Global FX, CNY Strength, NZD and GBP weakness to come
There will be no UK data releases today, but there are other reasons why GBP is expected to break lower. Next to the CHF, JPY, USD and NZD, we identified GBP as one of our preferred shorts in July,arguing that the combination of the BoE staying on the sidelines and inflation comfortably exceeding its 2% target will keep 10-year real yields near -2% for now. GBPUSD’s crucial support is at 1.2810, which we expect will break today. Sure, media reports of Brexit Secretary Davis proposing to soften the UK’s Brexit stance on the ECJ today is a positive factor, but this move does reveal a deep split within the government, leading to additional speculation concerning the political future of PM Theresa May. PM May has previously argued that leaving the jurisdiction of the ECJ would be essential to complete Brexit. It appears this position may no longer command a majority within the government.
The political tail risk in the UK seems to be rising ahead of the early October Tory party conference. The worst case outcome could lead towards new elections. This scenario would receive more support should the next few weeks see the successful launch of centre ground party ‘The Democrats’, leading to possible defections of centrist Labour and Tory MPs, which could lead the informal partnership of the Tories with the Northern Irish DUP to lose its majority within the Commons. Meanwhile, the Recruitment and Employment Confederation said an index of economic conditions has fallen to the lowest this year, with a greater proportion of survey respondents saying things are getting worse. It seems that the lack of clarity in respect of the UK’s post-Brexit position may start hitting investment plans. However, signs of declining investment are not only spotted within businesses. Take the prime London housing market as another indicator. Here, GBP weakness is no longer inspiring foreign buyers to come into the market. Brexit appears to be putting the UK economy into a relatively weaker position when comparing within G10. Moreover, the UK’s current account revision to 5.2% of GDP for 2015 suggests that foreign funding dependence may be a bigger issue than previously assumed. Obviously, the UK has entered Brexit at a time of relative weakness and vulnerability. We like GBP shorts even against an otherwise weak USD. EURGBP long is the best GBP bearish trade.
Despite our bullish risk attitude, we have turned NZD bearish arguing that New Zealand’s overleveraged economy is now rolling over. Overnight, the government trimmed economic growth and budget surplus forecasts a month before the country’s general election on 23 September. The appearance of populism could put the anti-immigration party ‘New Zealand First’ into a kingmaker’s position, suggesting its programme ‘to promote and protect the customs, traditions and values of all New Zealanders’ may be influencing government policies. Similar to the UK’s Brexit, New Zealand First’s influence on the government does not bode well for economic growth potential. Given the higher degree of NZD overvaluation, we expect the NZD to come under sustained selling pressure. NZDUSD should soon break the neckline (0.7225) of a ‘head& shoulder’ formation, targeting 0.7130 initially.
Despite the USD regaining some ground ahead of today’s speech by Draghi and Friday’s Jackson Hole Symposium, USDCNY has remained under selling pressure. The 3-year RMB-denominated sovereign bond auction drew good demand, following last auction attracting the strongest bidding on records going back to 2005. We expect the RMB to remain bid as China tries to attract foreign funds into the country via its Stock and Bond Connect programmes. Domestic liquidity conditions are tight, manifested by banks’aggregate excess reserve ratio falling to only 1%. The low reserve ratio could cause unwelcome volatility. There are choices for the PBoC. Either it helps the central bank’s foreign exchange purchase position to increase sharply, or the PBoC may have to inject a large amount of liquidity. We think the PBoC may opt for the first option and recent data suggests that it is on the right track. Overseas investors increased their China onshore bond holdings by RMB 62bn ($9.3 bn) in the second quarter after a reduction of RMB22bn in the first three months of this year.