FX Weekly: Uncertainty Versus Growth

|
Includes: FXA, FXB, FXE, FXF, FXY, UUP
by: Rothko Research
Summary

Risk eased globally in the end of last week with the VIX falling below 20, the US 10Y stabilizing around 2.40% and the Japanese yen starting to depreciate.

Price volatility remains elevated in China as weakening fundamentals continue to weigh on asset prices.

This week will be marked by the European Parliament elections starting on Thursday with voting continuing into the weekend across the 27 member states.

Participants will keep an eye on political developments in Westminster this week, but we think that Sterling will remain under pressure this week due to European elections.

The little yen depreciation has not changed our view on the pair; we like to be short USDJPY in this current economic environment.

Macro News

Global: Risk eased globally in the end of last week with the VIX falling below 20, the US 10Y stabilizing around 2.40% and the Japanese yen starting to depreciate against most of the major currencies. However, price volatility remains elevated in China as weakening fundamentals continue to weigh on asset prices. Figure 1 (left frame) shows the significant deterioration of economic indicators in the past few months, leading to a 14% drawdown in equities (Shanghai Stock Exchange). The pressure on the Chinese yuan remains high in the short run, with the USDCNY exchange rate trading slowly approaching the 7 psychological resistance. Will it break through?

Overall, uncertainty in the market is still very elevated (see the significant divergence between the EPU index and VIX here) following the White House’s moves on Chinese telecommunication company Huawei. An interesting recent study from Ahir, Bloom and Furceri (May 2019) shows that the increase in uncertainty observed in the first quarter could be enough to ‘knock up to 0.5%’ of the global growth over the course of the year.

Euro: This week will be marked by the European Parliament elections starting on Thursday with voting continuing into the weekend across the 27-member states. Results will be closely watched by market participants, particularly given the rise in populism and euro-skepticism in recent years. Liquidity combined with political uncertainty were the two main factors explaining the cheap valuation of European equities (relative to the US stocks for instance), hence the rising stake of ‘anti-Europeans’ will continue to weigh on capital markets, especially equities.

Japan: Government data showed that Japanese real wages fell 2.5% YoY in March, the biggest decline since June 2015 following a revised 1% drop in February, raising concerns about the hit to the consumer sector from the persistence of global uncertainty. With the core inflation rate currently at 0.8%, April BoJ forecasts show that core CPI will still remain well below the 2-percent target by FY 2020 (1.5% on the upper range).

UK: The collapse of the cross-party Brexit talks on Friday heavily impacted the British pound, which has been the weakest performer relative to other major currencies. Participants will keep an eye on political developments in Westminster this week, but we think that Sterling will remain under pressure this week due to European elections.

Figure 1 Source: Eikon Reuters

US Treasuries Net Specs

While net shorts have started to increase again for the 5Y and the 10Y contracts in the past 6 weeks, they have continued to fall for the short end of the curve. Net short for the 2Y totaled 33.3K contracts in the week ending May 14, down 140K in the past month and almost 400K since their mid-December high. On aggregate, net shorts have slightly increased, by 12K in the past week and 34K in the past month.

Figure 2

Source: CFTC

FX Positioning

EURUSD: As expected, the euro still remains under pressure against the US dollar, with the exchange rate struggling to break through its 50D simple MA at 1.1240. EURUSD is trading below 1.1185 again, the 61.8% Fibo retracement of the 1.0340 – 1.2550, and momentum is clearly bearish for the time being. Any short-term recovery on the euro could be viewed as a good opportunity to short the pair; we keep our short order at 1.1330.

Figure 3

Source: Eikon Reuters

GBPUSD: Sterling has been the worst performer among the G10 currency space in the past couple of weeks on the back of a rise in uncertainty around Brexit outcome and doubts over PM May’s potential successor. Cable is down almost 5 figures since the beginning of May, and the trend looks currently bearish. We would stay out of it for the time being.

EURGBP: Despite the euro’s vulnerability, the pair is up 3 figures this month approaching its 0.88 resistance, which corresponds to its 200D SMA. RSI indicator shows that EURGBP is overbought, hence we would short some at 0.88 for a small consolidation following the latest rally. We keep a tight stop at 0.8840 with a target at 0.87.

Figure 4

Source: Eikon Reuters

USDJPY: After hitting its short-term support at 109.15, corresponding to the 50% Fibo retracement of the 99.60–118.70 range, USDJPY rebounded on the back of yen weakness. The little yen depreciation has not changed our view on the pair; we like to be short USDJPY in this current economic environment. AUDJPY also remains under pressure due to both the vulnerability of the Aussie (see article here) and the yen strength; the pair is slowly trending towards its LT support at 74.50.

Figure 5

Source: Eikon Reuters

USDCHF: The pair has been fairly flat in the past week, currently trading around 1.0080, its 76.4% Fibo retracement of the 0.9250 – 1.0330 range. We are still waiting for higher levels to short it.

Chart of the Week

This chart shows an interesting co-movement between the Australian dollar (vs. USD), copper and Chinese credit impulse since 2004, which we measure as the annual growth of Total Social Financing (TSF, a broader measure of credit). Over the years, practitioners have considered copper as a reliable leading indicator of economic health, reflected in the market price of the commodity. With China alone representing 50 percent of the global demand for the industrial metal, it is obvious that loosening credit conditions in giant China tend to lead to a higher copper price and often correlates with an acceleration in the global economic activity.

We also tend to look at the Australian dollar as a leading indicator, where a positive trend on the Aussie usually indicates a rising risk-on environment, which is usually positive for stocks. For instance, the 2016 reflation, which was partly generated by loosening Chinese credit conditions (annual growth of China TSF rose from -19% in mid-2015 to 25% in mid-2017), was positive for both copper and the Aussie. The year-on-year change in AUDUSD switched from -20% in mid-2015 to over 30% in mid-2017. However, in the past two years, the Aussie has been trending lower, completely ignoring the positive market news and the recent rebound in China credit. Should investors worry about the weakening Aussie?

Figure 6

Source: Eikon Reuters

Disclosure: I am/we are short USDJPY. 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.