FX Trade Ideas abd Global Trends
The global reflation trade has increased its momentum, but unlike what we saw for the firstnine months of this year when reflation focused on EM asset classes it is now Japan and the US which are in investors’ focus. Meanwhile, the EM currency index has lost 5% since 7 September. Long positions in S&P futures, which fell sharply in early Q3,are now back close to their highest levels of the year. This bullish equity positioning was mirrored by a sharp reduction in long positions in U.S. Treasuries and oil prices reaching a two-year high. mirrored by a sharp reduction in long positions in U.S. Treasuries. In this sense markets have similar characteristics to what was observed late last year when prospects of US tax reform and other regulatory changes pushed the USD higher with the help of widening interest rate differentials, allowing US, Japan and EMU equities markets to outperform the EM markets. Indeed there are signs that foreign investors are rushing in to buy Japanese equities as in 2013 when ‘Abenomics’ lifted off. Nonetheless, there is one big difference. In 2013, Japan’s equity market received its inspiration from a sharply falling JPY. Nowadays, the inverse relationship between the evolution of Japan’s Topix and the performance of the JPY has eased.

ECB succeeds. The ECB has provided a dovish taper with President Draghi stressing that there is still “a large amount of uncertainty”adding that the decision about the asset-buying plan “is for an open-ended program”and it is not going to stop suddenly. His suggestion the ECB may lag the Fed by about 3-4 years pushed long-term yield differentials sharply in favour of the USD. Markets will now have to rebalance, suggesting EURUSD could see 1.1530/10 before stabilising. However,as long as EURCHFremains in a bullish trend we see longterm EUR buyingneeds soon returning, pushing the EUR higher once again.
JPY should weaken. This morning’s release of Japan’s September core CPI (0.7%Y)undershot the median (0.8%) supporting our view of the BOJ maintaining current parameters of its yield curve management for longer. Recently, Japanbased investors have increased their purchases of short-dated foreign currency denominated bonds. Short term bonds tend not be currency hedged, indicating that confidence in foreign currency strength has increased.

US data strength. Today’s US focus will be on the release of the Q3 GDP report. Adverse weather conditions may have depressed activity in Q3(our tracking estimate is at 3.2%) which should be made up by a better Q4 reading. Hence markets may tolerate a weaker GDP reading and put their entire focus on the core PCE. Should the PCE exceed the consensus 1.3%Q estimate, US bond yields may rise further taking USDJPY beyond the 114.40 chart mark, openingupside potential to 116.75. The University of Michigan will provide us first indications concerning the strength of the economy entering November. Latest PMI reports including yesterday’s Kansas City Fed’s October manufacturing index rising to 23, setting a 6-year high, suggest that the economy is in good shape.
AUD in trouble. Australia, which is in the middle of a consumer slowdown, will be exposed to political headwinds as Australia’s High Court invalidated the election of the country’s deputy PM Barnaby Joyce, losing the Turnbull government its majority. There will now have to be a by-election – which Joyce will recontest – but that will be on Dec 2at the earliest. There will be a period of increased uncertainty which should put the AUD under additional selling pressure. The break of AUDUSD 0.7710 has opened downside potential to 0.7340.

While President Trump did say that he would nominate a new Fed Chair around mid-October, it looks like the search is nowhere near being concluded – with White House Chief of Staff John Kelly last week noting that interviews are still in the ‘first round’ stage, while Treasury Secretary Mnuchin hopes that a nomination will be made within the next month.
We strongly believe that it is way too early to make any sweeping assumptions about what particular nominees would mean for the future of Fed policy. Yet, we are wary that markets are likely to react to President Trump’s nomination based on their current preconceived ideas. And while perceptions and reality may be two different things, our scenario analysis table below aims to provide a snapshot of what we expect to happen in markets if one of the leading Fed Chair candidates were to be nominated in the coming weeks.

Given that uncertainty over the next Fed Chair is likely to be weighing on short-term rates – not least because it currently makes any US monetary policy call largely invalid beyond Feb-2018 – the nomination of a new Chair would be USD positive. But most of the candidates would not be game-changing for our strategically bearish USD view and we would be inclined to fade any post-announcement moves.

In fact, we think only John Taylor – renowned economist and pioneer of a rules-based monetary policy framework – would pose serious risks to the current ‘goldilocks’ market environment. But again, the reality may not be what it seems on paper; even Mr. Taylor knows that for his more radical rules-based policy proposal to work, it requires international coordination to the likes not seen since Bretton Woods. The likelihood of this happening is trivially low.
Elsewhere, we do see the next few weeks as a window of opportunity for the EUR. It’s somewhat disappointing not to see the EUR higher on the latest ECB ‘sources’ floating the idea of a cut in monthly asset purchases to EUR 30bn from January 2018. However, expect more of these ‘sources’ and ‘leaks’ to sporadically appear in the build-up to the 26 OctoberECB meeting – and it’s hard not to see Eurozone yields and the EUR moving higher on any relatively aggressive QE taper speculation.
Discounting the hurricane-related distortions to headline CPI and retail sales, the softer 0.1% MoM change in core CPI has dented any trivial US inflation optimism. The fallout may be limited given the lack of inflation premia priced into markets, though the lack of any upside risks to the long-run US economic outlook reaffirms the idea of structurally low bond yields for longer. Such an environment supports our strategically bearish USD view. Fed speakers this are unlikely to rock the boat – especially as the Sep minutes suggest that confusion seems to reign within the committee.

The Austrian elections over the weekend should have a limited impact on the EUR. Reality is that the currency will shift its focus to 26 Oct ECB meeting over the coming weeks and any talk from ECB speakers that errs on the more hawkish side should keep the currency bid. We feel the announcement of a ‘lower for longer’ QE taper schedule would drive Bund yields circa 10bps higher, with a one-time move up in EUR crosses. Eurozone data wise, we have the final release of Sep CPI and the German ZEW survey (both Tue), as well as balance of payments data (Fri).

After a few weeks of highly charged political focus, we expect the narrative for GBP to slowly shift towards the November ‘Super Thursday’ BoE meeting. This week’s UK data releases – including the CPI report (Tue), job market report (Wed) and retail sales (Thu) – are unlikely to derail sentiment for a 25bp Bank rate increase next month. While that’s all but in the price of the pound, we prefer to focus on how robust underlying UK inflationary pressures are – and whether any upside surprises prompt the Bank to signal the start of a ‘more than a withdrawal of stimulus’ hiking cycle next month. On that note, Governor Carney testifies to UK lawmakers this week (Tue) – along with new MPC members Ramsden and Tenreyro. Any hawkish signals could steepen the UK rate curve and we think GBP/USD at 1.35 is a strong possibility around the Nov BoE meeting.
Lacklustre US inflation dynamics should see the benign bond market environment persist and the high-yielding AUD and NZD recover some recently lost ground. In Canada, there’s key inflation and retail sales data to keep an eye on before an important Bank of Canda meeting later this month.

It’s a fairly eventful week in the domestic calendar with the September labour market report (Thu) in the spotlight; market consensus is looking for a slowdown in the pace of monthly job gains (+15k), although this will still be seen as signs of a tighter labour market. Some good data needed for the AUD after the disappointing retail sales figures earlier this month.

We’ll also get the October RBA meeting minutes (Tue) – as well as a couple of central bank speakers in Ellis (Tue) and Bullock (Wed). AUD moved lower after the RBA’s Harper recently failed to rule out a rate cut, though we think markets may have overreacted to this. Expect AUD/USD to remain anchored around the 0.80 level in 4Q17 amid the lack of any major directional catalysts.

Canadian CPI and retail sales data (both Fri) will dominate the focus for CAD markets this week – especially ahead of the 25 Oct BoC meeting. Policymakers have been gradually shifting to a more cautious stance over further rate hikes amid concerns that markets may have moved too far too fast for their liking. In the absence of any big positive inflation surprise (consensus is looking for core common CPI at 1.5% YoY), we would expect a pause in the tightening cycle for the remainder of the year.

Watch out for the 3Q BoC Business Outlook Survey this week (Mon) and in particular whether local firms see recent CAD strength as weighing on competitiveness. Manufacturing sales data (Wed) may show some preliminary evidence of this. Equally, ramped up NAFTA uncertainties could keep the BoC in wait-and-see mode for the time being. We expect CAD to remain on the back foot given the more contentious US trade stance, with a move to 1.27 not off the cards if further tariffs on Canadian firms are issued.

Recent days saw a rapid decline of US corporate bond spreads with the BBB spread seeingnew cycle lows this morning. EM tends to rally when US corporate bond spreads decline. NAFTA talks have turned into an idiosyncratic MXN downside risk with Mexico’s Secretary of Economy Ildefonso Guajardo Villarreal saying the country has the strength to face any long-term structural challenges in the absence of a NAFTA agreement. Overnight data releases including Japan’s machine tool orders and Australia’s consumer confidence have come in on the strong side supporting our view of an increasing pace of global economic synchronization.

Semiconductor stocks have hit a new high, oil has remained bid, but the CRB Rind index has turned offered telling us to stay short the AUD. US 10-year Treasury yield has bounced from its 200-day MAV working in favor of our bearish JPY and CHF calls.
The USD has halted its three day decline against the RMB, but China’s Ministry of Finance starting this week to discuss issuing its first USD denominated bond since 2004 tells us that USD stabilization will be short-lived. In 2004, China’s RMB was pegged to the USD and it was the outlook of USD weakness which prompted China to consider ‘currency hedging’ its strongly rising reserves by issuing USD denominated bonds. It finally converted its USD peg into a ‘dirty float’ in July 2005 starting to fix the RMB against a non-specified basket of currencies. This marked the time when global reserve managers started reallocating their currency reserves, pushing in particular the weighting of the EUR higher.

Moreover, RMB stability seems to attract foreign capital making its way into the RMB. Net investment flowing into mainland China from Hong Kong through the Shanghai-Hong Kong Stock Connect and the Shenzhen-Hong Kong Stock Connect totaled a daily record of CNY7.68bln on Monday. As of the end of August, foreign investors had put a total of CNY857.36 bln into the Chinese bond market, representing a CNY15.9 bln increase from the end of July. The RMB inflow combined with the increasing issuance of private and sovereign accounts should boost China’s FX reserves, compensating for the decline of its current account surplus of 2.9% in 2015 to 1.34% in Q22017.

Concerning the EUR we need to differentiate between noise and what determines the long-term trend. Catalan’s President Carles Puigdemont backing away from breaking the link to Madrid should normalize Spanish markets, allowing sovereign spreads to come in and the IBEX to rally. However, the long-term outlook of the EUR will be driven by reforming EMU institutions and turning EMU towards deeper integration. All this seems to be happening within an environment of strong global liquidity conditions and increasing signs of synchronized global growth creating an ideal backdrop for the EUR to rally.

Importantly, EMU’s debate has turned around and with Chancellor Merkel opening the path to creating a small and tax funded pan EMU budget, the starting signal for a move towards deeper fiscal integration has been provided. This is an important signal for the still undervalued EUR. Real money including reserve managers may increase its EUR holdings from here keeping the EUR bid. Moreover, moving away from EMU sub-optimality allows the ECB to move away from providing accommodation for its weakest link. This is why we believe markets will turn from what we called ‘trading the Italian EUR’ towards trading the EUR up towards is fair Eurozone valuation level of around 1.30. A daily closing price above 1.1850 suggests EURUSD seeing new cycle highs.


Semi-core and peripheral spreads tightened further last week, with long-end Belgium and Austria standing out positively and 15-30yr BTPS bucking the trend. Given the fairly tight spread levels, especially of 5-10yr semi-core, we see widening risk as the ECB October meeting draws closer.
• Bearish momentum in Bunds has eased somewhat as rhetoric on North Korea has heated up. But with tax reform plans in the US set to take shape and 10yr Bund ASW remaining more than 5bp above our FV estimate, we stick to the view that 10yr Bund yields will breach 0.50% over coming weeks.
• The sharp shift to the right in the German elections suggests a tougher German stance towards Eurozone fiscal integration and in future debt (re)negotiations, implying (at the margin) somewhat wider peripheral spreads.
Rich/cheap analysis
• 2/3yr BTP-SPGB spreads tightened further as the situation in Catalonia escalated, but now look stretched assuming independence won’t happen.
• Long-end E-names continued to perform last week and now look expensive versus core and semi-core EGBs.
• Despite richening in ASW, 20yr NEDWBK cheapened further vs EIB, perhaps due to the tap of the NEDWBK 10/41.
• 7yr EFSF looks attractive vs. NEDWBK as earlier this year at the time of the French elections, probably since investors expect Q4 EFSF issuance (€5.8bn) to target the belly of the curve.
Supply
• Scheduled EGB supply of up to €15bn this week, from Germany and Italy (p. 3). Italy will announce the 28 Sep. medium/long term auctions today.
• Belgium will redeem €6.9bn and pay out €2.9bn in coupons.
• EFSF will tap the 0 11/22 line on Tuesday (€1bn). This will complete Q3 funding.
• The DSTA estimated funding needs of €49.6bn in 2018. Based on this we now think DSL issuance will come in below 2017’s nominal total of €31.6bn. Net issuance – even before subtracting PSPP buying flows – will thus be deeply negative. Q4 issuance will comprise a new 7yr (Oct 11) and a 10yr tap (Nov 14).
Events • Multiple ECB/Fed speakers during the week, with ECB’s Draghi speaking today and Fed’s Yellen tomorrow.
• EUR flash CPI (Fri) should not change much, with the risk of a higher headline reading. It is the last month before negative energy base effects kick in.


Global Rates, 5-30 Spread Widening, Jackson Hole
BTP/Bund spreads experienced increased widening pressure yesterday, with investors appearing to unwind some of their summer carry trade positions. 5-30 spreads over Bunds widened by c.7bp, while the concession versus Bonos was c.3-4bp. The upcoming weeks and months hold quite some headwinds for BTPs: the resumption of supply pressure, with BTP auctions slated for Wednesday next week, an ECB QE taper decision pending this autumn and the general elections looming early next year. That this is not yet a classic flight to safety episode is underscored by the fact that 10yr Bund yields were unchanged at 0.40%. Moreover, semi-core spreads were little changed, even though 10s30s in OLOs and OATs steepened by more than 1bp. Meanwhile, equity markets (outside of the FTSE MIB) seemed more preoccupied with regaining some of the lost ground over the past weeks.

Ahead of the Jackson Hole symposium kicking off tomorrow, ECB Draghi’s opening speech at the Lindau Nobel laureates meeting on economic sciences today will be followed closely. But it would be an unusual choice of venue and timing to provide new policy guidance. Elsewhere, flash Eurozone PMI data should confirm the ongoing recovery across the currency bloc. EGB & SSA supply. Today Germany will tap the 10yr benchmark DBR 8/27 for €3bn. Absolute 10yr yields are relatively low given that levels around 0.60% were seen a little more than a month ago.

The recent richening of 10yr Bunds is also evident in the 5/10/30yr fly valuation, which is back near the levels prevailing before Draghi’s Sintra speech. The auction may nonetheless be supported by its timing, with the carry trade unwind seemingly having started. Moreover, repo specialness (c. 25bp in s/n yesterday) remains a strong selling point of the 10yr Bund. In SSA space UNEDIC has mandated banks for a tap of the 4/32, thus following in the footsteps of NWB bank and Rentenbank yesterday. The former priced a €600mn 30yr social bond NEDWBK 1/48 at MS+19 versus an initial guidance of MS +22. The latter launched the 8yr RENTEN 8/25 at MS -23 coming from an initial guidance of MS -21. We are also still waiting for an RfP from the EFSF ahead of next week’s auction slot.

Poland: Preliminary estimate of the June balance of payments data and the final details of the July CPI inflation data will be released on Friday (11 August). According to the preliminary estimate of the Central Statistical Office, headline inflation picked up to 1.7% yoy in July from 1.5% yoy in June. In our view, the increase in headline inflation was driven by higher food price inflation, which means that core inflation should remain unchanged in July.

Hungary: First, budget data for the calendar-year to July will be published today at 10:00 a.m. London time by the Ministry of National Economy. In June, the deficit widened sharply, taking the cumulative fiscal-year deficit to HUF911bn, from HUF213bn at the end of May and compared to HUF402bn in the period January-June 2016. As a percentage of GDP, the cumulative deficit in 1H 2017 was an estimated 2.6%, compared to 1.2% in the same period in 2016 and 2.5% in 1H 2015. Second, external trade data for June will be released tomorrow at 8:00 a.m. London time by the Central Statistical Office. In May, the trade account recorded a surplus of EUR959mn, which was 29% higher than in May 2016. On a three-month moving average basis the surplus in May was 4.7% higher than in the same period in 2016. Import growth in May, on a three-month moving average euro basis, outpaced export growth for a fifth consecutive month.

Third, consumer price data for July will also be published tomorrow at 8:00 a.m. London time by the Central Statistical Office. We expect that headline inflation increased to 2.1% yoy from 1.9% yoy in June. The Central Statistical Office’s core inflation measure increased to 2.4% yoy, a three-year high. Our estimate of the runrate of core inflation surged to 3.6% yoy in June. The National Bank said of its measures of core inflation for June that they “remained stable, in line with expectations”. The average of the Bank’s three core inflation measures was 1.9% in June, compared to a low of 1.4% in August 2017.

Russia: Headline inflation fell to 3.9% yoy in July, below the central bank’s 4.0% inflation target. According to Rosstat, headline inflation fell to 3.9% yoy in July after a sharp increase to 4.4% yoy in June on the back of higher prices for fruits and vegetables. The outcome was a surprise for the market that expected headline inflation at 4.3% yoy (according to a Bloomberg survey), but actually it was consistent with weekly inflation data (on our estimates, weekly headline inflation fell to 4.0% yoy as of 31 July). July inflation report confirmed the recent developments, especially those with regards to food prices that started rolling back aggressively in July.

This drop in headline inflation was mainly driven by food price inflation that slowed to 3.8% yoy in July after a spike to 4.8% yoy in June. Durable goods inflation fell to 3.7% yoy in July (from 4.0% yoy previously), while services inflation was at 4.1% yoy in July, unchanged from the previous month. Official core inflation fell from 3.5% yoy in June to 3.3% yoy in July, its lowest level on record. Our measure of core inflation (net of all food and energy prices) picked up to 2.3% yoy in July from 2.2% yoy previously. Our estimate of the run-rate of core inflation picked up to 2.2% in July from 1.8% in June, while the run-rate of official core inflation picked up to 2.6% from 2.2% in June. Run-rate of headline CPI inflation picked up to 5.2% in July from 4.1% in June. The increase in the run-rate of official core and headline inflation was due to the impact of higher prices on some food categories. If there are no further disruptions to the harvest, we believe headline inflation will be 3.8%-3.9% yoy in August.

We think that concerns over inflation were not the main reason behind the CBR’s decision on 28 July to keep the policy rate unchanged at 9.00%. In our view, the main argument for keeping the policy rate on hold was the risk related to higher rouble volatility in an environment with increased geopolitical risks. If the impact of the new US sanctions on the rouble turns out to be mild, the CBR will catch up with its easing cycle and cut the policy rate by 50bps to 8.50% in September, in our view.

South Africa: The noteworthy event this week is the National Assembly’s vote on a motion of no confidence in President Zuma tomorrow. Our key thoughts are: First, we do not think the motion will succeed, even if the Speaker decides that the vote should be held in secret. Second, some ANC MPs look likely to vote in favour of the motion, but not enough to make up the shortfall of 50 votes required for the 201 majority. Third, though there may be more MPs that agree with the motion, they likely believe that the leadership crisis is best resolved at the party’s Elective Conference in December, when 4,500 voting delegates will gather. Fourth, if the parliamentary motion were to succeed, then the President and his entire cabinet would have to resign. The speaker of the National Assembly, Baleka Mbete, would then become acting President, while the National Assembly debates and appoints a new President. Fifth, such a scenario, where the motion succeeds, raises a variety of risks for the ANC and the country. The risk of a split in the ANC would increase in our view. Governance of the country could be further weakened.

On Friday (11 August), Moody’s will deliver its second formal review of the sovereign for this year. We don’t think that the agency will make any changes to its ratings or outlook. It looks likely to wait until year-end, by which time the outlook for fiscal policy under Minister Gigaba will be clearer, with the Medium Term Budget Policy Statement published on 25 October. Furthermore, there may also be greater clarity on the direction that the ANC leadership contest is taking. Moody’s has another scheduled review on 24 November.


• A solid US jobs report has dented any immediate prospect of EUR/USD hitting 1.20 and we think a little more downside could be seen this week. Driving this should be firmer US price data (PPI Thu, CPI Fri), where PMI indices are starting to warn of a slight uptick in US pricing power. • Some modest uptick in US rates (and quite a negative patttern on the weekly candle chart), warns that EUR/USD could make a run to 1.1650/80. Yet what should be good German IP data should keep the downside limited.

• $/JPY remains key vehicle to play both: (i) Trump’s political travails and (ii) the US growth/rates story. On the former, it’s hard to know when the bad news will hit, but on latter, this week should prove +ve for the USD. The US rates curve is very flat & higher US prices should steepen the curve. • In Japan this week, we’ll see surveys on activity (Mon & Tue), June trade & regular portfolio data. We’re still of the opinion that Japanese residents should be accelerating foreign bond purchases around now.

• The combo of a dovish BoE disappointment and a slightly rejuvenated USD has seen GBP/USD fall back to 1.30; we see near-term risks of a move below here as the BoE’s patient policy approach could see GBP take on more of a funding currency role in a diverging monetary policy environment. • Expect GBP to remain sensitive to UK data outcomes as markets continue to reassess 2017 BoE rate hike odds; Jun industrial production and trade (Fri) to note this week, with both important for any 2Q UK GDP revisions.

• The Aug RBA meeting noted greater concern over the recent AUD rise (albeit USD related), though the central bank’s slightly more optimistic projections have limited any meaningful fallout below 0.80. • We think a neutral RBA policy bias will remain in place and see limited scope for AUD rates moving higher. Focus will be on speeches by the RBA’s Kent (Tue) and Lowe (Fri) for clarity on the inflation outlook, while the data docket sees the latest consumer and business confidence indicators.

• A small miss in both Canadian job gains and the Ivey PMI has added to the fading CAD optimism. We see scope for a bigger USD/CAD correction higher as markets have got ahead of themselves in pricing an extensive BoC hiking cycle. Lower short-term CAD rates would fuel a move back to 1.27-1.28. • The domestic calendar in the week ahead is sparse, with only housing data to note. CAD vulnerable to noise around the OPEC meeting (Mon-Tue) – but oil stuck in the $45-$55/bbl range won’t be a big catalyst for the pair.


GBP shorts are recommended as the UK economy shows increasing signs of losing growth momentum as households adjust spending to their weaker balance sheets, investment stays weak due to Brexit related uncertainties and real rates stay one of the lowest within the G10 with 10-year inflation adjusted returns at minus 1.799%. GBPUSD may see a marginal new cycle high but levels near 1.33remain a sell.

This morning GBP markets wake up to a set of mixed news. GBP positive is that, according to the Telegraph, the government may be willing to pay an exit fee of EUR40bln. However, this is not entirely new news as the UK government turned towards a more constructive Brexit negotiation approach under the leadership of Chancellor Hammond indicating that it is willing to honour its obligations, hoping that it can negotiate a multi-year transition when leaving the EU. This allowed markets to re-price prospects of a March 2019 cliff edge, pushing GBP temporarily higher. The more constructive UK negotiation approach is in the price. Moreover, Brexit MPs have accused Brexit negotiators of using the summer quiet period to press through the ‘Brexit bill’ which could become the early start of fresh Tory rebellion (Telegraph).

Credit card transaction data suggest a sharp slowdown in UK consumer spending as households try to consolidate their currently high level of non-secured debt. Weaker household spending may allow the BoE to look through the CPI reaching 3% in October, suggesting the window for the BoE taking out last August’s ‘insurance’ rate cut is closing rapidly. Former chancellor Lord Darling has warned in the Sunday Times that “small rate rise could kill spending”, after a “decade of rock-bottom interest rates has left consumers vulnerable to a ‘shock’ from even a marginal increase in borrowing costs” … “with knock-on effects for the broader economy”. The best outcome for the UK is its main trading partners maintaining its high economic growth rates providing net trade support. Within this scenario the UK should find enough willing investors to fund its twin deficits. A more difficult scenario would spring into place should global growth slow down and reduce cross border funding flows. In this case, the UK’s credit risk would have to adjust upwardly pushing its real rates up not because of economic growth, but to attract sufficient international capital to fund its current account deficit.

A dose of additional uncertainty has been injected by comments by Nick Timothy, the ex-adviser to PM May, suggesting that the position of PM May concerning Brexit has not changed. In September, PM May will have to clarify her official position concerning the subject. Currently, markets hope Chancellor Hammond represents the government’s (now moderated) position. Should May’s September speech (date not announced) move the clocks back to what investors would interpret as a hard Brexit then GBP would weaken significantly.

The Goldilocks scenario is staying with us as China surprises by its growth resilience. Since June, steel rebar has increased by 45% due to China-related demand dragging other industrial metal prices higher too. China’s July trade date will be released tomorrow and is likely to show a strong performance. Even oil, dealing with oversupply and inventories, has broken above significant chart levels. Today and tomorrow an OPEC/Non-OPEC meeting will be commencing in Abu Dhabi. US corporate earnings surprises plus July labour market data showing strong activity and only moderately better wage data should push financial conditions further up from here. China agreeing to sanctions against North Korea by supporting a related UN resolution is a positive.

Energy • WTI speculative long: Over the last reporting week, speculators increased their net long position in WTI crude oil by 23,013 lots, to leave them with a net long of 238,501 lots. This is the largest position speculators have held since the end of April and, given the price action seen since last Tuesday, this position is likely to be larger than what was reported in the latest release. • Another OPEC/non-OPEC meeting: OPEC members, along with a handful of non-OPEC producers, are set to meet in the UAE on 7-8 August, according to reports. The meeting will be to discuss compliance issues around agreed production cuts, and why some countries are falling short.

Metals • Chinese aluminium capacity cuts: Bloomberg reports that Shandong province in China will be even stricter on aluminium smelters during the winter months. Shandong province makes up c.30% of Chinese production and it was mentioned previously that smelters in the top seven producing cities would face capacity closures over the winter months if they did not meet emission standards. However, there are now reports that all cities in Shandong will be targeted. • Base metals push higher: Further positive data from China has pushed the whole base metals complex higher this morning. China released manufacturing PMI data that showed that factory activity in the country continued to expand, although it was slightly lower than what many were anticipating.

Agriculture • EU sugar prices rise: Latest data from the European Commission shows that average white sugar prices in the region climbed to EUR497/t in May 2017, up from EUR495/t the month before and the highest price reported by the EC since October 2014. However, with the lifting of production quotas from 1 October 2017, expect sugar prices in the EU to come under pressure. • Soybean speculative position: Speculators continue to build on their net long position in CBOT soybeans. Over the last reporting week, speculators bought 12,534 lots, to leave them with a net long of 50,885 lots. This is the largest position speculators have held in soybeans since March 2017. The bulk of the buying over the week was short covering, rather than fresh long positions.


Emerging Markets, US Yields, Yellen and the ECB
Currencies and asset prices in the EM world have responded strongly and favorably during the past ten days to dovish Fed signals, sharply declining UST yields, and a string of predominantly helpful data releases out of the US and China. The ECB president, Mario Draghi, will have an opportunity to put an end to the party at his press briefing tomorrow, but we do not think he will. If anything, he may be slightly inclined to help halt the euro rally by conveying a dovish message, though we think he is more likely to be neutral. With uncannily poor timing we warned on these pages a week ago (12 July) of possible negative consequences for EM investors of the Fed’s and the ECB’s pending tightening of their balance sheet policies; but a few hours later those concerns were moved to the sidelines by the Fed Chair, Janet Yellen, as she offered Congress and the market new and soothing commentary on the recent low US inflation numbers. Her wording persuaded the broad investor community (and us) that she and her FOMC colleagues feel only halfheartedly committed to their plans for monetary policy tightening.

EM investors responded with enthusiasm. Yellen’s testimony set off a fall in yields on US Treasuries, depreciation of the dollar against most other currencies, and a bounce in the dollar price for EM assets across most of the world. Yesterday’s decision by Republicans in the US Senate to abandon their health care reform plans has further fueled the down move in US yields and the dollar. We still think investors will eventually switch their focus back towards concerns about the ECB’s and the Fed’s pending balance sheet reduction, but this month’s muted inflation data, Yellen’s soothing choice of words, the dwindling chances of US tax reform, and ECB President Draghi’s likely reluctance to push up bund yields (and the euro) at his press briefing tomorrow will probably ensure that investor concerns about potential eventual global monetary policy tightening stay on the sidelines for at least another couple of weeks, as the market waits for the release of further US inflation data that may (or may not) upset the apple cart.

In Yellen’s testimony on 12 July she used the word “partly” to describe the contribution to low US inflation that reflects one-off declines in certain price categories. Four weeks earlier she had used to word “significantly” in the same context. Though the distinction between the two words is subtle, the change of wording is likely to reflect a wish on the part of Yellen to send a signal to the market. In the prepared text for her Congressional testimony, Yellen used text that she had previously published. Text from her last FOMC press briefing was copied wordby-word, except for the replacement of “significantly” by “partly”. The switch of words suggests an increase in her doubt about the likelihood that inflation will really bounce back. US Treasuries rallied strongly in response to the word-switch.

A few days earlier, a batch of US labor market data had conveyed a picture of still-muted wage growth alongside still-strong employment growth. On Friday 7 July, when the data were released, UST yields initially rose by a couple of basis points as investors responded with greater force to the strength of the employment figures than to the muted nature of the wage numbers. However, yields began to drop slowly the following Monday and continued to do so Tuesday as investors swung their focus in the direction of the soft wage data. Thus, bond investors were already primed to question Yellen’s confidence in the prospect of an inflation bounce when she initiated her testimony to Congress. Once she delivered her dovish linguistic innovation (the switch from “significantly” to “partly”), UST yields dropped in earnest. By the end of Wednesday (12 July) ten-year yields were 7 bps lower than they had been by the end of the preceding Friday (7 July).

Some DM central banks potentially undergoing a regime shift – trying to avoid mistakes of the previous cycle when funding costs undershooting nominal return expectations for too long led to a leveraged-funded boom and capital misallocation, eventually unleashing a substantial deflationary shock – stand in contrast to falling energy prices in terms of market implications. Fed minutes confirmed anticipated hawkishness, leaving it only a question of time before the Fed starts its balance sheet reducing operations. The ECB will release its minutes today. More important will be ECB’s Weidmann’s speech on the future of the EUR.
Simultaneously, markets have to digest oversupply issues mainly affecting energy markets. Here, two big issues seem to stand out. First, OPEC’s inability to stay compliant with previously agreed production cuts and second, the US turning into an energy exporter following its shale energy revolution. Our US economist estimates business investment into US oil and gas drilling structures will increase by 80% in Q2and 25% in Q3,not only supporting US economic growth via its implementation, but also adding to the supply of energy into global markets. The FT is running an article today suggesting that LNG supply could increase by about 50% from 2015 to 2020. The US will turn into a leading LNG supplier. Australia has also now built up infrastructure to become a big LNG exporter. Our stance of selling currencies of traditional oil suppliers such as NOK and COP remains unchanged.
Declining energy costs have helped dampen inflation expectations and yesterday’s pause of US yields breaking higher despite increasing prospects of the Fed adding to future net bond supply should be attributed to oil prices showing their biggest decline since 25th May. The 5% oil price decline on 25th May set the starting point for a four-week decline, seeing Brent losing around 17%.
The exhibit illustrates the crucial position in which markets are currently progressing. We compare the 10-year US real yield with 10-year US breakeven. For risk markets to flourish, a combination of falling real rates and rising inflation expectations bodes well, explaining the strong equity performance witnessed in 2012/13. The reverse picture emerged in 2015, pushing share markets into two significant downward corrections in August 2015 and January 2016. The problem is that real rates have diverged from falling inflation expectations as they did in 2015. In this sense, falling energy prices are not risk supportive if not compensated by other reflationary forces. Yesterday, we mentioned rallying soft commodity prices. Today, we like to put our emphasis on growth data where we hope the upcoming June ISM non-manufacturing PMI and NFP report may allow the gap between US real rates and inflation expectations to narrow somewhat.

This analysis suggests that the risk outlook has turned more data sensitive. The Fed’s potential change of its reaction function – now increasingly emphasising buoyant financial conditions – and its readiness to look through current weak inflation data have created this new data sensitivity. The Q2 earnings reporting season starting tomorrow should help tip the balance in favour of risk appetite for now. We stay USDJPY bullish and use a near term setback to last Friday’s bullish 112.00 break point as a buying opportunity. The 10y JGB yield trading up to the unofficial 10bp upper ceiling due to a weak open market operation should not strengthen the JPY. There is no appetite within the BoJ for moving the signposts of its yield curve management policy yet. The MoF weekly security flow data showed foreign investors shying away from JPY money market investment, suggesting the USDJPY cross-currency basis should stop tightening, thus no longer reducing Japan-based investors’ hedging costs. Japanese investors reducing their FX hedge ratio should strengthen USDJPY.

GBP has corrected some of its recent gains in light of weak UK postelection PMI readings. Remember, post-Brexit UK soft indicators crashed for a couple of months before turning back up again. Anyhow, our GBP optimism finds its foundation in what we call ‘Brexit economics’ and the BoE reconsidering GBP weakness and its impact on the economy. So far, GBP weakness has been unable to lift net exports, but ithas undermined real disposable income via rising import prices. In short, GBP weakness has undermined living standards and with inflation above the BoE’s 2% target and its own staff projections, GBP stabilisation should now be on the BoE’s agenda. Talking up rate expectations is a sufficient tool to reach this target. With regard to the GBP outlook, we should not underestimate the growing influence of Chancellor Hammond within the Cabinet. There is a new openness to listen to businesses to reduce Brexit-related supply and market access restrictions, which should work in favour of the market which is still GBP short positioned. We hold our GBPUSD 1.32target.

Energy • ICE Brent speculative position: Similar to WTI data, positioning data released for ICE Brent yesterday showed that speculators reduced their net long by 24,366 lots, leaving them with a net long of 283,157 lots. Since the end of May, speculators have reduced their net long in Brent by 66,723 lots. • API US inventory data: Later today, the API is scheduled to release its US inventory report. Expect volatility in prices if the number is significantly different from the 1.2MMbbl drawdown the market is expecting the EIA report to show on Wednesday.

Metals • Indonesian nickel smelters suspend operations: According to Bloomberg, thirteen nickel smelters in the country, including some that are still under construction, have suspended operations, given the fall seen in nickel prices. According to the Indonesian Processing and Refining Industry Association, prices have fallen below the cost of production, which is estimated at US$9,000- 10,000/t. The smelters have a combined capacity of 750,000t pa of nickel pig iron. • Silver ETF holdings: Having seen quite the recovery over May, ETF holdings in silver have started to decline at a fairly rapid pace. Total holdings currently stand at 664moz, compared to 671moz seen at the end of May. Expectations of a US Fed rate hike (which materialised last week) have weighed on the precious metals complex.

Agriculture • US spring wheat rating: Data released by the USDA shows that just 41% of the US spring wheat crop is rated good-to-excellent, which is down from 45% last week. It looks even worse when compared to the same time last year, when 76% of the crop was rated good-to-excellent. • Indonesian sugar output: According to the Indonesian government, the country expects domestic sugar production this season to reach 2.5mt, up from 2.2mt last season. Improved weather has helped the crop this season. Meanwhile, for next season, the country is targeting 2.7-2.8mt. Indonesia is aiming to move towards sugar self-sufficiency, with an increase in acreage and a number of new mills expected to start up in the coming years.


GDP expanded by 5.0% YoY in 1Q17, much higher than the market consensus at 3.5%. The rebound was driven by private consumption while net trade had a significantly positive contribution with improving export performance. The data show continuation of the recovery that started in 4Q16 at a strong pace. Economic activity was higher than expected in 1Q with 5.0% YoY growth while market expectations, according to a Bloomberg Survey were at c.3.5% with a range between 0.8% and +4.8% vs our call at 3.6%. Accordingly, following a contraction in 3Q16 for the first time since the global crisis, growth has maintained an improving trend, pulling annual GDP growth to 3.0% in 1Q17 from 2.9% in 2016. In seasonal and calendar adjusted terms (SA), GDP expanded 1.4% QoQ, down from 3.4% QoQ a quarter ago, though showing that the recovery has remained in place. 12-month cumulative adjusted GDP growth accelerated to 1.1% from 0.9% on a sequential basis.

Looking at the expenditure breakdown, we see that private consumption was again the main contributor to growth at 5.1% YoY in the first quarter of the year. This shows the improvement in consumer sentiment in recent months with stabilisation in the currency and the impact of stimulus measures such as VAT cuts in some consumer durables and social security premium cuts as well as easing macro-prudential measures, ie, extending the maximum maturity of consumer loans, arrangements in credit card installments, etc. Fixed investment gained further strength despite the political uncertainty ahead of the referendum and recent CBT tightening with 2.2% YoY growth. This is attributable to significant lending acceleration as credit growth (13-week MA, FX-adjusted and annualised) has converged to 25% on the back of contributions from the Guarantee Fund. Public consumption was up by 9.4% YoY with the introduction of stimulus packages and with increased public spending, providing a stronger contribution to growth vs 4Q. We think this will likely reverse in the second half of the year. Also, exports were up by 10.6% due to the strong economic growth in the EU and recovery in trade with Russia while imports recorded a mere 0.8% increase with the result that net trade provided the first positive contribution to the headline since 2015. Finally, inventory depletion shaved a significant 2.3ppt from GDP growth, supporting the view that production should improve in the coming period. All in all, the improvement was relatively broad-based in 1Q17 showing a further rebound after the robust performance in 4Q16 following a significantly weak 3Q16 with implications of the failed coup attempt in July on household and corporate sector behaviour.

Among the sectors, manufacturing stood out with a 1.1ppt contribution with a second strong reading after the drop in 3Q16, while construction was another driver with a 1.6ppt (including real estate activities) addition to the headline. Overall, after economic growth rose back into positive territory in the last quarter of 2016 following political tensions and a shock to the tourism sector, we saw across-the-board strength with further recovery in private consumption and net exports. For 2017, risks seem to be on the upside given the acceleration in activity in 2Q17 and low base effect of 3Q16. Recently released indicators hint at some further acceleration in 2Q17 economic activity, with higher PMI in tandem with rising CUR. Improvement in sectoral and consumer confidence after the referendum should also contribute to the recovery.


Energy
• US oil rig count: The number of active US oil rigs increased by 8 over the last week, taking the total number to 741 rigs. The rig count has increased consistently since mid-January 2017, with producers bringing back 219 rigs since then. The growth in the number of active rigs has supported production, which has increased by 548Mbbls/d since the start of the year.
• Oil speculative position: The latest Commitment of Traders Report shows that speculators increased their net long position in WTI crude oil by 15,037 lots over the last reporting week, leaving them with a net long of 221,140 lots. However, given the pressure on prices since Tuesday, it is expected that the speculative position will show a large reduction in this week’s release.
Metals
• Chinese iron ore inventory: Latest data from Steelhome shows that Chinese iron ore port inventory stands at a record 140mt, up 26mt since the start of this year, and up 40mt YoY. We expect that the scale of Chinese inventories should keep prices under pressure.
• Chinese steel output: Metal Bulletin reports that Chinese crude steel output over the last 11 days of May averaged 1.7639mt, compared to a daily average of 1.8050mt seen over mid-May. It appears that production has started to respond to lower domestic steel prices, which have been under pressure since early March.
Agriculture
• WASDE report: The USDA released its latest WASDE report on Friday. While the market was expecting the USDA to lower US ending stocks for corn and soybeans, the department kept corn ending stocks unchanged. For US soybeans, the crush estimate was lowered for the current season, which saw the estimate of ending stocks for this season and next grow by 15m bushels to 450m bushels.
• Global coffee market: Brazilian coffee trader Comexim expects that the global coffee market will see a deficit of 4.2m bags over the 2017/18 season, compared to a deficit of 1.7m bags in 2016/17. The market has largely expected a deficit for the 2017/18 season, particularly because Brazil is in the lower-yielding year of the biennial cycle

USD: Role of Fed hikes reduced to providing a buffer for the $, not a driver When the FOMC meet this week (Wed), there’s no doubt that the case for a rate hike will be less compelling than it was back in March. Economic data, especially short-term inflation dynamics, have been unnervingly soft and one could argue that this should keep a data-dependent Fed sidelined until things pick-up. Most FOMC members, however, have been quick out of the blocks to dismiss this soft patch as nothing more than a transitory phase. Still to us, this week’s move looks like an opportunistic rate hike if anything, making use of the fairly benign market conditions to take another step away from the zero-lower bound. Not everyone in the FOMC may agree, so watch out for dissenters (Kashkari, possibly Brainard). As for the economic projections, well there’s an outside chance that the growth and inflation profile could be tinkered lower – the extent to which will be telling of just how transitory some members see the current slowdown. We see downside risks to the Fed’s dot projections as well, although it’s more likely that we’ll see a more positive skew rather than any wholesale changes to the median dots. We think the Fed have been somewhat clever in constructing a dot plot that serves to fit in either a world of Trump ‘reflation’ or the status quo of secular ‘lowflation’. A hike this week means that we’ll move one step closer towards the start of the Fed’s balance sheet reduction. We’re likely to see the normalisation principles updated, though overall we don’t expect to see any surprises that could lift the $.

EUR: Quiet EZ week allows focus to shift to central bank events elsewhere In the EZ, we expect a relatively calm week following the June ECB meeting; the German ZEW index (Tue) should pick up. EUR/$ neutral around 1.12 this week.

GBP: Short-term political woes could see GBP/USD decline towards 1.25 The dust is beginning to settle following another UK election rollercoaster. Still, there remain many domestic political – as well as Brexit policy – unknowns that will continue to hangover the pound over the coming weeks: Domestic political risk premium: Theresa May has unequivocally stated her intention to stay on as Prime Minister and while there may be some underlying unrest within the Conservative Party, it seems that a leadership contest at this stage remains highly unlikely – especially as it would see another election that could risk handing the keys to Downing Street over to Jeremy Corbyn. On that note, the Labour leader hasn’t given up on forming a minority government and putting forward an alternative Queen’s speech – but again this seems unlikely. Still, we note that any confidence and supply arrangement between the Tories and DUP would be a less stable form of government than the 2010 coalition. It would risk slowing down the legislative process on key policy areas – not least the Budget and Brexit. Political uncertainty remains a headwind for GBP. ‘Hard’ Brexit risk premium: Brexit negotiations are set to begin shortly and the UK’s position remains up in the air. Calls for a ‘softer’ Brexit seem pre-mature, especially as Labour have signalled their intent to leave the single market. What we do see, however, is an economically rational Brexit – with the dial shifting towards obtaining a deal that is in best interests of the UK’s long-run economic prospects. This would be a net positive for a undervalued GBP.

The failure to secure political stability – and the outcome of a hung parliament – was always going to be the pound’s nightmare scenario. When Theresa May called this election, markets were viewing things through the rosiest of lenses – with hopes that political uncertainty would decrease substantially under a more stable Conservative government. That narrative has been all but dashed. With the two-year Article 50 clock ticking, the passage of time is GBP negative; a working government is needed as soon as possible to avoid a further drop in the pound. The most likely path looks to be a Conservative-led coalition with the Democratic Unionist Party (DUP); while it may not be straightforward given noise over Theresa May possibly standing down, GBP could enjoy a small relief rally on any political clarity. The worst outcome for GBP now is any prolonged political uncertainty and difficulties in forming a working government over the coming days; here we would expect GBP to trade with a 3-4% political risk premium, with GBP/USD falling back to 1.24 and EUR/GBP moving up towards 0.90.

The FT reports that Labour and Conservative party strategists predict a comfortable 50-100 seats majority for the Tories. If confirmed, markets may see an initial relief rally. Nonetheless, over recent weeks, GBP has turned from a ‘buy the dip’ into a ‘sell the rally’ currency. We cite a handful of reasons.First,valuation is no longer as much in favour of sterling as compared to November when we expressed our out-of-consensus bullish GBP call. Second, GBP weakness has failed to provide a positive contribution to net exports. Third, EMU’s negotiation stance has hardened. Instead of considering making concessions to the UK, the EU has started focusing on deeper political and economic integration.Fourth, PM May has been criticised of weakness during what the FT has suggested has been “widely seen as a misfiring campaign’after the apparent reversal of part of the social care policy.Finally, the UK’s national balance sheethas weakened over recent months as households reduced savings, bringing forward consumption, while the real estate sector has started slowing as indicated by today’s release of the May RICS house price index slowing from 22% to 17%.

As USD sentiment hits the lowest level since May 2011 (only 5% of traders are bullish), we are now seeing the flows-related impact on the treasury market. Yesterday saw a very weak 1 year US government T-bill auction, where the bid to cover ratio, at 2.84, was the lowest since 2009. USDJPY may have rallied yesterday in response to longer end yields rising but we feel that for the USD to rally more broadly, you need to have the supporting capital inflows to the US. Lack of demand at a bond auction may naturally suggest less global USD asset demand. Recently, foreign investor participation in 10y bond auctions has fallen to 16% relative to a high of 28% in April. We see the USD weakening vs the EUR and tactically further vs NZD.

Political stability and increasing voices from core Eurozone countries to move towards a fiscal union have driven the EUR higher. The improved sentiment and growth outlook supports equity inflows. Helped further by Schauble and Merkel saying the EUR is too low for Germany, foreigners have been buying Eurozone equities on a currency unhedged basis (USD7bn since March via ETFs), in contrast with only a fraction with the FX hedge (USD0.9bn). In 2014, when inflows were with a currency hedge, stronger risk appetite drove EURUSD lower (the negative correlation). Today, stronger risk appetite should drive EURUSD higher (the positive correlation). We are already starting to see the EUR moving in line with positive economic data surprises (see Exhibit). Stronger growth means a stronger EUR.

But what about EUR bond flows? EURUSD is trading much higher than where the German-US 10y spread would suggest. Since August 2016, the correlation between the bond and FX market was close and using that relationship, the EUR should be trading close towards 1.10 (vs 1.1170 today). . The difference, we think, can be attributed to the equity inflows. Bond inflows may have not picked up as significantly due to the uncertainty that ECB tapering may bring for that market. We believe we need to see much higher yields before the equity inflow turns into a more sustained bond inflow. As of the last update of the balance of payments in March, Eurozone investors were still buying more foreign bonds than foreign investors were buying of theirs. Japan’s weekly security flow data is released overnight, where weakness in USDJPY would suggest Japanese had slowed bond purchases last week, but we don’t expect that to last.

As equity volatility has come down to close to its lows (VIX at 10.72),even China’s sovereign rating being downgraded by Moody’s to A1 from Aa3hasn’t dented risk appetite in the Asian market. China was put on negative watch in March 2016, therefore it is the timing of today’s announcement thathas come as a surprise. Moody’s cited an expectation that financial strength will erode somewhat over the coming years as debt increases and potential growth slows. AUDUSD has weakened 0.5% overnight, suggesting the technical uptrend is complete. We keep our bearish AUD bias driven more by domestic factors, such as the housing market. Construction activity fell by 0.7% in 1Q, leading to a 1Q GDP tracking estimate of -0.2% QoQ.

The market prices an 81% probability of a Fed rate hike in June, supported further by the Fed’s Harker saying that a June hike “is a distinct possibility”. The FOMC minutes will be watched to provide clues on the path for rates and how the committee views that tightening measure along with balance sheet reduction. Market expectations for the OPEC meeting tomorrow are for a 9-month extension to the production cut. Today US crude inventory data will be watched for NOK and CAD investors. The US budget proposed yesterday to sell 270 million barrels of oil from the Strategic Petroleum Reserve over the next decade.


The JPY, US Yield Curve, Asian FX and Global Bonds
The JPY is set to weaken further from here. Importantly, US Congressional leaders reached a tentative deal on government spending to end Sep, averting a shutdown, suggesting the US Treasury will increase its cash balance somewhat. The sharp decline of the Treasury’s cash level starting in February has unleashed additional cash, pushing US front end rates lower, and adding to the trend of the 3m USDJPY cross-currency basis tightening from -91bp in November to -22bp in March. Now the reverse should be expected with higher US bond yields and prospects of the upcoming US tax reform not only increasing US demand for capital, but also the potential repatriation of part of the USD 1.2-1.4trn of US corporates’ foreign earnings held in cash and marketable securities reducing the availability of offshore USDs. EURJPY has reached its highest level since 14th March.

US Treasury Secretary Mnuchin underlined the government’s 3% GDP target which he hopes could be reached through revamping the tax system, regulatory overhaul and improving trade agreements. Interestingly, he pointed out that the difference between 2% or 3% GDP growth could make up USD2trn of additional tax revenues, providing further indication of the US administration aiming for a tax reform which initially may be funded via higher deficits. His hint of using the very long end of the US yield curve for funding added to the steepening of US yield curve. Transportation Secretary Elaine Chao said the Trump administration’s sweeping infrastructure proposal will be unveiled ‘fairly shortly’. Wednesday’s vote on the Obamacare Repeal Act – if successful – could spark further optimism around the administration regaining its ability to push through reform. It may be this optimism pushing US share prices higher, volatility lower and yield differentials and the USD higher against low yielding currencies.

It seems the US administration’s future economic and fiscal plans overrule macroeconomics for now. US and global data have all been coming in weak with the Australian and the Indonesian PMI being the exception. Despite a string of mostly disappointing PMIs from Asia, the procyclical currencies in the region are the outperformers globally so far this week: TWD, NZD, MYR, KRW and AUD. The US equity market no longer takes the lead from the economic surprise indicator which has fallen to its lowest level since October 2016. It seems that declining global headwinds and prospects of an increasing pace of reform in the US have persuaded US investors to stay long risk.

Interestingly,global bond yields rallied overnight with better risk appetite and rebounding industrial raw material prices helping. Barely noticed has been the stabilisation of the CRB Rind index and copper futures challenging its three months downtrend. Apparently, commodity markets have looked beyond China using the stabilisation of its capital account to rebalance the domestic side of its economy away from its old commodity-intensive areas such as property. According to the Chinese Economic Daily, the sale of commercial property in Beijing slipped to 84 units compared to 807 units this time last year,. Sales volume in first- and second-tier cities fell to the lowest level

Predictably, the announcement of the US tax reform lacked funding details and hence has come under immediate criticism. For instance, the Committee for a Responsible Federal Budget released a rough analysis saying the plan could cost USD3-7trn over the next decade, potentially “harming economic growth instead of boosting it.” Markets reversed early gains. We stay firmly within the reflation camp and view USDJPY setbacks to 111.00 as a buying opportunity. Today’s US durable goods release may confirm that US capex is on the rise, pushing rate and yield differentials wider in support of USDJPY. Today’s ECB press conference may see a cautious Draghi relative to expectations fearing an early tightening signal may push BTP spreads wider. EURUSD should stay offered below 1.0970 with the risk of closing Monday’s opening gap down to 1.0870.
Although Chinese equity markets recouped most of their early morning losses, the divergence in their performance relative to DM equity markets witnessed since November has caught our eye. We are bearish on low yielding commodity currencies and run aggressive AUD short positions. There are many reasons suggesting AUD weakness, reaching from too low AUD-supportive interest rate and yield differentials to fund Australia’s 60% of GDP foreign liability position, to an overvalued property market running the risk of unleashing deflationary pressures once prices come off the highs. However, our best reason for running AUD shorts is that Australia has builtup capacity to deliver into the ‘old’ China, an economy expanding via commodity intensive sectors such as investment and property. An evolutionary China rebalancing its economy away from investment and property will leave Australia’s commodity overcapacity exposed.

It may be debatable whether the equity performance gap between the US and China will widen further from here or whether China’s equity markets will catch up with the better US performance. What is true is that the recent decline in China’s stock prices came along with peaking margin debt. Higher RMB funding costs may have triggered leveraged share investors to take some chips out of the market, leading to the diverging China – US equity trend. The connectivity into the FX market comes via the RMB TWI weakness and may have contributed to the increase in RMB yields. While a lower RMB TWI helps China utilise its capacity and hence is good for its growth outlook, there is a risk within the highly leveraged economy that rising debt funding costs more than undermine the positive impact coming from the FX side. The relative weakness of China’s equity market may be a symptom of this development and this morning’s disappointing release of China’s March corporate profits did nothelp China’s equity markets either (the gain for industrial profits was 7.7% lower than in the January-February period, but it was 12.7% higher than the gain in March 2016). The message seems clear: China should concentrate on bringing its funding costs lower, shifting its focus away from RMB TWI weakness. Since the RMB is quasi-pegged to the USD, this shift of China’s policy focus will work in support of the USD.

AUD, with its significant trade exposure to China, should weaken most should China reduce its resistance to the USD rising allowing the RMB TWI to rebound. China may need capital inflows into the bond market to reduce capital funding costs. Since RMB hedging tools are not as developed as in G4 currencies and hence less efficient to use, currency stability is an essential tool convincing non-RMB-based investors to allocate funds into China. Consequently, the rising USD will put AUDUSD under selling pressure. This move may be leveraged by redirected capital flows from G4 into China, pushing G4 bond yields higher. Australia’s banking sector has reduced its wholesale funding dependence over the course of the past decade, but still has one of the most wholesale funding-dependent banking sectors within G10. Hence rising G4 rates and yields mechanically increase local AUD funding costs without the RBA increasing its rates. This is why we are sceptical of Australia maintaining its real estate strength at times of globally rising funding costs.

The best case scenario for markets would clearly be the elimination of the two “extreme” candidates: if Macron and Fillon manage to top French voters’ preferences on the 23rd, we anticipate a risk on move from financial markets. The worst outcome for risk assets would be a second round featuring Le Pen and Melenchon. Although we would expect markets to be volatile for some time, such an outcome wouldn’t equate to the end of the world (yet), as it is unlikely that an extremist candidate, even if appointed President, would be able to do much harm without a parliamentary majority.
Historically, France always had two strong candidates, coming from the two main parties. This time round, there is a significant chance that none of them will be represented in the second round. Indeed, this election has faced a series of twists:

? Initial favorite candidate, Francois Fillon (center-right), has lost more than ten points in the polls, partly because of his family’s allegedly fictitious employment issues. Although only third in most polls, Fillon can count on a solid base of center-right voters to keep alive the possibility of being in the second round.
? Macron (center) has managed to emerge as a credible candidate and is now ahead in all polls – with a remaining fragility, though: his voters’ loyalty is seen as lower than than of Fillon or Le Pen’s.
? Marine Le Pen’s campaign hasn’t seen any momentum so far. Starting from a very high position, she has slowly been trending down over the past two months – still, she should still manage to access the second round. She doesn’t seem able to attract new voters, though.
? Finally, Melenchon (far-left)’s support has surged in the past few days pushing him up to the fourth position in the presidential race with a score very close to Fillon’s one. Meaning he could still make it to the final round.
If anything, as soon as the risk of “Frexit” comes into view, we believe the issue for markets will not be France leaving the euro, but the euro leaving France. The most likely reaction to such an episode of financial stress would be a political response in the opposite direction, we believe. If Le Pen and Macron move on, they expect a likely unwind of some of the “redenomination risk” premium embedded in bunds and compression in peripheral spreads. Melenchon in the second round, on the other hand, would present a risk to markets given his favorable second round polling against Fillon and Le Pen. In a favourable outcome EURUSD may move quickly towards their 1.10 3 month forecast. An adverse scenario may see a drop towards recent lows below 1.04.

Historically, exit polls provide a first estimate of results at 8pm local time. However, conclusive results could be available a little later as it could be hard to get a precise estimate of the two winners early, if results are very close. Note that although French media are not allowed to publish any results before 8:00 pm on Sunday, it is possible, as happened in the past, that medias in other countries will. Participation rates at 12pm and 5pm are also worth watching: we believe a high participation rate could be negative for Le Pen (and to a lesser extent for Fillon) – and potentially positive for Macron or Melenchon – and viceversa, providing an early indication on the direction things might take.

Through the early-2017, Canada’s economy continued to bolster; however, the sources of the accelerating growth of the nation are proving slightly different from the ones expected a few months ago, noted Scotiabank in a research report. In the hand-off from last year, the rising affordability concerns were expected to be a drag on housing and auto sales, while record consumer indebtedness and increasing interest rates would possibly hurt consumption growth.

These mild drags were expected to be countered by strengthening investment, rising non-energy exports, and follow-through on public infrastructure plans. However, housing, auto sales and consumption growth have not decelerated, whereas business capital spending and non-energy exports have not accelerated. Also, public-infrastructure spending is delayed, stated Scotiabank.

The main growth drivers of Canada’s economy continue to be the same and imbalanced. According to Scotiabank, the Canadian economy is expected to expand 2.3 percent this year, whereas it is likely to grow 2 percent next year. The sources of Canada’s GDP growth are projected to start shifting and diversifying in the year ahead, lowering the economy’s dependence on housing and consumption and increasing the contribution of exports and investment to growth, added Scotiabank.

The Leading Economic Index for the U.S. rose again in the month of March, rising 0.4 percent. This is the seventh straight rise. Of the total components, six of them contributed to the topline figure, whereas two segments contributed negatively, noted Wells Fargo in a research report.

The labor market component contributed negatively to the index. It had been contributing positively in recent time. Initial jobless claims and manufacturing hours negatively contributed 0.09 percentage points and 0.13 percentage points respectively from the topline figure.

Optimistic consumer expectations contributed 0.12 percentage points to the index, the largest contribution since December 2004. The interest rate spread contributed 0.19 percentage points. This was the largest contributor to the index in March. Meanwhile, ISM new orders and the housing permits components also contributed to the segment, adding 0.19 and 0.11 percentage points respectively. The Leading Economic Index’s upward trend continues to signal moderate economic growth in 2017, stated Wells Fargo.


Since Monday, April 10, positioning has shifted. Within G10, the largest shorts are still in USD and GBP; the largest long is now in EUR. EUR positioning moves further into long territory: All components except IMM showed an increase in EUR positioning. Global macro funds and Japanese retail accounts were big buyers, moving from neutral to long. Japanese retail accounts are now small net long EURJPY for the first time since November. Sentiment also turned less bearish, helped by a fall in USD bullish sentiment after Trump’s comments that the USD was getting too strong.

Non-commercial IMM accounts were the only ones who sold EUR, but their net short EUR positioning remains near the smallest since May 2014. The French election this Sunday will be the main driver for EUR; see our expectations for EURUSD under different scenarios here. JPY positioning remains neutral: Investors’ JPY positioning was mixed. Among Japanese investors, retail accounts were JPY sellers but Toshin accounts were buyers. Among global investors, global macro funds were sellers, but non-commercial IMM accounts were large buyers, and sentiment turned bullish, with the percentage of bullish JPY traders rising by nearly 20% on the week. We remain bullish on USDJPY strategically.

GBP short positioning unchanged: GBP was the second most sold currency among non-commercial IMM accounts, bringing these accounts’ short GBP positioning back near the historical high. Global macro funds were also large sellers. On the other hand, Japanese retail accounts doubled their long GBP positions last week, and sentiment became less bearish. This short positioning is likely to contribute to GBP strength on any positive news, as shown by the GBP rally today after the announcement of early elections. We still like EURGBP shorts on positioning differentials and the potential for GBP to develop a safe haven status should markets get worried about Eurozone political risks.

After the U.S. Vice President Mike pence visited the demilitarized zones between the South and North Korea and warned that the United States’ strategic patience with North Korea is over and sent a message to North Korea to not to test the resolve of President Trump, Russia has issued a warning to the United States against unilateral action in the region. Vice President Pence said, “In the past two weeks, the world witnessed the strength and resolve of our new president in actions taken in Syria and Afghanistan……North Korea would do well not to test his resolve or the strength of the armed forces of the United States.”

Speaking at a news conference, the Russian foreign minister Sergei Lavrov said that this is a very risky path. He added, “We do not accept the reckless nuclear missile actions of Pyongyang that breach UN resolutions, but that does not mean that you can break international law………I hope that there will not be any unilateral actions like the one we saw recently in Syria.” Russia has also warned the United States against further unilateral actions on Syria.

China is reportedly working with the United States to resolve the issue with North Korea. However, the North Korean regime has so far remained defiant. It test fired a ballistic missile to commemorate the 105th birthday of the country’s founder Kim Il-Sung but the test failed as the missile detonated immediately after launch.

The independent centrist candidate Emmanuel Macron is still the favorite candidate to become the next French President. Odds of his presidency still hovers above 50 percent, far higher than any of his rivals, however, the odds have declined from 67 percent just three weeks ago to 52 percent as of now. While nobody can predict with certainty on who might win on May 7th, one thing is certain that the French are looking for changes and they are looking for it so hard that for the first time main political parties are not at all expected to make it to the round two of the election that will be on May 7th. The incumbent President is so unpopular in France that his approval rating at one point declined to just 4 percent and that legacy would continue to hurt his socialist party for years to come. That is probably is the main reason for his not running for re-election.

Shadow of his disastrous legacy is one of the reasons why the odds are declining for Macron. Many lawmakers of the socialist party are openly supporting Emmanuel Macron against his closest opponent Marine Le Pen. President Hollande has openly declared that it his duty to make sure that Le Pen doesn’t’ win the Presidency. The former Prime Minister under Hollande government of the Socialist Party Manuel Valls has openly declared his support for Mr. Macron instead of his own party’s candidate Benoît Hamon.

Mr. Macron is increasingly being seen as an extension of the establishment and the current socialist government and that is not a good portrayal on an anti-establishment year.

Defying demand for a general election for months, the UK Prime Minister has finally decided to hold a snap general election on June 8th in order to receive a mandate from the people of the United Kingdom to take the country through the two-year Brexit process. She surprised many politicians as well as the market with her announcement from the Downing Street. The decision reportedly came after consultations with senior figures and advisors within the party. The recent state of the opposition Labor Party which is fighting internal battles and revolts against the leadership of Jeremy Corbyn might have also influenced the decision. The recent opinion polls show that Theresa May’s conservative party is as much as 21 percent ahead of the main opposition, so holding an election now would likely provide Ms. May with a stronger majority in the parliament.

In addition to that, a win by Ms. May would also end the criticism that she has not contested her post; instead, it was given to her as the former Prime Minister David Cameron resigned after the referendum. This surely adds to the political uncertainties in Europe.

The pound initially suffered a shock selloff on the news but recovered and now trading stronger for the day at 1.264 against the dollar.

The opposition Labour party leader Jeremy Corbyn has welcomed the decision.

Energy • US crude oil inventories: Yesterday’s EIA report showed that US crude oil inventories fell by 2.17MMbbls over the week, the first significant decline seen this year. However Cushing, Oklahoma crude inventories increased by 276Mbbls, taking total Cushing inventories to a record 69.4MMbbls. • Chinese oil imports: Latest data from China showed that crude oil imports over March totalled 38.95m tonnes, which is a new record for monthly imports. Crude oil inflows for the month were 19% higher YoY, and 23% higher MoM. Stronger imports have come about as a result of declining domestic production.

Metals • China iron ore imports: Preliminary Chinese customs data shows that China imported 95.56m tonnes of iron ore over the month of March, which is 11% higher YoY, and 14.5% higher MoM. Iron ore inventory at Chinese ports remains at elevated levels, and we expect import demand to slow moving forward as a result. • Chinese aluminium exports: China exported 410,000 tonnes of unwrought aluminium and aluminium products over the month of March according to preliminary customs data. This is significantly higher than the 260,000 tonnes exported over February, but still 2% lower YoY. The stronger price environment should support higher Chinese output, leading to an increase in the country’s exportable surplus.

Agriculture • Malaysia cocoa grinding: Latest data from the Malaysian Cocoa Board shows that cocoa grindings over 1Q17 totalled 54,384 tonnes, a 15.7% increase YoY. However the grinding numbers were almost 5% lower than the 57,029 tonnes that was processed in the previous quarter. Although this decline is seasonal, and the grinding numbers are still fairly constructive for demand. • Chinese soybean imports: China imported a total of 6.33m tonnes of soybeans over March 2017, 4% higher YoY, and 14% higher MoM. Total Chinese soybean imports over 1Q17 totalled 19.5m tonnes, 20% higher YoY. However with Chinese crush margins now negative, we should see a slowdown in imports moving forward.

EUR: French elections likely to cap EUR/USD upside around 1.07 level Naturally one would have expected EUR/USD to have rallied substantially in the face of President Trump’s $ jawboning and rising geopolitical tensions. But gains have been harder to come by recently, with the pair struggling to push above the 1.0670/80 area. It is likely that EZ political risks are playing a role, with investors wary of chasing EUR upside in the run-up to the French presidential elections. A EUR/USD move above 1.0700 looks unlikely and could be met with spec sellers.

Verbal intervention does require the backing of fundamentals to develop a lasting impact on markets. Unlike previous occasions of talking USD down, President Trump has linked his dollar overvaluation comments to the US interest rate outlook. His suggestion thathe likes low interest rates (also said in May last year)has now put the debate on the appointment of potentially dovish Fed Chair, representing a fundamental shift compared to his election campaign when he criticised the Fed for running interest rates at a too low level. A reappointment of Janet Yellen seems to no longer be categorically ruled out. Alternatively, Trump could opt for a non-conventional appointment such as from the business world, declaring implicitly that the US still had a wide output gap by saying that the economy had a higher growth potential than currently calculated and therefore could afford lower rates for longer. Yesterday’s comments have opened a new playing field and markets will have to digest its implications.

Two countries, one interest: The good news of President Trump comments was that China will not be called a ‘currency manipulator’ when the Treasury releases its currency report this month. CNY has strengthened by 0.3% to 6.8745 this morning, reaching its highest level since March 31. However, RMB has weakened in TWI terms. In respect of USD, China and the US administration have the same interest. A weaker USD has the potential to boost competitiveness for both countries – directly in the case of the US and indirectly in the case of China, where a weaker USD allows China to depreciate RMB againstnon-USD currencies such as EUR, JPY and KRW just to name the heavyweights of China’s currency basket.

Commodities to undermine AUD: Australian labour market data for March were very strong on the headline, with job growth at 60.9k (20k expected) and all in the full-time sector (75k). In addition, China’s March trade balance, seeing exports growing at 16.4%, by far outpacing the 3.4% consensus expectation, while its imports expanded at 20.3%, is in line with our constructive view on the state of the global economy. However, the CRB Rind index has rolled over and iron ore prices have lost another 1.4% overnight, coming in addition to yesterday’s 2.3% decline. China’s commodity import seasonality may play in here, but China trying to curb housing sector investment and shift growth from the old, commodity consuming part of the Chinese economy towards its service sector may play in too. Anyhow, falling prices for China-related commodities have two effects. First, they should weaken AUD, in which we hold short positions, and second, they may allow international bond markets to keep rallying for somewhat longer, keeping USD selling pressure intact for now.

Does payrolls matter for the USD today? The FOMC minutes gave the market a lot of information on how the Fed is thinking about reducing monetary accommodation. In 2018 the focus will be on balance sheet reduction. The market took this as a signal that the focus in 2017 will be to use the pure interest rate tool to tighten. The market prices 38bp of hikes by the end of this year and a cumulative 70bp by the end of 2018. The strong ADP print on Wednesday has already pushed expectations higher for today’s headline NFP (MS: 195k), therefore it is the wage data that matters for the USD. Average hourly earnings above the 2.7% market expectations would drive the USD higher on the day, particularly vs the JPY. The US 10y breakeven rate has come down from the Jan high of 2.07% to 1.95% today.

Short EURGBP. The best way to play for a dovish ECB in the next 3 months is to sell EURGBP. The pair is developing strong bearish technical signals, which continue to hold as long as EURGBP stays below the 0.8610 level. Draghi and other ECB members yesterday tried to send a message that there has been a recovery in the economy, monetary policy is working but inflation needs to be sustainably close to 2% for us to consider changing policy. Emphasis was also on the sequencing of the removal of accommodative policy, should they reach their targets. We don’t think the ECB will raise rates before starting to taper asset purchases. The ECB minutes said they discussed removing the phrase “rates will remain at present or lower levels”, but that has stayed, possibly to give the ECB as much flexibility as possible, should political events cause market volatility. On the GBP side, a survey released overnight highlights some labour market tightness appearing. The Recruitment and Employment Confederation showed that companies are finding it difficult to fill jobs in London and the South, particularly in the temporary sector where staff availability fell at the fastest rate since January 2016.

SNB still intervening. After the Czech National Bank removed their EURCZK currency floor yesterday, focus will naturally turn to the Swiss. Without having a formal floor any more, we don’t think the SNB are near stopping their currency interventions since they currently have the flexibility to intervene if and whenever they like. Inflation data have been improving, with the latest headline print now at 0.6%Y, the highest since 2010. The latest core inflation print is now above zero (0.1%) but has not yet recovered to levels seen in late 2015 (0.4%). The domestic economy is still dealing with the impact of a strong currency and, more importantly, the slowdown in Chinese demand for luxury goods. For now we think the SNB will continue to intervene in the largest volumes around major risk events, with the next ones being the first and second round of the French election. Recently the SNB have been more explicit than ever before about their management of the FX reserves portfolio. Interestingly they are justifying holding a large equity position (20% of portfolio) by saying they need to do this because of the strong exchange rate. We expect EURCHF to stay stable for now.

South China Sea row intensified after Philippines President Rodrigo Duterte ordered the Philippines’ military to occupy and fortify islands in the South China Sea amid ongoing territorial disputes between China and other countries in the region. China exerts its claim on most parts of the South China Sea while Vietnam, Philippines, Indonesia, Malaysia, Cambodia, Thailand, Singapore, and Taiwan dispute such claims. Competing claims include,
• Indonesia, China, and Taiwan over waters NE of the Natuna Islands.
• The Philippines, China, and Taiwan over Scarborough Shoal.
• Vietnam, China, and Taiwan over waters west of the Spratly Islands. Some or all of the islands themselves are also disputed between Vietnam, China, Taiwan, Brunei, Malaysia, and the Philippines.
• The Paracel Islands are disputed between the PRC/ROC and Vietnam.
• Malaysia, Cambodia, Thailand and Vietnam over areas in the Gulf of Thailand.
• Singapore and Malaysia along the Strait of Johore and the Strait of Singapore.
Duterte told journalists at a press briefing that following his visit to a military base located in the Philippines western Palawan province, “It looks like everyone is making a grab for the islands there. So we better live on those that are still unoccupied. What’s ours now, we claim it and make a strong point from there….We tried to be friends with everybody but we have to maintain our jurisdiction now, at least the areas under our control…… There are about nine or 10 islands there, we have to fortify……I must build bunkers there or houses and provisions for habitation.”
The defense secretary Delfin Lorenzana has confirmed that President Duterte’s order by saying, “The president wants facilities built such as barracks for the men, water [desalination] and sewage disposal systems, power generators (conventional and renewable), lighthouses, and shelters for fishermen…”
The reactions from other countries including China are yet to emerge in response to this Duterte land grab.

Geopolitical tension intensified between the United States and Russia as the United States attacked the Assad regime by launching 59 tomahawk cruise missiles targeting airports in response to an alleged chemical weapon attack by the Assad regime. This week, the Assad regime reportedly used chemical weapons that claimed the life of 80 people including women and children in the rebel-held town of Khan Sheikhoun in Idlib province. Speaking at the Mar-a-Lago resort in Palm Beach Florida, President Trump confirmed the ordering of the missile launches. He said, “I ordered a targeted military strike on the airfield in Syria from where the chemical attack was launched…..It is in the vital national security interest of the US to prevent and deter the spread or use of deadly chemical weapons.” US missile attack reportedly destroyed 14 Syrian jets and destroyed much of the air facility in the area. Pro-government journalists in Syria have warned that actions like these will only boost the morale of the terrorists.

This action taken by the Trump administration puts it in direct conflict with Russia, who gave a different narrative of the situation. According to Russia, the Syrian government attacked a rebel-held arms depot in the area, which contained the chemical weapon; Sarin nerve agent.
The US Secretary of State warned against reading too much into the attack as according to him, the stance of the current administration is Syria remains unchanged and he insisted that the missile attacks only show that the President is willing to take decisive actions when called for.
While most of the US lawmakers lauded the President’s action, some still remain skeptical and feel that it is plausible that the Russian narrative could be true. Prominent senators like Rand Paul, Ted Lieu condemned the President’s action as he did not seek congressional approval before the attack. Senator Thomas Massie said that it was not in the interest of the Assad regime to use chemical weapons and believes that the Russian narration might be true.

Russia had already warned the United States on military actions against Assad regime saying that it will have negative consequences. Next few weeks would see a flurry of activities on this front and the attack has triggered a lot of uncertainties.

The UK gilts traded flat Tuesday, showing modest gains, following the country’s lower-than-expected construction PMI released today. Also, investors are eyeing the February manufacturing production data, scheduled to be released on April 7 for further direction in the debt market.

The yield on the benchmark 10-year gilts, which moves inversely to its price, hovered around 1.05 percent, the super-long 30-year bond yields fell nearly 1 basis point to 1.64 percent while the yield on the short-term 2-year traded flat at 0.10 percent by 10:10 GMT.

The seasonally adjusted Markit/CIPS UK Construction Purchasing Managers’ Index (PMI) dropped from 52.5 in February to 52.2 in March, to signal the joint-slowest upturn in overall construction output since the current period of expansion began in September 2016.

“Survey respondents noted that the resilient economic backdrop and receding Brexit-related anxieties have helped to stabilize client demand after the disruption to development projects last summer,” said Tim Moore, Senior Economist, IHS Markit.

When oil price bottomed around $27 per barrel last year in February, many predicted a major reversal and the dark days for producers to be over. Yet, more than a year after the bottom, the oil market is struggling to cope up with the supply glut and lack of clarity. A deal by OPEC and 11 participating non-OPEC countries to reduce production by 1.8 million barrels per day has failed to soothe the market concerns. Every day, contrasting forecasts continue to appear in the media suggesting a spike in oil price or a tumbling to the bottom once again. So, how can you know which side to take? We at FxWirePro believe (despite our guidance and forecasts) that readers should make up their own views (a must, even if they are trading on our calls) based on facts. Here are the key factors that one needs to watch to understand the market dynamics that might lay ahead,

US production has been recovering since it bottom in July last year. Though the country is producing lesser amount crude compared to the pre-oil-crush levels, production has increased by 719,000 barrels since July. The number of active oil rigs operating in the US has more than doubled since it bottomed around in May last year. It is currently at 662 and the production is at 9.147 million barrels per day.
OPEC deal is likely to serve as the most crucial factor to watch out for. On May 23rd, OPEC ministers are scheduled to meet at the Vienna headquarters to decide on the deal extension. Mark your calendars for that date. We expect the OPEC and participating non-OPEC countries to extend the current production cuts deal.
The level of inventories would also play a crucial role in price discovery. Declining inventories would invariantly result in a higher crude oil price. As of now, inventories in the US rests at 533 million barrels, the highest ever. Recently, the gasoline inventory has come down but still higher at 239 million barrels when compared to historical data. The OPEC deal has pushed the oil market to backwardation but the inventory is yet to come down significantly.
Demand has been growing at a rapid pace since 2016 thank to lower oil price and contribution from countries like India and China. But experts expect higher demand this year from the United States as record numbers of cars and trucks were sold during the winter and holiday season.
New projects would play a very significant role for future prices. Recently Goldman Sachs have warned that many projects adopted during the $100 per barrels crude oil are set to come online this year and in the next few and would lead to higher than expected production. On the other hand, International Energy Agency has warned that lower level of investments due to 2014 oil price crash and continued lower price would eventually lead to supply constrain and eventually higher oil price.
These five fundamentals would be crucial in determining oil price in the months and quarters to come. WTI is currently trading at $50.6 per barrel and Brent at $2.8 per barrel premium.

The German bunds slid Friday, after reading wider-than-expected decline in the country’s unemployment rate during the month of March. Also, investors remain keen to watch the Eurozone’s March consumer price inflation, scheduled to be released shortly today.

The yield on the benchmark 10-year bond, which moves inversely to its price, rose 1 basis point to 0.34 percent, the long-term 15-year bond yields rose 1/2 basis point to 0.54 percent and the yield on the short-term 2-year bond traded 1 basis point higher at -0.73 percent by 08:20 GMT.

German unemployment unexpectedly dropped to a new record low in March as Europe’s largest economy powered ahead.

The jobless rate fell to 5.8 percent, from 5.9 percent, and the number of people out of work slid by a seasonally adjusted 30,000 to 2.6 million, data from the Federal Labor Agency in Nuremberg showed on Friday. Economists in a Bloomberg survey forecast no change in the unemployment rate and a 10,000 decline in the number of people seeking work.

“The job market continues to develop favourably. With the onset of spring activity, the number of unemployed people has declined, employment growth is continuing unabatedly, and demand for new employees continues to be high,” Bloomberg reported, citing Detlef Scheele, Board Member, German Labor agency.

Energy • US crude oil inventories: Yesterday’s EIA report showed that US crude oil inventories increased by 867Mbbls over the last week, below the 2MMbbls stock build that the market was expecting. The lower-than-expected build was due to higher refinery throughput, which increased from 15.8MMbbls/d to 16.23MMbbls/d over the week. A higher refinery throughput rate and a decline in refined product inventories suggest strong demand currently. • Russia oil output cuts: According to reports, the Russian Energy Minister has said that the country has cut oil output by 200Mbbls/d so far, versus their agreed cut of 300Mbbls/d. However, the country expects to reach this target by the end of April. With regard to extending production cuts, Russia has said that it is too early to decide on whether an extension is needed.
Metals • Grasberg copper mine: Reports suggest that the Indonesian government and Freeport have finally completed discussions on converting the company’s current mining license to a new one. With Freeport apparently now agreeing to this new license, we should see Grasberg resume copper exports, while the mine is likely to ramp up operations once again. • Australian cyclone aftermath: Following the cyclone that hit Queensland, a number of coal mines in the state that were forced to shut are now looking to restart mining operations. However, currently, ports and rail lines remain shut. The scale of damage to infrastructure is still unknown.
Agriculture • Ivory coast cocoa export tax: There are reports that the Ivorian government is considering cutting the export duty on cocoa, from the current 22%. This comes at a time when Ivory Coast has seen a rebound in domestic production, evident through higher port arrival data. A lower duty does potentially mean increased exports from the country. • Brazilian robusta coffee imports: It appears that the government is close to deciding to allow the importation of up to 1m bags of robusta for re-export. Imports were initially approved, but this led to protests from coffee growers, which prompted the president to quickly reverse the decision.

The pace of credit growth to households and businesses in the Eurozone edged lower in February, data from the European Central Bank showed Monday. The broad money measure, M3, rose 4.7 percent year-over-year in February, slower than the 4.8 percent climb in January, missing expectations for a 4.9 percent rise. The Eurozone money supply growth eased for the second straight month in February.

Within M3, the annual growth rate of deposits placed by households stood at 5.4 percent in February, down from 5.5 percent in January. While, deposits placed by non-monetary financial corporations registered a decline of 2.0 percent.

The ECB has maintained an ultra-loose monetary policy with low interest rates and stimulus measures which have helped bolster credit growth in the Eurozone over the last two years. The narrower aggregate M1, which includes currency in circulation and overnight deposits, remained unchanged at 8.4 percent in February.

Details of the report showed that the annual growth rate of total credit to euro area residents decreased to 4.3 percent in February from 4.6 percent in the previous month. The yearly growth rate of credit to general government moderated to 9.8 from 10.5 percent.

The Australian bonds sharply rebounded on the first trading day of the week Monday as investors poured into safe-haven assets tracking firmness in U.S. Treasuries amid losses in riskier equities and oil. Also, the lower-than-expected reading of the latter’s manufacturing PMI added to the upside sentiment.

The yield on the benchmark 10-year Treasury note, which moves inversely to its price, slumped 6-1/2 basis points to 2.70 percent, the yield on 15-year note plunged nearly 7 basis points to 3.10 percent and the yield on short-term 2-year traded 5 basis points lower at 1.73 percent by 03:50 GMT.

The seasonally adjusted Markit Flash U.S. Composite PMI Output Index registered 53.2 in March, to remain above the 50.0 no-change value for the thirteenth consecutive month. However, the latest reading was down from 54.1 in February and signalled the slowest expansion of private sector output since September 2016.

Further, At 53.4, down from 54.2 in February, the headline seasonally adjusted Markit Flash U.S. Manufacturing Purchasing Managers’ Index (PMI) signalled the slowest overall upturn in business conditions since October 2016.

The Reserve Bank of India (RBI) is expected to maintain status quo throughout this year, keeping the repurchase rate steady at 6.25 percent in 2017. However, beyond this year, the next move is likely to be a rate hike rather than a cut as the RBI policy committee remains keen to maintain price stability.

Apart from domestic considerations, the RBI will also keep an eye on global developments, especially the direction of US Fed policy. Further compression in the US and Indian long term rates, coupled with US dollar strength could induce volatility in the financial markets. Stability, therefore, will be a priority for the RBI, prompting a status quo stance on rates, DBS Bank reported in its latest research publication.

The central bank surprised on two counts in February. Benchmark rates were left unchanged in contrast to expectations for a cut. The policy stance was also shifted to a neutral bias from accommodative earlier, pulling the brakes on the easing cycle that started in early 2015.

“Under the flexible inflation targeting regime within +/-2 percent of the mid-point of 4.0 percent, the RBI will not be required to hike immediately in case of an overshoot. Nonetheless, the rate bias is tilted more towards hikes than cuts going forward,” the report said.

After the new healthcare bill that was supposed to replace the current bill, which is popularly known as the ‘Obama-care’ failed to pass through the congress last week, the relation between the US President Donald Trump and the House majority leader Paul Ryan has probably taken a turn for the worse. The new bill was expected to be put to voting on the House on last Thursday, a day marked by the seventh anniversary of the old bill. But the voting was initially postponed to Friday and then it was again canceled on Friday. As the opposition and the media targets ‘dealmaker’ Donald Trump for this failure, President Trump has allegedly showered his anger and frustrations towards Paul Ryan.

On March 25th, President Trump tweeted, “Watch @JudgeJeanine on @FoxNews tonight at 9:00 P.M.” He usually endorses shows via his tweeter account whenever he is either due to appear or appeared already in a show but in this one he wasn’t there. Instead, it was all about criticism against the Republican Party for failing to pass the new health care bill. In that show, Judge Jeanine Pirro called for the resignation of Paul Ryan from his post as the House leader.

A rift between Paul Ryan and Donald Trump is not a new phenomenon. There were clashes many a time during the campaign but after the election, they were getting along well and a rift between the White House and congress will be in nobody’s interest. Trump has also taken a jab towards congressional freedom caucus which remains allegedly behind the failure.

The consensus expects the ECB to allocate EUR110bn via its target LTRO after allocating EUR62.2bln at its last operation. Given that this is the last TLTRO allocation, demand could be heavy and should the allocation exceed the EUR110 expectation,excess EUR liquidity will be parked at the front end of the EUR curve pushing rates lower, which at the margin is a EUR negative. However, for developing a more pronounced bearish impact on the EUR the liquidity boostneeds to impact the 2-year EUR swap. A decline of the German Schatz yield is not sufficient for driving the EUR lower. ECB’s Nouy (8am) and Lautenschlaeger (3pm) will speak today.

EM and risk outlook stays relatively supported but we see risk aversion alert signs across the board. While investors focus on US politics and especially on today’s vote on the repeal act of Obamacare, other developments should, in our view, not remain unnoticed: a research paper published by two Fed economists and released by the Brookings Institute suggesting US interest rates staying low with the Fed tolerating inflation overshooting targets, the ECB’s targeted LTRO allocations, and the continued fall of iron ore futures. Despite equity markets retracing some of the post-election rally, US monetary conditions have become more accommodative with the falling USD contributing most to this easing. Foreign conditions have turned from providing hefty headwinds as experienced from 2012-16 into tailwinds, helping US reflation gain momentum over time. Accordingly, we prepare for putting on FX trades that benefit from a steeper US yield curve. Short EURSEK and long USDJPY fall into this category. While short EURSEK should work from now, USDJPY’s current downward momentum suggests waiting for 109.50 or for a stabilisation above 112.50 before establishing longs.

US vote: Today markets will wait for the outcome of the vote but FX investors should note that the vote is not scheduled for a specific time. At the moment the vote count may be low so the Republican leaders need the time to gather votes, indicating why no specific time is provided. There is even a risk the vote may be delayed if the leaders feel the vote may not pass.

Watching iron ore. The PBOC-run Financial News newspaper highlighted that the recent rise of RMB money market rates should be put into the context of recent money market operations. China seems to be tightening its monetary conditions to deal with excessive leverage. Importantly, tighter RMB lending conditions have sparked China’s USD denominated loan demand, pushing its USD denominated liabilities up again. Should this loan-related USD inflow into China end up into a higher FX reserves (see chart below) – thus providing an additional signal that offshore USD liquidity conditions are on the rise – EM markets should see further inflows. Meanwhile, China has seen the ratio of mortgage loans to total credit of commercial banks reaching uncomfortably high readings. It has been China’s property and infrastructure investment driving commodity – including iron ore – demand. Authorities are now directing growth away from the property market which suggests that commodity prices may ease. Falling iron ore prices will not bode well for the AUD. Within this context we recommend using the AUD as a funding tool for high yield EM longs and for a long GBP position. GBPAUD has moved away from levels suggested by relative forward curves.

The Westpac-McDermott Miller New Zealand consumer confidence index edged slightly lower in the March quarter. Survey showed that people grew wary about the short-term economic outlook, but extended the nation’s run of optimism to six years.

The Westpac McDermott Miller consumer confidence index fell 1.2 points to 111.9 in the March quarter, but remained above the long-run average of 111.4. The present conditions index decreased 0.2 points to 111.2 and the expected conditions index fell 1.9 points to 112.4.

“March’s slight fall in confidence mainly reflected some anxiety about the upcoming election. It might also reflect concerns around housing affordability or political developments offshore, both of which continued to hit the headlines in recent weeks,” said Westpac Banking Corp senior economist Satish Ranchhod.

The latest economic data showed GDP figures showed that on a per-capita basis, household spending rose by around 2 percent last year which reflected a healthy level of spending confidence. With a growing confidence of consumers in their own household financial security, and a positive outlook for the New Zealand economy we could expect continuing positive consumer sentiment to translate into sustained growth.

Growth in Japan is holding up nicely and economic activity has gained momentum since 4Q16 with the pickup in the global capex and manufacturing cycle. Inflation has started to push back above the waterline. But as Governor Kuroda emphasized at a press conference last week, inflation expectations remain stuck, something highlighted by this year’s spring wage negotiation projected to produce only modest wage increases. With price pressures nailed to the floor, the Bank of Japan (BoJ) doesn’t seem to be in a hurry to raise rates.

“With our USD rates forecasts pushed upward, we now expect that the BoJ will taper its asset purchases at a somewhat slower pace than previously and that QE will end in H2 2019, instead of mid-2019. JGB rates unchanged,” said DNB markets in a research note to clients.

There is an ongoing debate whether the BoJ will have to raise its 10-year bond yield cap because of the lack of JGB liquidity. There seems to be still a split of views inside the BoJ on whether the Bank should or should not raise the 10-year yield target when the real interest rates decline further. The longer the BoJ keeps the 10-year yield target unchanged, the more rapidly it will have to adjust the target later.

Analysts expect the BoJ to maintain the current 10-year yield target through year-end, but if it sees greater yen weakness, it would adjust the target in 2H17. BoJ will have to strengthen communication strategy with forward guidance on its yield curve control (YCC) policy to manage market expectations. It would probably provide the conditions under which the BoJ would raise the 10-year yield target.

“While we expect the BoJ to introduce forward guidance on its yield curve control (YCC) policy relatively soon, we think it would do so in July at the earliest, when the BoJ reviews its economic outlook and discusses its monetary policy stance in the Outlook Report. If it may take time to build a consensus among the board members on this issue, delaying its introduction until October,” said J.P. Morgan in a report.

USD/JPY trades below 100-day moving average. The pair is tracking DXY lower, amid holiday-thinned markets (Japan closed for Vernal Equinox Day) and lack of fresh fundamental drivers. Technical studies are bearish, RSI and stochs are biased lower and MACD has shown a bearish crossover on signal line. 112 levels in sight, violation there could see test of 111.60 and then 111 levels.

As expected, the US Federal Reserve hiked interest rate by 25 basis points in its March meeting. However, aside from the rate hike, there were no major changes in the FOMC forecast or statement, except for few minor tweaks. With March meeting gone, there are now seven upcoming meetings this year and the Fed has forecasted hikes in two of them. Let’s look at the market pricing of the hikes, (note, all calculations are based on data as of 16th March)

May 3rd meeting: Market is attaching 94 percent probability that rates will be at 0.75-1.00 percent, and 6 percent probability that rates will be at 1.00-1.25 percent.
June 14th Meeting: Market is attaching 46 percent probability that rates will be at 0.75-1.00 percent, 51 percent probability that rates will be at 1.00-1.25 percent, and 3 percent probability that rates will be at 1.25-1.50 percent.
July 26th meeting: Market is attaching 38 percent probability that rates will be at 0.75-1.00 percent, 50 percent probability that rates will be at 1.00-1.25 percent, 11 percent probability that rates will be at 1.25-1.50 percent, and 1 percent probability that rates will be at 1.50-1.75 percent.
September 20th meeting: Market is attaching 21 percent probability that rates will be at 0.75-1.00 percent, 45 percent probability that rates will be at 1.00-1.25 percent, 28 percent probability that rates will be at 1.25-1.50 percent, 5.5 percent probability that rates will be at 1.50-1.75 percent, and 0.5 percent probability that rates will be at 1.75-2.00 percent.
November 1st meeting: Market is attaching 20 percent probability that rates will be at 0.75-1.00 percent, 43 percent probability that rates will be at 1.00-1.25 percent, 29 percent probability that rates will be at 1.25-1.50 percent, 7 percent probability that rates will be at 1.50-1.75 percent, and 1 percent probability that rates will be at 1.75-2.00 percent.
December 13th meeting: Market is attaching 10 percent probability that rates will be at 0.75-1.00 percent, 32 percent probability that rates will be at 1.00-1.25 percent, 36 percent probability that rates will be at 1.25-1.50 percent, 18 percent probability that rates will be at 1.50-1.75 percent, 3.5 percent probability that rates will be at 1.75-2.00 percent, and 0.5 percent probability that rates will be at 2.00-2.25 percent.
The probability is suggesting,

There hasn’t been much of a change after the FOMC. The market is still pricing a hike in June and a hike in December. It is still not clear why the market is predicting two hikes in H1 and just one in H2. This is probably because the market is pricing the Fed would keep additional room for easing.
We suspect that if the price of oil tumbles further, so would be the hike odds.