October 3, 2017 12:56 pm
Author — Nick Korzhenevsky, senior analyst with AMarkets Company. The anchorman of a TV program “Economics. Day rates”.
- Central banks’ assets will keep growing until Q2 2018; no global liquidity reduction in sight until 2019 despite the Fed’s QE unwind.
- The dollar creep up is a corrective move triggered by rising yields in the treasury market.
- Crude oil prices are going up alongside industrial metals, with both segments sustaining their positive momentum.
September has been quite a month for markets. It was particularly interesting to witness two things. The first one being, of course, the sterling’s jump to a one-year high on the Bank of England’s interest rate hint, which was certainly unexpected to us. We’ll break this down and discuss what’s next for the British currency in greater detail. The month was also marked by stronger crude oil prices. And while this rally wasn’t much of a surprise—in fact, it is right in line with the scenario we outlined earlier—that doesn’t make it any less impressive. Commodities remain very much in demand.
A broad trend worth mentioning is the sell-off across global debt markets. As central banks shift towards normalization, yields are going up in nearly every country. The fastest change is occurring in the U.S. This is mostly due to the fact that the Fed is leading the world in the normalization effort. The FOMC has confirmed its plans to start unwinding the balance sheet with the process starting as early as this week.
Concurrently, QE programs are still in place in Europe and Japan. The ECB is doing its best to delay any decisions that could scare the markets off. And it’s perfectly understandable. The political climate remains tense with Angela Merkel’s victory in Germany’s election being described as pyrrhic, and the developments in Catalonia looking very worrying. It would make more sense for the ECB to wait those headlines out before announcing any details on the balance sheet adjustments.
From the practical viewpoint, it is important that, cumulatively, central banks continue to supply liquidity rather than absorb it. Simple math shows that the ECB and the Bank of Japan will be offering more liquidity than what the Fed is taking back until at least the middle of 2018. By the end of next year, the balance will turn broadly neutral. Until then, however, the trend is unlikely to change. General volatility remains low (bar a few turbulent days here and there) and high-yielding currencies relatively strong.
Another key story is Donald Trump’s tax reform. We aren’t going to delve into the details of the new bill as there aren’t any significant changes compared to the previous version. The main takeaway: the new plan would reduce federal revenues by roughly $3 trillion over the next 10 years, with a decrease of $1.5 trillion. The shortfalls will thus total $1.5. In our view, that already sounds politically acceptable. The Senate and the House are set to vote on the plan this week.
Should the bill pass through both houses, the chances of the tax reform actually happening in 2018 would increase. That could revive the so-called “Trump trades” and inject some momentum into the stock market and the dollar. But if the bill is sent back to the White House and required to be budget-neutral (meaning zero revenue shortfalls over the next 10 years), all of Trump’s plans could be considered dead on arrival—which can’t be good for the dollar.
Now, on to the key themes. As mentioned earlier, the pound has performed way better than expected. Bank of England governor Mark Carney’s totally unexpected rhetoric sent GBPUSD to 1.365. In a speech last month, he said that he is ready to raise rates “in the near term” if economy “continues on the track that it’s been on.” And almost every economist read “near term” as “November.”
While the governor spoke a lot about GDP growth rates, rising inflation—or should we say risks to inflation expectations—are clearly what’s really affecting the central bank’s thinking. Indeed, the UK price data has been worse than expected. The CPI rose 2.9% year-on-year in August, the highest in over five years. Being the conservative monetarist that Mr. Carney is, he chose to address that immediately and respond by raising borrowing costs.
However, one should consider the rest of the data coming out of the UK as well, and it’s not looking pretty at all. In Q2 the GDP growth slowed to 1.5%, which is also the worst number in nearly five years. More importantly, the country’s current account deficit rose by 0.2 p.p. to 4.6% of the GDP. That is essential in the current situation as a stronger pound adds to long-term risks for financial stability. That is precisely why we think Mark Carney’s rhetoric is a little out of touch with the context. The central bank is likely to sneak in one or two hikes before having to return to a prolonged pause. We therefore don’t really see any upside potential for the pound.
Another September event worth mentioning is oil prices hitting two-year highs, with Brent crude almost reaching $60 per barrel. It has since corrected back, but remains in an upward channel. We have long expected that to happen as generally strong trend have manifested themselves in many commodities. The clearest signal was sent by the steady rally in copper. This metal is traditionally considered to be a good indicator of the economy’s health and, therefore, a proxy for demand for other raw materials.
On top of that, there is currently rising tension in the Middle East, this time in Kurdistan. The markets couldn’t ignore this problem like they did with Qatar a short while ago. Back then, it wasn’t apparent that OPEC and Russia were fully adhering to the production cuts, nor was there any real risk for supply from the region. This is different today, as the excess of oil supply in the market is significantly lower.
Kurdistan risks are for now hypothetical, but there is a probability of losing 500-600 thousand barrels a day if Turkey carries through with its threats to block oil flow from the Kurdish area.
One more thing, which is important for all commodities, is the PBOC’s unexpected decision to cut the reserve requirement ratio. As we have explained numerous times before, this is a merely technical move that has to do with interventions in China’s internal foreign exchange market. The central bank, however, didn’t have to offset yuan liquidity changes. We believe that the officials are trying to prevent further slowdown in credit growth.
That’s an obviously good thing for commodities as the PBOC’s tight policies have been, perhaps, the main problem for this type of assets. Copper’s recent corrective move, in particular, was mostly caused by the bank wanting to crack down on shadow credit activity and capital outflows. Should the stance switch to a more neutral one, the rally in metals and oil can very well resume.
And finally, a few words on cryptocurrencies. The growth trend in bitcoin and other assets has manifested signs of breaking down, while volatility is going wild. This again is a reminder that the speculative bubble is in its late stage. However, normally one could still expect an exponential-style move before the asset collpases. We still believe that trading cryptocurrencies is not worth the risk and encourage to refrain from speculating on bitcoin and its cousins.
EURUSD: still going strong.
We buy EURUSD at 1.1805, will add to the position at 1.162, take-profit at 1.212, stop-loss at 1.1555.
The euro remains generally strong. Its move up was temporarily interrupted by the global debt market sell-off that occurred over the latter part of September. For now, a risk remains that the corrective move in the euro continues. Its next target lies at 1.16 and it may well be reached if the political situation in Europe grows worse or if Trump manages to get his tax reform through the Congress.
Still, the broader upward trend doesn’t look completed just yet. EURUSD should retest the 1.2 mark, with the conservative target all within the 1.21-1.22 range. The most optimistic scenario would take the pair to 1.3020. This is clearly a longer-term set-up and isn’t very realistic until H2 2018. A rally of that magnitude would require a number of factors to be present, including a tighter ECB policy, and a turbulent political landscape in the U.S.
GBPUSD: the king is dead, long live the king.
We will sell GBPUSD at 1.381, take-profit at 1.235, stop-loss at 1.405.
The sterling managed to break the upper end of its downward trend and start a steady correction. GBPUSD somewhat was pushed up by EURUSD, i.e. the dollar’s general weakness against most currencies. The pound briefly went up even against the euro following Mark Carney’s hawkish remarks, but at the time of writing this review EURGBP is already sending conflicting signals. We suspect that there might be a base building up at 0.89 and the cross will be back on its way to parity soon.
As for GBPUSD, there’s still some potential upside. It goes technically well with both the EURUSD targets around 1.21-1.22, and the DXY. Yet we once again stress the fact that monetary policy is unlikely to offer sustainable support for the sterling, and its current strength increases Britain’s balance of payments risks. Going long the currency at current levels should already look unreasonable to conservative investors. We choose to watch the market and should the cross reach 1.38, will go short targeting 15 full figures lower.
USDCAD: too many unmet targets.
We sell USDCAD at 1.248, will add to the position at 1.271, take-profit at 1.158, stop-loss at 1.2805.
The American dollar managed to gain against its Canadian counterpart as well. The pair has regained the 1.25 mark and it’s possible that it moves towards the 1.271-1.273 range. Nonetheless, we most definitely view this as a corrective move to a wider downward trend. There’s a very strong mid-term target just below 1.16 for the unit, and it’s very probable that it will be reached.
Aside from the general USD trends, we should also point out that the loonie is relatively cheap against oil. Crude is Canada’s main export and its currently trading just under $60 for Brent. Therefore, both Canada’s trade balance and the current account surplus are fundamentally improving. By the way, the differences between the Canadian and British BoP trends could actually be a good trading idea. If GBPCAD manages to get to the 1.74-1.75 levels, a short position there is a very attractive opportunity.
Copper: healthy correction on a fundamentally favorable background.
We buy copper at 6355, will add to the position at 6175, take-profit at 7295, stop-loss at 5930.
Copper prices made an impressive leap towards the $7000/ton mark, but then quickly lost about 10%. From a technical point of view, this is a classic correction which should be followed by the final leg up. The scale of the move can vary greatly. The conservative target lies just below $7300/ton, while the maximum one is at $7865.
We believe that the rally is going to find a second wind in the face of PBOC’s recent decisions. The bank has slightly loosened its grip on the liquidity supply, and commodities should be the first to respond to that. The global macroeconomic background remains favorable. Growth rates in the United States, Europe and Japan are still positive, and the leading indicators are near their cycle maximuma. A growing global economy implies strong copper demand, and that is exactly the situation we’re in right now.
Analytical materials and comments reflect only personal views of their authors and can’t be considered as trading advices. AMarkets is not responsible for losses as the result of analytical materials usage.