FX Weekly: Dovish-er Than Expected

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Includes: DEUR, DGBP, DJPY, DRR, ERO, EUFX, EUO, FXB, FXE, FXY, GBB, JYN, UDN, UEUR, UGBP, UJPY, ULE, URR, USDU, UUP, YCL, YCS
by: Rothko Research
Summary

The risk-on environment continues globally after Governor Powell delivered a more dovish than already expected conference last week.

The suspension of the debt ceiling signed by Trump in February 2018 is set to expire next month and therefore will deprive the US Treasury from issuing new notes.

The US Treasury will need to reduce its cash balance by USD 200bn, which could potentially weaken the US Dollar in the coming weeks.

Macro News

Global: The risk-on environment continues globally after Governor Powell delivered a more dovish than already expected conference last week, stating that the current pace of monetary policy is ‘appropriate’ and that a decision of another rate hike will depend on future data points. Overall, the conference was not very informative, neither on the balance sheet process nor on the policy rates trajectory, but it seems that the US equity market performance is an important component of the Fed’s reaction function. Powell comments on interest rates switched from ‘a long way’ from neutral in his October speech to ‘appropriate’ currently standing within the range of estimates. Like Draghi, Powell also mentioned that the persistence of global uncertainty in addition to idiosyncratic risks such as the slowdown in China and in the Euro area, the uncertainty on Brexit negotiations as well as the government shutdown could affect US policymakers' forecasts this year. According to the EuroDollar futures market, the Dec20-Dec19 ST yield curve is currently trading at -15bps, implying that the Fed’s tightening cycle is now done, and we could see a potential rate cut in 2020. The 2Y10Y yield curve has been steepening since its low last month, currently trading at 20bps (according to Eikon Reuters), while the 5Y30Y is now standing at a 1-year high on the back of a sharp drop in the 5Y yield in the past quarter.

US: The suspension of the debt ceiling signed by Trump in February 2018 is set to expire next month and therefore will deprive the US Treasury of issuing new notes. As a result, the US Treasury will have to use its cash buffer ahead of March 1st, which would therefore increase liquidity in the market. In order to meet the debt limit in the beginning of next month, the US Treasury will need to reduce its cash balance by USD 200bn, which could potentially weaken the US dollar in the coming weeks.

UK: As we mentioned in one of our previous articles on the UK economic outlook, business investment has been decreasing drastically in the past two years due to the elevated uncertainty around Brexit, with the Bank of England slashing its forecasts to zero for 2018. In addition, productivity growth has significantly underperformed other developed nations (to the exception of Italy) and remains the major problem for the UK in the medium term. Bank of England meets this week and is expected to maintain its Official Bank rate at 0.75%.

Figure 1

Source: Eikon Reuters, FRED

US Labor Market

US Unemployment rate: Non-Farm Payrolls came in much stronger than expected at 304K (vs. 165K) in January, which eases concerns over some of the surveys pricing in a significant slowdown in the economic activity. However, we notice an interesting development when we look at the YoY change in the unemployment rate U6, a broader measure of the official unemployment rate that includes part-time workers. The annual change has slowly been converging to zero, and a switch back to positive territory could actually be perceived as negative.

Figure 2

Source: Eikon Reuters, FRED

FX Positioning

EURUSD: The pair still oscillates within a 300-pip range between 1.1250 and 1.1550. We did not manage to take profit on our long position as EURUSD lost a bit of momentum above 1.15 and is now trading back below 1.1450 (50% Fibo retracement of the 1.0440 – 1.2550 range). We still think the euro should get some support below 1.14 in this risk-on environment.

Figure 3

Source: Eikon Reuters

GBPUSD: As we expected, Cable showed some signs of ‘fatigue’ above the 1.32 level, which corresponds to the 50% Fibo retracement of the 1.20 – 1.4340. Traders benefit from the significant jump in January to take profit last week and GBPUSD has been consolidating in the past few days, currently flirting at the 1.30 level. Next support stands at 1.29 (100D SMA and 61.8% Fibo), where we should see some technical support.

EURGBP: As in mid-November last year, the pair got strong support below 0.8650 and is now back in its LT range of 0.8690 – 0.9070, which are the 61.8% and 23.6% Fibo retracement of the 0.8310 – 0.93 range. We did not buy the dips; however, any sell-off bringing the pair back towards 0.8650 should be considered as a good buying opportunity.

Figure 4

Source: Eikon Reuters

USDJPY: We took profit on our long position at 110 as the slight increase in US LT yields has pushed the US dollar higher. However, we remain skeptical on the January rally in stocks and would wait for higher levels of USDJPY and AUDJPY to consider going short those pairs. We do not see any imminent threat for the stock market, however, we think it is more interesting to be long Japanese yen after the recent rally in equities.

USDCHF: The pair is approaching the high of its long-term range of 0.9250–1.0330. We would take the opportunity to go short above 1.0080 for a first ST target at 0.9920 with a stop at 1.0180.

Figure 5

Source: Eikon Reuters

Chart of the Week

As in many other developed nations such as Australia, Canada or the UK, economists have been questioning the sustainability of property prices, especially in major cities such as New York and San Francisco where the house-to-annual-income ratios have reached unprecedented highs. In addition, we saw that the housing affordability index (HAI) has been trending down for the past 6 years, from over 200 to 144 (November 2018), implying that the household income was roughly 44% above the necessary income to qualify for a mortgage loan on a typical home at the national level. In addition, some surveys and leading indicators such as the 30Y fixed rate have been pricing in a slowdown in the US housing market in the coming months. For instance, our excess liquidity indicator, computed as the difference between real money growth and industrial production, has been contracting sharply over the past two years and therefore suggest we should see a slowdown in the US housing market in the coming months. Should we worry?

Figure 6

Source: Eikon Reuters, RR

Disclosure: I am/we are long EURUSD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.