USD safe haven buying, GBPUSD, European Unity and High Yielding Currencies

The USD may replace its reflation related bid with safe haven related demand. This scenario suggests the JPY staying correctively strong for now, gaining on many crosses, while GBP and high yielding currencies may be hit as political and currency related concerns increase. This morning, GBP will be in the centre of currency traders’ attention reacting to weekend press speculation regarding Theresa May’s government laying the foundations for a ‘clean’ Brexit and possibly abandoning what had been perceived as a ‘have your cake and eat it’ strategy, which aimed to keep access to EU’s single market. The possible new strategy leaked by the Sunday press suggests the UK regaining full control over immigration, sovereignty from European Court of Justice decision-making and readiness to exit the customs union. Chancellor Hammond suggested in an interview with German’s ‘Welt’ that the UK may head towards an alternative economic model, threatening to cut UK corporate tax rates should the exit negotiations not show desired results. Note, BoE’s Carney was warning last week that failing negotiations could impose risks to financial stability, but that these risks could be bigger for the EU than for Europe, providing another sign of the UK taking a tough stance.

Northern Ireland heading towards new elections may complicate matters, leading to speculation that Article 50 may not be triggered in late March which could increase economic uncertainty even more. Key EMU states have scheduled elections too: Netherlands, France and Germany. According to the deputy PM the Netherlands will block any EU trade deal with the UK, unless it signs up to tough tax avoidance regulations preventing it from becoming an attractive offshore haven for multinationals and the rich, giving the impression of the UK and the rest of EMU drifting apart.    

European issues seem to release a dose of deflationary pressures. Deflation tends to increase real yields of low yielding currencies, suggesting USDJPY may drift towards our 112.50 target. However, GBPUSD breaking lower will undermine any bid in EURUSD too. This applies even more when following the Carney argument of seeing a failure of UK-EMU negotiations leading to a disproportional increase in inner EMU financial stability risks. Peripheral spreads quietly working higher supports Carney’s view. Meanwhile, Greece could move quickly back into focus should the IMF opt-out require new negotiations with Greece and a new approval by the German Bundestag according to Germany’s Schaeuble. Accordingly, there could be a new programme implying additional fiscal measures and further drastic reforms in Greece. The issue becomes even more complicated when we put the views of the incoming US administration into Europe’s context.

The German tabloid Bild released an exclusive interview with US President elect who predicted other countries following the UK in leaving EMU, calling EMU as servicing the German interest and saying that the UK was smart to leave. In relation to Brexit, Trump said that he could offer the UK a quick and “fair” trade deal. On the global trade front, Trump suggested imposing 35% duty on German cars made in Mexico and exported to U.S. It seems the incoming US government has taken a very different position compared to President Obama’s approach of supporting the idea of a politically unified Europe as much as possible. There could be an early meeting between PM May and Trump trying to help the UK to establish good post EMU trade deals with the US.

High yielding currencies including the AUD could come under selling pressure should the recent round of weaker Chinese economic data releases translate into growth concerns. Car sales and the housing markets have weakened in November/December. This morning, Xiao Lisheng, a researcher with the Chinese Academy of Social Sciences, wrote in the outlook page of the China Securities Journal that “China should stop intervening in the foreign exchange market as soon as possible, conduct a one-off devaluation of the yuan and let the yuan float freely”. The advantages of a one-off RMB depreciation include a competitive gain that would help to utilise China’s substantial output gap and prevent further capital outflows linked to current RMB overvaluation expectations.