By Stephen Innes
As we move into the second trading week of 2017, two macro narratives are evolving: Chinese FX policy and US interest rates. For traders that were expecting a free lunch in early 2017, going long on USD and short on bonds, the market has quickly reminded them that nothing comes easy in the world of Foreign Exchange. Early 2017 trade has been full of twists and turns. You know the old saying, there is no dull moment in the world of FX, and last week was the proof in the pudding.
Exaggerated moves in G-10 last week were more about heavily skewed short-term long USD positioning jitters, after a subtle shift in Investor sentiment emerged, suggesting the recent moves in US yield have run up far too quickly. This notion could dampen the USD bull's short-term enthusiasm and despite supportive US data, the USD may continue to consolidate before the anticipated resumptions of the USD uptrend, which should return full-bore post-Trump inauguration.
As for the near-term calendar, although not jam-packed, we may be in for some excitement none the less. Tuesday could be very engaging if Chinese CPI or PPI deviates from expectations and of course, Aussie traders will dial in on domestic retail sales that same day.
With attention squarely on China this week, the AUD could re-emerge as the quintessential China proxy trade.
However, my focus is on Friday, as Fed Chair Janet Yellen will deliver a speech on Thursday evening (EST), which will be available on webcast. Given the market's focus on all things Fed, we could be in for a bustling APAC session at the end of the week. China's December trade report will also be released on Friday.
Traders treated last Friday's NFP with little importance ahead of President-Elect Trump's inauguration and possible policy game changers. While the 156K rise in non-farm payrolls in December fell short of market expectations, the huge story that emerged was the sharp gain in average hourly earnings (AHE), which was the call to action for traders, as the employment report was viewed in a positive light. Keep in mind that both resurgent wage inflation, coupled with buoyant oil prices, have been supporting the reflation trade. Thus, US bond yields rose on the AHE headline and a stronger USD ensued. Despite the 10 Year UST yield moving higher to 2.42-3% after a holiday-induced position squaring rally, the S&P closed at a record high, while the Dow Jones closed at 19,963.8, just shy of the major psychological 20,000 mark.
Non-aggressive USD buying mainly centred on USDJPY, EURUSD and USDSGD
While the AUD closed the year on an offered note, the odds of that bias to re-emerge strong and a recent sell-off in USDCNH has permeated into strength in commodity currencies, as the AUD remains tentatively perched just below the .7300 level.
If you're surprised by the uptick in volatility to start the year, you are not alone, as a vicious wave of short CNH covering, on the back of ridiculous funding costs, has caught more than a few traders by surprise. While the effects have spilled over into the G-10 basket, memories of 2016 China hysteria gripped the market. The fact is, it appears to be more or less a CNH contained phenomenon and has not affected general market sentiment anywhere near to the panic levels of early 2016.
As the CNH effect begins to temper, not a great deal has changed in the AUD trade. A tug of war between commodity prices and rising US interest rates will continue to play out, as will a possible trade disruption from political uncertainty associated with the US Presidential transition and regional trade sanctions.
Asset classes continue to trade favourably and commodities trade bid on expectations of massive US infrastructure spend. If current price action is telling us anything, it is that commodity currencies should continue to hold up well, even in the face of a continued USD uptrend.
However, the commodity block remains intrinsically linked to the price of oil and with both OPEC and NON -OPEC members' assurance to turn off the spigots, prices should rise. However, the fly in the ointment remains the shale producers, as the latest data from Baker Hughes reveals that the number of active US rigs drilling for oil climbed by 4 to 529 rigs this week. That marks the tenth weekly rise in a row.
On the Diary, Tuesday's domestic retail sales report and Wednesday's quarterly ABS job vacancy data are the featured events on a relatively quiet local calendar, so look for the external factors to continue driving sentiment.
It has been a tortuous start to the year on the CNH trading desk as funding conditions continue to wrong foot market participants. Despite some semblance of order emerging, we should expect volatility to remain high. I also expect that the underlying yuan depreciation pressures should return as fundamental reasons that are driving depreciation, such as capital outflows and concerns on Trump's China policies, because they haven't changed.
Although the CNH moves have put traders on edge, the global impact is not in the same league as the turmoil created last year. Moreover, as history so often repeats itself in the Forex world, we should expect the yuan to resume its course of depreciation post Trump's inauguration and at latest, post the Lunar New Year.
How to move forward and time a position entry is very tricky and open to much debate. While I suspect we are firmly entrenched in a longer-term USD bull rally, traders will tread lightly or remain sidelined in the CNH short trade, likely until "Tom Next" drops below the implied 10% level.
Given prohibitive CNH funding costs, look for traders to continue expressing regional views via the USDSGD mainland proxy. Singapore dollar volumes continue to surge as cool heads view opportunity at current levels.
After a spate of Twitter tantrums directed at Tokyo by Donald Trump, senior Chinese officials have warned the US that Beijing is ready to retaliate if Donald Trump's incoming administration imposes new tariffs. Let us hope we do not go down this road, as the last thing the global supply chain and a recovering global economy needs is a reciprocal trade war between the market's two biggest players. The global economy cannot run without China-US trading winds blowing.
China's foreign-exchange reserves fell to their lowest level in nearly six years last month, falling $41.08 billion in December to $3.011 trillion, which marks the lowest level since March 2011. While the print was in line with market expectations, it nonetheless highlights the PBOC's willingness to dip into the Reserve cookie jar, while maintaining an iron fist on capital controls in an attempt to support the yuan.
USDJPY continues to be the prime mover in the G10 space as it is the favoured pair for traders to express their USD bias. However, recent price action is primarily news driven and due to heavy weighted long USD bias. The market has shown a gibbous response to data released. This bias leads me to believe the USDJPY could be extremely susceptible to weak US economic data over the short term. However, the long run paradigm continues to suggest that US fiscal infrastructure spend, coupled with tax reform, could provide sufficient tailwind effect to break the 120 level, for a possible test of 125.
Expect lots of racket in the local EM space as there is no escaping the stronger US dollar, due to policy divergence and while I think capital market growth differential will certainly favour the region, managing the foreign exchange exposure is another question.
Global yield curves will continue to accelerate higher and omnipresent regional capital outflow will continue to be a major headache for local central banks.
With the ever present possibility for increased US trade protectionism, it paints a less than positive outlook for local currencies. The regional whipping boy is still the Malaysian Ringgit. Other than relying on a wing and a prayer for higher oil prices, there seems to be no respite in sight as the currency remains Asia's worst performer.
Sydney Open v Friday's NY close
EUR 1.0535-50 (1.0530)
JPY 116.85-99 (117.02)
GBP 1.2261-1.2315 (1.2283)
CAD 1.3235-80 (1.3235)
CHF 1.0150-80 (1.0178)
AUD 0.7291-95 (0.7297)
NZD 0.6954-89 (0.6957)