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