November 2017

Nov. 24, 2017 (Tempus Inc.) - The greenback has been unable to shrug off its turkey-induced malaise this morning, falling versus most of its major peers. The Bloomberg Dollar Spot Index is set for its third weekly loss, its longest losing streak since July. The Index is down 1.6% so far in the month of November.

There is no major data set for release today. We expect trading conditions to be light and likely boring, especially when European traders head out for the weekend.

EUR

The Euro looks to build on its gains from yesterday’s session. The common currency received a boost following strong German GDP yesterday which showed the economy expanded 0.8% in the third quarter.

The good news continued for Europe’s largest economy. A separate report showed that business optimism climbed to a record high. In addition, the largest German opposition party indicated it is willing to form and back an administration led by Angela Merkel.

The Euro is at its strongest level in 6 weeks versus the U.S. dollar.

GBP

The British pound was modestly stronger against the U.S. dollar, mostly on greenback weakness. News was light out of the United Kingdom, but a comment by a Bank of England official has been creating headlines. Silvano Tenreyro reiterated recent BoE sentiment by saying that two more interest rate hikes will probably be needed to get inflation back to target.

However, Brexit will be the real determinant of where policy goes next. The comments again highlight how the central bank is being hamstrung from political uncertainty.


USA 

Nov. 24, 2017 (by Zach Pandl & KT Trivedi, Goldman Sachs) - The Goldman Sachs co-heads of FX Research Zach Pandl & KT Trivedi outline their views as we head into year end. In short: they believe that EUR weakness can continue and UK political risks may still weigh on GBP while NZD pessimism is overdone. Here is their latest research note:

1. Counter-trend Euro weakness can continue a bit longer. Over the past two months, EUR/USD has declined about 3.5%, from a high of just over 1.20 to 1.16 today. We see three main drivers behind the move: (1) open-ended bond purchases by the ECB, which look likely to continue longer than investors had expected, (2) the nomination of Governor Powell for Fed Chair, a candidate likely supportive of continued funds rate increases, in contrast to expectations in late summer that the White House would opt for a more dovish choice, and (3) further progress in the US Congress on tax reform. While the first two catalysts have played out, we expect that Congressional Republicans will continue to move the tax reform ball down the legislative field over the next month. Moreover, investor positioning still appears long EUR. In futures, for example, aggregate USD positioning has swung from a short of $20bn in late September to a short of $4bn as of last week. However, much of this move was against currencies other than the Euro: futures length in EUR has declined by just $3bn over this period, and net length of +$10bn remains close to multi-year highs. Over the medium term, the Euro probably has more upside than downside, but we think the near-term trajectory is still lower, and are sticking with our year-end target of 1.15.

 

2. A sharper bout of political pressure in MXN, ZAR and TRY than we anticipated. The drawdown in FX and local rates in these high-yielding markets over the past few weeks has been sharper than the bumpier ride we expected, even taking into account the well-flagged risks from a core-rates selloff. In effect, idiosyncratic political risks have returned with a vengeance in each case, overshadowing any improving macro developments: renewed noises of a US pull-out of NAFTA, in turn giving further impetus to local populism, has pushed $/MXN back above 19; the continued divisions within the ruling ANC and the resultant fiscal slippage and potential for rating downgrades have sent $/ZAR back above 14; and $/TRY is above 3.80 as tensions between Turkey and the US, as well as Germany, show few signs of de-escalating quickly. At these levels, each of these currencies is significantly undervalued again on our GSDEER and GSFEER metrics (roughly by more than 15%), and this is reflected in our constructive 12-month forecasts. But unlocking that value typically requires a long investment horizon and some resolution, or at least de-escalation, in these political risks. The upcoming ANC party election in December is at least a concrete binary or potentially ternary event that could provide some clarity on political and economic direction in South Africa, whereas in the other two cases, we are unlikely to have much clarity until well into next year.

 

3. But, over the longer run, macro adjustments supporting EM FX continue and the risk-reward looks attractive for the BRL. The broader case for EM FX is still solid in our view – most EMs have significantly improved external balances and cyclical macro fundamentals, and this is an asset class with undemanding valuations, a generous level of real carry and exposure to the synchronised growth recovery across the EM world. Even in the three economies – South Africa, Mexico and Turkey – that have lagged other EM high-yielders in correcting external imbalances and raising real rates to bring inflation under control, some adjustments, warts and all, have been taking place. In South Africa, core inflation peaked at the start of the year, and the subsequent declines allowed the SARB to cut rates for the first time in July since 2012. In Mexico as well, core inflation looks to have peaked in August, and the non-oil trade balance is in surplus. Turkey has seen a much more moderate correction of its external imbalance relative to Mexico and South Africa, and still has core inflation moving higher, although our economists expect it to peak in the next couple of months. But the tension between improving macro and political uncertainty is most acute in the BRL as the currency has sold off on the back of falling expectations of pension reform. While that is clearly a setback for the fiscal picture, the external balance and inflation profile in Brazil are unquestionably better – in 2017Q2 Brazil recorded its first current account surplus since 2007Q2 and core inflation was comfortably below the 4.5% target. So, with $/BRL back above 3.25, the risk-reward of owning BRL looks attractive as long as there is at least some prospect of modest progress on fiscal reform.

 

4. Bank recapitalisation an additional positive argument for INR. Just as this latest bout of pressure on EM FX was getting underway, we argued that INR and IDR were good candidates to fade any selloff even if the eventual upside was more limited because the fundamental backdrop was still solid, and the revealed aversion of the RBI and BI to large spikes in the respective currencies and ample reserves meant that the bumpier path in these currencies would be less bumpy than other high-yielding alternatives (see EM FX viewsPressure now, value beyond, 29 Sept 2017). Since then, the announced bank recapitalisation in India has bolstered the supportive case for the INR further. Whereas much of the market focus has been on the negative fiscal implications of the recapitalisation effort, our economists have highlighted that the impact on economic growth from a re-energised public sector bank credit impulse could easily exceed a few percentage points. With that type of growth upside, flows into Indian equities and the INR should remain well-supported in the medium term, and we see risks to our 3-month $/INR forecast of 64 tilted towards further INR strength. In the case of IDR, the heavy positioning of foreign investors in local bonds is often a source of vulnerability, but as Danny Suwanaprutihas argued, if Indonesia is included in the Global Aggregate Index, which looks likely, it could catalyse further capital inflow in 2018.

 

5. PEN: A positive carry mid-yielder for volatile times in EM FX. We have described CLP and PEN as the hare and the tortoise of Andean FX. Both are attractive currencies among EM mid-yielders with supportive macro fundamentals. But, whereas CLP has rallied hard in recent months (even taking into account the recent selloff), the PEN has lagged. From current levels CLP is becoming a less obvious “value” story. Still, there is potential for positive surprises in the cyclical picture and a market-friendly outcome in the upcoming elections could be a positive catalyst. So there is some scope for modest spot appreciation, although with copper prices already having risen so much, the move towards our 12-month forecast for $/CLP of 615 is likely to be choppier. The PEN looks more compelling from a valuation standpoint, has a higher nominal carry (of around 2%) and we are optimistic on the medium-term growth outlook as cyclical headwinds fade. Given the heavy intervention in FX market, we expect any move towards our 12-month $/PEN forecast of 3.15 to be slow and steady, but then in volatile times for EM FX, that is an attractive feature rather than a bug.

 

6. Monetary policy is unlikely to pressure the Pound, but politics might. Markets saw a relatively dovish signal in the BoE’s rate decision last week, as the Bank no longer said that policy needs to be tightened “by a somewhat greater extent over the forecast period than current market expectations”. However, we read the accompanying Inflation Report (IR) as saying the Bank remains in tightening mode (albeit at a very slow pace). Conditional on current market pricing, CPI inflation in the IR does not converge fully back to the Bank’s 2% target even by the end of 2020 (it sits just above at 2.15%)—which, taken literally, means that a higher policy rate path would be desirable. This point also came across in Governor Carney’s press conference, where he noted: “…we, in fact, need those two additional rate increases in order to get that return of inflation to target. In fact, if you look closely at the forecast, inflation approaches the target, it doesn’t quite get there, and the economy is likely to be in a position of excess demand, in other words, running a little hot at that point”. So we do not think the BoE gave an all clear for going long EUR/GBP. We ultimately expect more Sterling weakness, but surprises from the increasingly messy political environment are more likely catalysts than new dovish signals from the BoE.

 

7. Lastly, we still see downside to AUD/NZD. In our view, election-related pessimism around NZD looks overdone. First, in our view, yesterday’s announced Review of the RBNZ Act recommending a shift to a dual mandate (inclusive of “full employment”) is more of a reinforcement of the existing “flexible inflation targeting” status quo rather than a material regime shift. Second, most forecasters—including ourselves and the RBNZ—already assume a slowing in net migration, so policy changes under the new coalition government may not introduce much more downside risk. Third, politics aside, the New Zealand economy is in solid shape: last week we learned that labour market activity was firm in Q3, and the level of output already looks to close to its potential. Rate increases still look some way off, but the NZD is unlikely to remain depressed given the economy’s healthy cyclical backdrop.

Nov. 22, 2017 (Tempus Inc.) –  The U.S. Dollar remains quiet ahead of the Thanksgiving holiday, even after the release of Durable Goods Orders.

USD

The figures surprised as the indicator was expected to show a 0.3% expansion, instead contracting by (-1.2%). When transportation costs are excluded, a 0.4% increase was registered, but this still fell below expectations of 0.5% for October.

The saving grace may be the revision of September’s numbers where the expansion was thought of being at 0.7%, but came in upgraded at 1.1% Overall; this piece of data has lacked consistency over the year and may not be as influential as we close the year.

The FOMC Minutes are scheduled for 2PM, but we see little if any reaction as the Fed’s move towards hiking is very much determined and priced-in. Tempus will be closed Thursday in observance of Thanksgiving and will be open again on Friday.

EUR

The Euro continues to swim in relatively calm waters after Monday’s half-percent decline based on worries in German political stability. At the moment, Chancellor Angela Merkel would not refuse to have another snap election in order to gain seats and have an easier time forming an alliance.

However, headlines overnight saw the prospect of another vote as worrisome, but welcomed the idea of forming a “grand coalition” with the Social Democrats, a party usually aligned with Merkel’s goals, but that suffered bigly on election day and blamed her platform for the failure. We shall see if downside risks manifest themselves into further depreciation, but for now Euro is not paying any heavy tolls.

GBP

The Pound’s recent gains have been subdued slightly due to concerns over Brexit and its symptoms affecting the economic outlook. Later today, the Chancellor of the Exchequer, Philip Hammond, will present a new budget and his remarks may provide guidance the state of affairs. PM Theresa May is just hoping that the EU embraces new talks and the idea of being paid an agreed final bill amount.

Orders in the UK are up to their best level in 30 years per a survey by the Confederation of British Industry. This mix of good economic data and bad news on the Brexit front are likely to dominate the Sterling environment for what’s left of the year and beyond.