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Another Brick in the Wall

News   •   Feb 28, 2017 11:41 SGT

The Dollar ended the week on firmer ground across most currencies, despite Friday's weaker than expected Q4 GDP. Figures on capital goods were positive, despite the headline disappointment in US GDP and durable goods. The markets are less focused on backwards looking data as President Trump has yet to cement key policies involving Trade, Tax and Fiscal expenditures. Depending on the scale of the infrastructure projects, fiscal US GDP could push well beyond 3% this year.

The BoJ played a significant role in USDJPY fortunes by increasing the 5-10 year bond purchased to ¥450 bln from ¥410 bln. It was a big surprise to traders on Friday as the BoJ had skipped the 1-5 year bond purchase on Wednesday, which likely exacerbated Friday's outsized topside move. However, with the BoJ policy meeting next week, the Central Bank is sending a clear signal to the markets that they will be resolute in keeping the JCB’s 10 year yields near 0% for the foreseeable future.

The Mexican Peso will remain in the limelight, with current proceedings being viewed cautiously around the world. US trade policies directed at Mexico could be a precursor of the events to unfold in Asia. However, when trading in a market driven by political headlines, it is a dangerous game to separate chaff from reality. While relations between Trump and President Nieto are clearly a work in progress, it is clear that Obama’s administration diplomacy is out the window in favour of boxing gloves in the ring. On a positive note, the discussions will likely continue.

Not to be outdone by headlines, USDTRY had a wild ride in very thinly traded markets when comments from Turkey’s President Erdogan hit the news ticker. He has said that raising interest rates would impact both the currency and inflation in a negative direction and defended the removal of the top-bottom issue to maintain the policy rate. With the policy “more or less" greenlighted, additional intervention on the TRY interest rate is now unlikely.

While the confluence of the Credit Rating Agency’s warning and downgrade added some fuel to the fire, we have come to accept that these moves have legs. But given the sheer amount of negativity in the TRY trade, it certainly didn’t help matters.

Monday Morning Regional G-10 Market Roundup

Australian Dollar

Currently trapped in the .75-76 range trade as the confluences of carry, China and commodities (3C equation) continue to shape Aussie sentiment.

The carry trade was dealt a significant blow after the miss on last week's CPI. In my view, carry is the most important factor in the 3C equation, as the prospect of narrowing interest rate differential has hiked substantially this week. Yearly CPI has trenched in the 1.5-1.6% domestically, despite the uptick in global inflation. There is growing concern amongst investors that there is some risk of not hitting the midpoint of the RBA’s CPI forecast, which will force the RBA to lower rates. While the market is pricing a high probability of a US hike in May, sentiment has shifted from a possible RBA rate hike bias to a greater chance of an interest rate cut. If a slowdown in the Australian housing market unfolds as some expect, an RBA rate cut will be on the table in 2017. If this likelihood becomes a reality, look for the Aussie to move towards .7000.

I have been fairly consistent in my view of China over the past few months regarding the possible adverse implications for Australia if a China-US trade war escalates. However, without clarity on President Trump’s trade policy for China, we need to be extremely guarded on this view. The globalist in me hopes for a working agreement, but the pessimist in me is preparing for the worst.

Last week, China’s Medium-term Lending Facility (MLF) hike was a real game changer for the Mainland’s interest rates. Even though the hike was minor, it indicated that the PBoC is clamping down on leverage and the ultra-accommodative monetary policy gauge is getting dialled down. Although it’s Short Term Lending (SLF) that sets interbank rates, there may be some feedback nonetheless. The onshore rate hikes will likely have negative implications for Chinese growth and demand, which could bubble over into the commodity markets, in particular, iron ore.

Keep in mind, surging iron ore prices and the prospects of rising domestic inflation have kept the Aussie dollar bears at bay since the US election.

Japanese Yen

Yen sentiment drivers put in a mixed close on Friday. UST 10 year yields stumbled late in the NY session dropping to 2.49 after failing to breach 2.53 levels. Stock indices, for the most part, languished in no man's land while the WTI succumbed to profit taking. In the end, USDJPY held above 115.00 at the NY close supported by the BoJ’s 5-10 year Rinban operations on Friday. USDJPY caught up to US bond yields, and Friday’s 115.63 high print offers the next key target. A break above could be clear sailing to 118.00 support on the technical edge, which remains firmly entrenched around 112.50/.

APAC EM Roundup

Chinese Yuan

The RBM complex remains very much shackled to the broader US dollar momentum, yet we continue to witness some extreme moves in low liquidity NY trading hours. Given that we are in the midst of the Lunar New Year, China’s most important holiday, liquidity is expected to remain quite thin and minor headlines from the US administration, especially those around trade, could produce a significantly outsized move.

Mainland policymakers’ unyielding approach to both FX regulation and capital controls have greatly decreased outflow pressure. However, given just how big negative reception these iron-fisted policies have had from the international investor community, it is unlikely these systems can continue in perpetuity.

Domestically, the RMB may not receive much support for the recent MLF tightening as it does not necessarily mean higher SLF (interbank rates). However, early January's funding conditions have severely dampened investor appetite in the offshore markets.

The key to the Yuan’s fortunes may lie in future implications around US-China trade relationships. If we thought the Mexican standoff had far-reaching consequences, just wait until these two major powers enter the ring. Given the new globalist tact from Mainland policymakers, it is possible negotiations will commence from polar opposite sides.

Negotiations will take the long road, fraught with peril, so expect a very bumpy ride. Overall, I expect cemented views on US Trade, Tax and Fiscal policies to be the ultimate dragon slayer as broader USD appeal will ultimately weigh negatively on the RMB. Pick your spots wisely on the short CNH trade.

ASEAN Basket

A call was scheduled between Trump and Merkel, as well as Trump and Hollande this weekend. Merkel is reportedly urging EU countries to expedite Asia trade given Trump’s policies. A leaked paper to EU finance ministers cited 12 Asian countries as the targets: IDR, PHP, MYR, INR, CNY, SGD, JPY, THB, VND, MMK, AUD and NZD. However, the discussion between Trump and Merkel was more focused on NATO and more specifically, sharing the burdening costs among all members.

With regards to the recent strength in local currencies, it is more about less USD conviction in very crowded trades as investors were very much convinced local currencies would weaken in early 2017. And while we continue to see pockets of interest on selected ASEAN currencies, I suspect it’s more a case of position squaring and foreign investors buying into regional undervalued equity markets on some extreme currency moves early in the year. As I continue to monitor the US economic uptrend intact, I struggle to see a sustained regional economic uptick, especially in the face of possible US trade sanctions. So buying into the current local rally may be little more than an exercise in folly.

The Fed Funds’ futures markets are under-priced by only factoring in two rate hikes for 2017. With the inflation aspect of Trumpenomics, the local currencies are very susceptible to a higher repricing of US interest rates, especially if the next FOMC meeting delivers a hawkish view and a March hike becomes a reality. Further pressure on regional currencies will happen if the Feds hint at the eventual balance sheet taper.