1.2323 and lows in USDJPY at 110.20, a move that has been quickly corrected to return to the levels of yesterday's session.

The psychological barrier of 110 in the USDJPY has served as support especially after the statements of the Japanese government showing some concern for the appreciation of the JPY

It seems that the upward movement in the European currency begins not to satisfy the ECB that is coming to the fore in different ways in recent days trying to relax expectations. According to sources from the monetary authority, they do not plan to modify the "forward guidance" at the next week meeting. In addition, french Villeroy commented that the strength of the currency is a factor to be taken into account in order to achieve the inflation target. On the other hand, Weidmann said in an interview that a rise in mid-2019 could be appropriate (compared with the expectations that are at the beginning of 2019) and Constancio this morning has stressed that it is still far from achieving the inflation targets of the 2%.

Therefore, we recommend caution after the rally seen at the start and end of last year in the single currency, which could have overreacted with a clear divergence in monetary policy between Europe and the US, with a EUR long positioning at hisorial highs, that could lead investors to take profit.

The Central Bank of Canada meeting will be carefully watched today. The market discounted today`s rise with an 85% probability and another three additional ones until the end of the year, which would make it the more "hawkish" Central Bank. We could find today an upward movement in rates but a "dovish" message for the market to reduce its expectations, which will cause a strong impact on the CAD that against the USD that has left more than 3% in the last month.

Take profit in short USDJPY at 110.25 opened at 112.90
Long USDCAD at 1.2435 - TP 1.2750 - SL 1.2350


Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria