Wary of long EURUSD calls
FX markets are slowly waking up at the start of this trading week. With limited news flow no one is rushing to get out of bed (end of the week brings, BoE MPC, FOMC, US jobs reports, and local UK elections). Paradoxically, US equity markets surging, volatility widely contracting yet JPY outperforming G10 peers. Confusing price action indicates that traders are having a hard time pinpointing cyclical drivers. EURUSD staged a minor bounce to 1.1175 prompting some to issue calls for buying EURUSD. Their analysis includes the forecasted stronger Q1 Eurozone GDP read and cheap relative valuations in European companies. Yet we are not convinced. Judging from last week’s weak PMI and IFO reads economic improvement has not crossed the Atlantic. Marginally shifting growth expectations in Europe will not offset very alive US equity rally and attractive real yields. Finally, ultra strong US GDP read last week (1Q 3.2% q/q) has investors rethinking the Fed pause while the ECB is nowhere near reviewing policy normalization. This divergence should benefit USD near term. We remain cautious on calls that EURUSD has built a stable base (likely short-term consolidation phase) and could easily see the establishment of a lower range.
Also limiting Euro upside potential is political uncertainty in Spain. Spain’s incumbent Prime Minister and leader of left-leaning Spanish Socialist Workers Party (PSOE) Pedro Sanchez has declared victory but with no clear majority in parliament. The market should anticipate weeks of tense coalition negotiation in a highly divisive fragmented political landscape. The most likely outcome is PM Sanchez will need to rely on Catalan separatists to form a government. This action will have a “cost” that will likely be seen as Euro negative.
The race for trade agreements is on
Now that the US slowly enters into election season, time is running out to ratify trade agreements. The US – China trade talks have been lasting longer than the Trump administration had expected, but it seems on good track as US negotiators are turning their effort towards other partners, including Japan and the EU, although further hurdles remain.
Indeed, as US Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin are expected to travel on Tuesday in Beijing while a second meeting in Washington will include Chinese Vice Premier Liu He next Wednesday, it seems that hopes of a trade deal by next month are rising. Progresses have been made on issues such as intellectual property and technology transfer while the enforcement mechanism framework, including a defined timeline, is still in production. Yet despite this potential breakthrough, Trump’s campaign promise of reducing trade balance deficit is still on the table. Bilateral trade talks between both US and Japan had already been confirmed last September and have only started this month while it is not expected to be a quick resolution. Both Japanese PM Shinzo Abe and US President Donald Trump have differing political schedules timing, pushing the date of a potential agreement by September 2019 earliest. The topics targeted would focus mainly on agriculture as US concerns are that the 11-country Trans-Pacific Partnership (TPP) agreement, effective since last December and which the US decided not to be part of, would allow Australia to absorb a significant market share at the expense of US farmers. In addition, discussions with the EU have not even begun yet, and a conflict in the topics to be addressed is already emerging. Whereas the EU is willing to open discussions on cutting tariffs in industrial goods (incl. automotive) and work on EU/US product standards facilitations, a red line for what concerns agriculture restrictions should stay, paving the way for further trade tit-for-tat actions.
EUR/USD is trading at 1.1165, approaching 1.1145 short-term.
