gfx

FED Hike possibility, G10 currencies and USDCNY

 

Markets now pricing over a 70% probability of a Fed hike this year and inventory data pushing oil down by 2% have caused Asian equities to weaken slightly overnight. However, the weakness has been limited as global cross asset implied volatility has hit the lows last seen in 2014. The set-up fits with our view that the much better fundamentals in EM today relative to the 2013taper tantrum means that the risk-sensitive currencies can handle a rate hike this year and are unlikely to see a similar magnitude move to back then. That said, the current USD momentum and higher global inflation indications suggest that our strategy of buying the USD remains intact, particularly since the Fed’s Broad USD Index is sitting at the top end of a channel. Australia’s headline CPI coming in higher than expectations at 1.3%Y (1.1% e) Trimmed mean inflation remaining steady at 1.7%Y has caused markets to reduce probabilities of a near term RBA cut. We are still looking for a bounce in GBPUSD to sell but are conscious that EURGBP has bounced exactly from a previous upper channel support around 0.89.

Yesterday’s London afternoon USD rally seemed to be led by USDJPY breaking through its October 13high at 104.64. While the momentum for G10 currencies, including GBP which at one point had weakened over 1.2%, faded by the end of the day, there were some interesting observations to make. The press have been focused on USDCNH moving towards multi-year highs, which we still think is a function of a stronger USD; as is the higher USDCNY fixing, which is being adjusted higher against the USD in order to keep RMB stable against the basket. As USDJPY moves higher, all else equal, the CNY basket would strengthen, particularly since the JPY forms around 15% of the basket. Now as USDJPY breaks higher, other currencies must weaken vs the USD, to make the USD generally strong and thus allow the USDCNY to be naturally fixed higher (which may be becoming investor expectation based on the market moves). Our model had predicted a fall in the USDCNY fix today. Click here for our economist capital flow update. Cross asset correlations are still at all multiyear highs, maybe now G10 FX correlations are starting to increase again too.

The market is still marginally long the JPY, according to  trackers and the CFTC contract data but without the extreme long positioning seen at the start of the month, it is hard to justify that USDJPY will strengthen on position adjustment alone. Our regression based analysis is suggesting that in the past 2 months, USDJPY has become more sensitive to the performance of Japanese yields relative to the US. Overall, USDJPY remains the most sensitive to the 10y yield differential but both 2y differential and the 2s10s differential are becoming more important for the currency. The chart below shows that the current level of sensitivity to yields was last seen at the end of August, when USDJPY was trading just below 104. Since the US curve started steepening on 29th August, US 2s10s is up by 15bp, while Japan’s only 7bp, allowing USDJPY to rally by over 1%. Over this time, JPY has become less driven by global equities.

When the SNB tells you they think the CHFis overvalued, you wouldn’t think USDCHF hitting an 8 month high and approaching 1.00 would be an issue. However when the USD has been rallying this month, EURCHFhas been falling to approach the 1.08 level, which we think has been a line in the sand for the SNB before. Of course whether the SNB intervene to stop the CHF appreciating will depend on the pace of the EURCHF move but we are finding that pace is becoming increasingly related to reaching this 1.08 level. Actually the SNB doesn’thide away from the fact they have been intervening since formally removing the floor in January 2015. The SNB’s VP Fritz Zurbruegg said yesterday “We don’thave a fixed limit for growing the balance sheet; it’s a corollary of our foreign exchange market interventions”. Sight deposits, a measure of intervention, have increased by 10.8% since the start of the year. We expect EURCHFto remain in a 1.08-1.10 range, while USD strength should push USDCHF towards 1.01 in coming weeks.