Risk Aversion Percolates

Markets oozed that distinctly risk-averse mindset on Friday, as jitters were apparent in numerous pockets of the market. One could almost sense the currency markets antipathy for risk as we entered week's end. However, this is not too surprising given the current French election climate and just how consistently unpredictable President Trump has been on the policy front.

Bloomberg reports a new poll by IFOP which shows 66% of French want Fillon to drop from the Presidential race. You may recall that the right-wing candidate Francois Fillon’s campaign is marred by Penelope-gate, and thus the French want him to drop out of the presidential race. However, Reuters reported that a large percent of the French believe Fillon will stay in race until the vote.

US equity investors, on the other hand, appear immune to any market hiccup, taking U.S. equities higher for the week as the Dow industrials extended its streak of record closes to seven sessions. However, with US Treasury yield back pedaling on Friday, softer bond yields likely helped the Dow squeak out those gains on Friday.

We expect a calm session during the US holiday today, but in politically driven markets, I am not taking any holiday session lightly.

Australian Dollar

The Australian dollar has been on an incredible tear for the past five weeks, supported by a massive rally in Iron Ore and mellowing expectations of Fed rate hikes. However, the current “death valley” at .77-7750 remains intact, suggesting that investors continue to grow cautious of not only of the long Aussie position overhang, but also question the sustainability of iron ore prices.

While a much-speculated correction in iron ore prices has yet to evolve, fiscal spending expectations for both China and US should prevent prices from falling off the cliff. Likewise, we should not expect the Aussie dollar to fold up tent anytime soon.

On the carry trade front, this week’s Minutes of the recent RBA meeting will contain little new. However, Governor Lowe is slated to make two speeches this week which will be closely monitored by Aussie dealers. Given the recent strength in both employment and NAB business confidence, I think the tail risk would be for a more hawkish lean from the RBA than the market has priced in, but at a minimum, there’s little impetus for the RBA to veer from its current neutral tack.

On the other side of the carry, the Federal Reserve continues to serve up their best version of a waffle. Dr Yellen, who forever cautions, again used the Fed’s time-honoured verbal gymnastics to avoid any direct answer as to whether or not the Feds are close to flipping the interest rate switch.

It has been a relatively quiet open as traders digest the weekend news. One of the key regional pieces is on the diplomacy front. Specifically, the China-US olive branch exchange appears to be gearing up as over the weekend as China hit North Korea with a massive blow by suspending its coal imports from North Korea. While Beijing is mum, it’s worth noting that North Korea fired a ballistic missile last weekend, the first such incident since Donald Trump took office. One cannot help but think this is an encouraging sign that Mainland is ready to deal on multiple fronts.

Japanese Yen

It was a very soggy Friday for risk appetite and predictably the JPY was the favoured parking spot amongst G10 currencies. It was not so much a USD storyline as the EURJPY led the charge taking it on the chin from the opening bell in London. The cross came off from 121 to eventually settle below the 120 handle primarily driven by investor queasiness over upcoming French elections. Then came the predictable follow-through price action on USDJPY as risk-off mode kicked in as safe havens rallied, and then US yields tanked.

This once again left dollar bull’s mired in a wool-gathering session, musing where the next catalyst for a significant US$ move will come from, if at all. Reuters reports that, “Speculators reduced bullish bets on the U.S. dollar to their lowest since the week ended Oct. 11, cutting net longs for a sixth straight week, according to Commodity Futures Trading Commission data released on Friday and calculations by Reuters”.

Japan’s Finance Minister Aso is planning to start an economic dialogue with Trump administration in April. While they have not decided the agenda, I am sure Tokyo is hoping that the Trump administration will be less severe than Presidents Trump's campaign currency rhetoric. April is setting up to be a very testy period for Asia’s currency markets, as the first FX report under the Trump government is due out then. Let's face it, the currency/trade war is Asia's biggest horror story, and while a sense of relief came over markets after the civility expressed during Xi-Trump call and US-Japan summit, the topic remains an emotional issue.

Chinese Yuan

The Yuan continues to track the broader USD, more specifically the USDJPY.

On the domestic front, given the uptick in inflation and the PBOC’s recent policy tightening moves, the big question is will the PBOC start to use the Short Term Lending Facility (SLF) to manage their currency policy via short-term interest rates. Indeed, this month's surprise tightening is being viewed as part of a PBOC policy overhaul, as the central bank gradually moves to a more liberalized policy stance.

In a policy shift applauded across all trading desks Friday, Beijing loosened its iron grip on stock index futures trading by reducing margins from 40% to 20%, while relaxing both positions limits and fees. In the same manner, mainland investors jumped all over the opportunity almost doubling the five-day average of contracts traded. It looks like we may have a simple cure for capital outflow, just make mainland financial markets a friendlier place to do business.

On the diplomacy front, the China-US olive branch exchange appears to be gearing up as over the weekend China hit North Korea with a massive blow by suspending its coal imports from North Korea. While Beijing is mum, it’s worth noting that North Korea fired a ballistic missile last weekend the first such incident since Donald Trump took office. One cannot help but think this is an encouraging sign that Mainland is ready to deal on multiple front.

EM Asia

It is a trade fraught with peril, but the longer the wait is for US policy clarity on both the Fiscal and Monetary policy fronts, especially with commodity prices booming and global growth on the ups. It is tough not putting money to work in regional undervalued equity markets or even to resist the temptation of the ASEAN carry trade, however, we know the trade is fraught with danger, if not from the Fed flipping the March rate hike switch, it can certainly come in the form of a “currency manipulator” tweet from President Trump.

Monday Morning Futures Run

ENERGY

WTI

US oil markets were in consolidation mode ahead of the US long weekend with Oil Traders doing little more than the position shifting shimmy ahead of Tuesday’s March Futures Contract expiration. Adding to the oil and gasoline supply overhang, data from Baker Hughes on Friday revealed that the number of active US oil drilling rigs rose by 6 to 597, marking the 5th consecutive weekly increase.

US Nat Gas

Henry Hub Natural Gas trade saw a brief short covering rally ahead of the US long weekend, but failed to make any dent in market sentiment as the North East USA basks in a balmy January, with temperatures topping +12 degrees Celsius. Moreover, the weather outlook continues to trend warmer. Not a convincing outlook for natural gas prices.

METALS

Gold

Given the politically charged climate in Europe surrounding French elections and growing pessimism over the US administration's fiscal policy or lack thereof, gold prices could shift higher to the 1250-65 level before encountering any significant resistance. However, one thing we can all agree within the gold pit, is the biggest threat to the current gold rally is a resurgent USD, and all eyes remain glued to the Greenback.

Copper

Copper could fall further in the near term, given that recent supply concerns over the recent strike in Chile could start to unwind as a dialogue between BHP and striking miners at the massive Escondida copper mine gain traction.

Iron ore

Chinese steel demand and prices continue to outpace even the most optimistic of views and as such, Iron Ore prices continue to froth. Despite record high inventories, as the global economy exits several trying years in secular stagnation and with China's characteristic Q2 strong seasonality demand barking, Iron ore prices are likely to remain well supported through the first half of 2017.