FX

Global FX and USD Drivers

Central bank dovishness will likely keep the carry trade well-supported. Following comments by the Fed’s Powell warning that the US was at risk of being trapped in low growth, it was the BoE’s Mc Cafferty warning that the cash rate could be cut further closer to zero and quantitative easing could be stepped up. The release of weak Australian consumer and business confidence data has pushed more private forecasters into our camp suggesting the RBA cutting rates next year. We expect the RBNZ to cut rates when it meets on Thursday. Importantly, the RBNZ is likely to underline its easing bias, which should keep NZD offered for now. CFTC data show record NZD long positions. Easy monetary policy should keep risky assets supported and divert funds into yield-offering FX. Laggards of the recent EM rally seem to be catching up now. Notably MXN has gained against most currencies, with funds piling into its hard and local currency fixed income products. Oil prices rallying by 2.9% on the back of OPEC’s president predicting that the current bear market may be short-lived and Mexico reporting an 11.8%Y surge in its autos production helped too. Asian shares have reached one-year highs as China’s PPI release(- 1.7%Y after -2.6%Y) provided the impression of a stabilisation of the Chinese economy. Higher oil prices plus the dovish comments by the Fed’s Powell pushed the US 5Y/5Y inflation swap higher initially, but inflation expectations fell back to 1.9350% this morning. Yesterday’s release of the New York Fed’s July consumer survey showed steady short-term inflation expectations, but reported a decline in medium-term inflation expectations. Labour market expectations generally deteriorated, with earnings and job finding expectations declining. The findings of this survey are in line with our view of the US economy slowing down later this year. Against this background the Fed should stay dovish. An economy burdened by high debt and low investment returns requires a sustained rebound in inflation expectations before the Fed can act. Importantly, inflations expectations should lead bond yields, thus keeping real yields low. A pre-emptive Fed pushing bond yields higher and inflation expectations lower may see economic activity pushed back by higher real yields. An additional problem has come up for the Fed with currency-hedged USD-denominated bond returns for Japanese and European investors falling back to zero. Hence, inflows into the US bond market may ease for now, keeping nominal yields supported unless domestic US demand and the supply of capital shift into the direction of local savings exceeding local investment, which is generally the case when there is an economic downturn. Should, for some reason, US inflation expectations fall now, but US nominal bond yields stay steady (pushing real yields up), the Fed may haveto sharpen its dovish rhetoric. Unlike the ECB or BoJ, the Fed still has the tools to push real rates and yields towards desired levels. The ECB’s and BoJ’s domestic yield curves are ‘exhausted’ and offer little room for nominal yields to fall further, leaving markets exposed to an unwanted increase in real yields, which could happen should inflation expectations be hit again. Accordingly, real yield and rate differentials should work in favour of EUR and JPY. : Accordingly, there are two themes currently occupying the markets. Within the low-yielding FX world it is the real yield differential theme, and else where it is the carry theme. The combination of these two themes should keep USD generally offered. It is only GBP that does not fit into this framework, running its own bearish agenda. Better July BRC like-for-like sales – stripping out stores that have opened or closed – rose by 1.1% in the period July 3 to July 30 from the same period a year ago. In July 2015, they increased by 1.2%.Total sales rose by 1.9% compared with a 2.2% gain in July 2015, boosted by promotional activity and warm weather. his result is the strongest growth since the start of the year. Nonetheless, GBP has come under additional selling pressure as the BoE’s Mc Cafferty offered more easing steps. : Accordingly, there are two themes currently occupying the markets. Within the low-yielding FX world it is the real yield differential theme, and elsewhere it is the carry theme. The combination of these two themes should keep USD generally offered. It is only GBP that does not fit into this framework, running its own bearish agenda. Better July BRC like-for-like sales – stripping out stores that have opened or closed – rose by 1.1% in the period July 3 to July 30 from the same period a year ago. In July 2015, they increased by 1.2%.Total sales rose by 1.9% compared with a 2.2% gain in July 2015, boosted by promotional activity and warm weather. This result is the strongest growth since the start of the year. Nonetheless, GBP has come under additional selling pressure as the BoE’s McCafferty offered more easing steps.

GFX