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FX Weekly: Mind The Pullback In CPI Shelter

Includes: FXB, FXE, FXY, UUP
by: Rothko Research
Rothko Research
Macro, currencies, short-term horizon

Trade uncertainty remains high as Trump renews tariff threat on South American nations and France.

Overall, fundamentals have disappointed in the last quarter of 2019; we saw that the Citi G10 economic surprises index fell below 0 in the past week.

Global liquidity, which has been one of the main drivers of stocks this year, has also tightened in November by $500bn.

However, investors are still positioned defensively and equity funds could experience significant inflows in 2020 if uncertainty eases and fundamentals improves.

Falling new home prices in the US is sending a warning signal to CPI shelter for the months to come, a heavy component of core CPI.

Macro News

Global: Trade uncertainty remains high as Trump renews tariff threat on South American nations – Brazil and Argentina – as the series of currency devaluations have been impacting US farmers. As a result, Trump announced that he will ‘restore the Tariffs on Steel and Aluminium’. In addition, US officials are discussing tariffs of as much as 100 percent on $2.4bn in French products including cheese and champagne as a response to the new French tax on digital services that represents a barrier to trade. Overall, fundamentals have disappointed in the last quarter of 2019; we saw that the Citi G10 economic surprises index fell below 0 in the past week, slightly diverging from global equities. Global liquidity, which has been one of the main drivers of stocks this year, has also tightened in November, down $500bn to $75.5bn according to Bloomberg.

However, despite the little pullback in fundamental indicators, investors are still positioned defensively with 2019 being the year of the record outflows from equity funds, down $215bn while bond funds experienced $757bn of inflows based on JP Morgan calculations (figure 1, left frame). Hence, if uncertainty eases and fundamentals improve in the coming months, 2020 could be the year of Great Rotation II with investors piling into equity funds like we saw back in 2013 (that year the SP500 was up 30%!).

US: Business sentiment continues to weaken in the US with the ISM manufacturing falling to 48.1 in November, implying further deterioration in the economic activity. A few employment leading indicators are now showing potential weakness in the job market coming ahead. For instance, we saw that the annual change in the JOLTS survey, which is a survey done by the BLS to help measure job vacancies, has been falling significantly in recent months and historically co-moves strongly with the non-farm payrolls times series.

Euro: Fundamentals recovered modestly in the Euro area in the fourth quarter and we saw that PMIs rebounded recently in most of the countries. Easing financial conditions combined with better-than-expected fundamentals and speculation on a possible fiscal stimulus in 2020 in Germany and Netherlands have levitated equities with the Eurostoxx50 flirting with the 3,700 level, its highest level since Q1 2015. With the index up more than 20 percent year-to-date, European equities are on track for their best year since 2009. One sure thing is that European equities will need lower uncertainty related to the trade war and better fundamentals in order to continue to reach new highs. The next important resistance on Eurostoxx50 stands at 3,840.

Figure 1

Source: Eikon Reuters, JP Morgan

US Treasuries Net Specs

Net short specs were barely unchanged in the week ending November 26th at 1.03M contracts. We saw that in the past few weeks, speculators have become increasingly more bearish on US Treasuries as rates seem to have normalise lately. Even though fundamentals have been mixed in the US lately, the positive surprised was the upward revision on growth from 0.3% to 1.3% in the past two weeks according to GDPnow.

Figure 2

Source: CFTC

FX Positioning

EURUSD: The pair has been very rangy in the past month, oscillating around 1.1040 (its 50D SMA). Volatility in the FX market overall has been fairly low and EURUSD has not responded to the recent rebound in fundamentals neither to the rising inflows in equity funds. We are neutral on the pair for the time being.

Figure 3

Source: Eikon Reuters

GBPUSD: As for the euro, Cable has been trading within a narrow range in the past two months following the pound rally in October; the pair has been oscillating around 1.29, which corresponds to the 61.8% Fibo retracement of the 1.20 – 1.4340 range. Volatility may start to pick up again in the coming week as we are approaching the General Election on December 12th. We could see a little pullback in the short run, which we think could be a good opportunity to buy GBPUSD on dips if long-term developments on Brexit keep improving.

EURGBP: The pair is still trading at the low of its 3-year range and we are still optimistic that EURGBP could experience a short-term technical (bull) rebound. We keep our long position ahead of the general election, with a tight stop at 0.8450.

Figure 4

Source: Eikon Reuters

USDJPY: The trend looks slightly bullish on the pair after it broke its psychological resistance at 109.15, which represents the 50% Fibo retracement of the 99.60 - 118.70 range. The bullish environment for stocks globally has also been favouring most of the risk-on FX crosses against the Japanese yen in the past few weeks (EUR, GBP and AUD). We missed our entry on USDJPY but keep an order at around 107 in case we see a short-term consolidation.

NOKSEK: We took a long position on the pair as we were speculating on a short-term rebound as NOKSEK was approaching a LT upward trending support. Even thought the pair broke below that support, we keep our long with a tight stop at 1.0280.

Figure 5

Source: Eikon Reuters

Chart Of The Week

In the past few months, we saw that leading indicators of inflation in the US have shown mixed signals. For instance, the unit labour force or the velocity of money are both showing that inflationary pressure remains firm, however other indicators such as the underlying inflation gauge have been fading recently. This chart shows an interesting pattern between the price of new homes and CPI shelter. Price of new homes have been falling in the past 18 months in the US, from 5% to -2.5% (looking at a 12M SMA). This chart shows that the annual change in the price of new homes tend to lead the Shelter CPI by 16 months and is currently pricing a significant deterioration in the CPI rent. As shelter has a heavy 42% weighting in the core CPI, a deterioration of shelter in the coming months would significantly pressure inflation to the downside. As Albert Edward pointed out recently, without shelter, core CPI would be running around 1 percent (vs. 2.4% actual).

Figure 6

Source: Eikon Reuters

Disclosure: I am/we are long EURGBP, NOKSEK. 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.