Currency markets confuse
Risk appetite seem to be recovering, as shown by EUR/CHF testing 1.2000. Yet demand for emerging market currencies remains weak. Brent crude is nearing US$75/barrel on the back of supply concerns, declining US inventories and OPECs announcement that the supply glut is now gone. The correlation of FX and interest rate spreads has weakened, yet with US 10-year treasuries nearing 3%, markets are starting to find them attractive. Trump tax cuts will widen US deficits.
If all this sounds confusing: yes, it is. Markets have been too quick to embrace flavours-of-the-month. Fashionable thinking makes us sceptical. Take India: despite solid structural fundamentals, a cyclical upturn in oil price has triggered fear of capital flight. The US Treasury has placed the rupee on the watch list of currencies, which has freaked out traders. However, India is far from a currency manipulator, due to persistent current account deficits. With global yields low, volatility low and growth solid – this is what we will trade on. If you must trade now, higher oil should support NOK, CAD, ZAR, BRL and AUD.
Germany inflates!
The German economy is showing signs of recovery: March producer prices rose 1.9% annually and 0.1% monthly, following a 6-month decline. This indicates an increase in consumer demand, which along with an improving trade balance in February, set the scene for growth in 2018. GDP forecasts are being hiked to 2.2% in 2018 (initial estimates at 2%), which supports optimism for the Euro region. April economic data are softer, with GfK consumer confidence and ZEW current conditions given at 10.90 and 87.90 (2 years averages at 10.30 and 75), so we suspect the economy will continue its acceleration, though at a slower pace than in 2017. The EUR/USD currently trades at 1.2324, moving sideways in April, but will slide a bit until the end of the month, heading to 1.2310 in the short-term
NZD in the doldrums
Expect further downside in NZD/USD, as the interest rate differential continues to move negatively, making NZD shorts costly. Speculators are still net long Kiwi (non-commercial position: net long 40% of total open interest) and will unwind position as the currency nosedives. The next key support can be found at 0.7188 (low from 29 March), then 0.7154 (low from 21 March). On the upside, resistance lies around 0.74 (high from mid-April). All in all, a return towards 0.70, or even below, seems reasonable.
The New Zealand dollar saw heavy selling on Friday amidst weak inflation data. The Kiwi fell 0.53% against the greenback and hit $0.7230. Headline inflation eased to 1.1% annually in Q1, down from 1.6% in the previous quarter. After increasing 0.5% in the Q4 last year, tradable inflation contracted 0.40% annually, while non-tradable inflation eased to 2.3%. The relative strength of the Kiwi during that period explains most of the reduction in price pressures. However, the sector factor model, used by the Reserve Bank of New Zealand, shows a brighter picture, holding steady at 1.5%.
US inflation vs Euro
This Thursday the European Central Bank will update monetary policy: we expect that interest rates will not change. The ECB will say it needs to wait again in its slow move to normalise money without pushing EUR/USD significantly higher. As Janet Yellen, former Chair of the US Federal Reserve Bank, managed to do in the USA: end ultra-loose policy without driving a USD stampede. ECB President Mario Draghi’s will focus on details for ending quantitative easing yet avoid discussion on interest rates.
With US 10-year treasuries making a run at 3.0%, rising bond yields are giving the greenback a solid boost. Markets are focused on inflation, thanks to higher oil prices. A steeper US yield curves will keep USD strong against oil-importing EM currencies such as INR and TRY. March weakness in European economies was temporary: April purchasing managers’ data came in above expectations: PMI composite rose to 55.2 versus 54.8 expected, while manufacturing was slightly below at 56.0 vs. 56.1 expected. June and July should bolster the case for a Euro interest hike.
It will also be a busy for corporate earnings, with over a third of the S&P 500 set to report.
