FX Weekly: How Confident Are You In The Equity Recovery?

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

The persistence of global uncertainty and the recent deceleration in global growth has been weighing on China’s macro data in recent months.

Even though global yields have been falling since the beginning of the year, the US 10Y has remained steady oscillating around 2.7%.

The increase in the interest rate differential has pushed preference for the greenback with the USD index testing the 97 level.

A sudden rise in risk-off sentiment could again increase interest on safe-havens, bringing down US LT yields and therefore depreciate the US dollar.

Macro News

Global: After months of falling Chinese inflation prints, with CPI inflation down to 1.7% YoY January (from 1.7% in December) and PPI inflation down to 0.1% YoY, its lowest level since 2016, the PBoC reported that financial institutions made a record CNY 3.23tr of new loans in January, with the aggregate financing up CNY 4.64tr (figure 1, left frame). The persistence of global uncertainty and the recent deceleration in global growth has been weighing on China’s macro data, therefore the injection of new liquidity could help to offset the recent weakness in the economic activity. The market's response was positive, pushing preference for risky assets; VIX is trading at around 14, its lowest level since early October 2018.

US: Even though global yields have been falling since the beginning of the year (German Bund trading at 10bps, UK Gilt trading at 1.15% according to Eikon Reuters), the US 10Y has remained steady oscillating around 2.7%. Hence, the increase in the interest rate differential has pushed preference for the greenback with the USD index testing the 97 level. Even though the change in the Fed’s tone has also been one of the major contributors of the recovery in stocks this year and could help US equities to reach new highs in the coming weeks, we do not feel very confident at this stage especially when we look at the cumulative ETF flows that have continued to fall. A sudden rise in risk-off sentiment could again increase interest on safe-havens, bringing down US LT yields and therefore depreciate the US dollar.

UK: It seems that time is running out to pass all the laws needed for Brexit; the next important date will be on February 28th, a deadline agreed by May and Juncker to discuss progress made by the two sides. Uncertainty around the outcome is still very high, and the European election in May also adds pressure on UK assets as the extension period might be shorter than expected. After a significant rally in January, the pound may experience another sell-off in the coming weeks.

Japan: An interesting observation lately has been the slowdown in BoJ purchases in the 10-25 year segment as the pressure on global yields has eased in the recent month. No upside pressure on global yields means fewer JGBs to buy by the BoJ to manage the yield curve control.

Figure 1

Source: Eikon Reuters

US Treasury Speculative Positioning

Net speculative shorts continued to decrease in January, with the aggregate change down 308K in the 4 weeks preceding January 22nd. Total net shorts is now at 873K, down from 2.1M in the end of September, with a sharp reduction in the 5Y and 10Y contracts. Net shorts on Long US Treasury Bond have increased to 314K contracts, its highest level on record.

Figure 2

Source: CFTC

FX Positioning

EURUSD: We were stopped on our position on EURUSD at 1.1350, but we did not register any loss on that trade as we increased our entry level in early February. It seems that the Euro struggles to break through the 1.15 level, and has been raging between 1.1250 and 1.1450. Even though we find the Euro cheap at current levels, we may see some pressure on the downside in the short run. Next key support stands at 1.1180, which corresponds to the 61.8% Fibo retracement of the 1.0340 – 1.2550 range. It may be worth trying to buy some below 1.1250.

Figure 3

Source: Eikon Reuters

EURGBP: After breaking below its 0.8690 support, the pair is back in its 0.8690 – 0.8920 range and has been very rangy in the past two weeks. Next resistance on the upside stands at 0.8860, which corresponds to its 100D and 200D SMA. We are looking to buy the dips if the pair falls below 0.87.

GBPUSD: After experiencing a significant rise in January, Cable topped above 1.32 and is now down by 3 figures. The pair is currently trading above 1.29, which corresponds to its 61.8% Fibo retracement of the 1.20 – 1.4340 range and its 100D SMA. The February deadline could pressure the British pound to the downside in the coming ten days, however, we would stay out of it for the time being.

USDJPY: The Japanese yen has been depreciating since the beginning of January on the back of a rise in risk-on sentiment, compressing implicit volatility and pushing preference for stocks. However, USDJPY did not manage to break through the 111.30/111.40 level, which corresponds to its 200D SMA and 38.2% Fibo retracement of the 99.60 – 118.70 range. We do not want to get overexposed to the US dollar by shorting the pair, however, we may consider a short position on AUDJPY if this equity rally persists.

Figure 4

Source: Eikon Reuters

USDCHF: We are short USDCHF at 1.0080 on the back of a ST consolidation in the US dollar. Our first target stands at 0.99, which corresponds to the 61.8% Fibo retracement of the 0.9250 – 1.0330 range and the 200D SMA.

Figure 5

Source: Eikon Reuters

Chart of the Week

An interesting chart this week is the persistent divergence between the percentage of high sales growth (>8%) and low sales growth (<4%) companies in the past two decades in Europe. Looking at companies in the STOXX Europe 600 index, high growth companies have decreased from over 40% in 2001 to 10%+ today, while lower growth companies have surged from 20% to roughly 50%. Analysts have argued that the prolonged period of ZIRP or NIRP policies by central banks has increased the number of so-called ‘zombie’ firms, defined as companies that are unable to cover debt servicing from current profits over an extended period. According to a BIS paper, the 10-percent decline in nominal interest rates since the middle of the 1980s account for 17 percent of a six-fold rise in the number of zombie companies. Bianco Research also calculated that more than 14% of US companies cannot service their debt with 3 years of EBIT, which is higher than the 12% observed in 2011 and 9% observed in 2003.

What happens to that chart if the ECB starts to tighten its monetary policy? Is there room for zombie companies in a tightening cycle?

Figure 6

Source: Goldman Sachs

Disclosure: I am/we are short USDCHF. 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.