Long AUD & EUR vs USD (From 7-Dec to 13-Dec) Views on Fed, RBA & ECB
Stopped out of AUD on 14-Dec after weaker than expected Chinese economic reports and a weaker than expected Eurozone PMI data sparked broad fears for the global economy and a fall in global equities.
Real-time AmpGFX – Bought AUD/USD to add to long position (Wed 12/12/2018 8:01 AM MT)
Bought one unit of AUD/USD at 0.7222
Comment
The WSJ is reporting that China is prepared to make changes to its “Made in China 2025” policy levelling the playing field for foreign companies. Little detail, but it goes to the heart of the US complaints about Chinese protection of its tech sector, and at least initially should be seen as improving the odds of a trade deal.
Trump also said he would be prepared to intervene in the Huawei CFO case to help a trade and security deal. He did this before with ZTE, and this too should be seen as positive news for a trade deal.
No doubt there remains a significant risk that we see news and events that may reduce the chances of a deal going forward, but these events should improve confidence for global markets, including Asian equities that have been highly correlated with the AUD this year.
Given we are already long AUD, we are keeping a narrow range on our orders around this portion of the trade
Positions
Long one unit AUD/USD at 0.7232; s/l 0.7157; t/p 0.7445 (Capital at Risk 0.75%)
Long one unit AUD/USD at 0.7222; s/l 0.7193; t/p 0.7372 (Capital at Risk 0.29%)
We were stopped out of our long EUR position yesterday.
Stopped out of the long EUR position on 11-Dec following the French budget announcement, expanding spending to calm the ‘yellow vest’ protests, but causing widening French government bond yield spreads and a drop in the EUR. Brexit uncertainty also weakened GBP and spilled over to EUR.
Real-time AmpGFX – Bought AUD/USD and EUR/USD (Views on Fed, RBA and ECB) (Fri 12/7/2018 1:55 PM MT)
Bought one unit AUD/USD at 0.7232
Bought one unit EUR/USD at 1.1398
AUD Comment
We bought the AUD this morning following the US employment report and OPEC meeting. We decided to shoot first and ask questions later, so we have spent several hours evaluating whether to hold this position.
A factor that makes us less sure about this position is the weakness in the Australian housing market that has accelerated in recent months. The weak GDP outcome has brought more market attention to the potential for a weak housing market to drag down consumer spending and generate a case for the RBA to cut rates again. As such we are less sure on our view that AUD/USD should recover.
There are a number of other risks, the slump in the US stock market is a double-edged sword. On Friday, it appeared to drag the AUD lower. On the other hand, weaker US stocks are dragging on the USD, most notably against Gold and to some extent EUR.
Weaker US equities have lead global equity market weakness in recent months; in contrast to earlier in the year when US assets were more stable in the face of weaker global markets. Now that US assets are leading global market uncertainty, it is dampening expectations for US rate hikes, and generating some weakness in the USD.
The other risks include the US-China relationship in the wake of the Huawei CFO arrest. But at this stage, the trade talks are continuing.
In general, there is increased volatility in global asset markets and commodities, leading to increased correlations in currencies, and moves that are largely driven by short-term position squaring and pockets of illiquidity. This poses a further risk to the downside in the AUD unrelated to fundamental developments.
US payrolls data were weaker than expected at 155K (198K expected), a net downward revision of -12K to the previous two months, a rise in the underemployment rate from 7.4 to 7.6%, a tick down in the average workweek to 34.4 hours, and a tick downward revision in the monthly increase in average hourly earnings in the previous month (down from +0.2 to +0.1%m/m).
Otherwise, the unemployment rate was as expected, unchanged at 3.7%, and the year-ended average hourly earnings were as expected, unchanged at 3.1%.
You might perceive a hint of peaking in the strength in the labour market.
Oil prices jumped after OPEC+ agreed to a larger than foreshadowed cut in their production target (1.2mn bpd).
The CAD rallied on the back of the oil news and a stronger than expected Canadian employment report. The strength in the CAD may spill over to the AUD to some extent.
The AUD is near the low end of its range over several weeks, and we are looking for it to hold these lows.
Fed Views
The mood around the Fed is shifting towards a lower overall rate increase outlook. This may continue and allow for some broader weakness in the USD and stronger global risk appetite.
We note a degree of inertia in market expectations for the Fed. Everyone is still confident that they hike on 19 Dec, and most economists are sticking to their calls for several hikes next year. This inertia may be limiting the fall in the USD and increasing downward pressure on US equities.
We can see the argument to keep calling for rate hikes, but we can see the market building in a wider range of possibilities for rates, including some risk that they are cut. The USD will be vulnerable to any evidence that the economy has lost momentum. At the very least the Fed might be inclined to pause and watch and wait for an extended period.
Personally, I think the case for a hike in December is weak. The Fed should pause immediately, but project an outlook for rates to increase next year. This would highlight its willingness to react to current events without exhibiting undue alarm over the overall economy.
However, even though the Fed is saying it is now more data-dependent, it is not yet displaying a capacity to change direction as needed. It may prove incapable of fully incorporating the balance of risks into its decision making.
RBA Views
The Australian rates market has moved to price in a small risk that the RBA will cut rates over the next year. This appears to have followed the weaker than expected GDP report and some increased fear over the housing market and banks tightening credit conditions in the wake of the Royal Commission.
Deputy Governor Guy Debelle gave a speech on Thursday that helped push AUD to its lows this week.
He said, “The Reserve Bank has repeatedly said that our expectation is that the next move in monetary policy is more likely up than down, though it is some way off. But should that turn out not to be the case, there is still scope for further reductions in the policy rate. It is the level of interest rates that matters and they can still move lower.
“We have also been able to examine the experience of others with other tools of monetary policy and have learned from that. Hopefully, we won’t ever have to put that learning into practice. QE is a policy option in Australia, should it be required. There are less government bonds here, which may make QE more effective. But most of the traction in terms of borrowing rates in Australia is at the short end of the curve rather than the longer end of the curve, which might reduce the effectiveness of QE. The RBA’s balance sheet can also expand to help reduce upward pressure on funding, if necessary, as occurred in 2008.
“Finally, the floating exchange rate matters and remains an important shock absorber for the Australian economy.”
Alluding to the tightening in credit in the wake of the Hayne Royal Commission. Debelle also said: “The crisis very much demonstrated the critical importance of keeping the lending flowing. The lesson is that countries that did that fared better than countries that didn’t. That lesson is relevant to the situation today in Australia, where there is a risk that a reduced appetite to lend will overly curtail borrowing with consequent effects for the Australian economy.”
The Q&A spend much time talking about the weaker housing market and weaker credit growth. Debelle indicated that the RBA is watching both closely, while at the same time tending to downplay fears that this would require further policy easing.
The speech was about the GFC and what the RBA could do, so naturally, it included the possibility of more easing.
It also fed the fears over the housing market and Hayne Royal Commission. These fears have been lurking for some time. They appeared to diminish through much of the year because employment growth has been strong and it might help sustain household demand even if housing prices were slowing. However, these fears have increased recently as the housing market slowdown has intensified a bit more, and the GDP report showed weaker household consumption. Additionally, weaker global asset markets and commodity prices are tending to further undermine confidence in the Australian economy.
We have a mixed view on the impact of housing on the Australian economy. We had come to see it as a factor that may dampen the recovery but not cause significant deceleration that that might require the RBA to cut rates.
Our thought was that a moderate pace of downturn in housing would be accepted by households as a payback to extraordinary strength, in some ways welcome, especially by a high proportion of people more worried about affordability for themselves and family rather than their wealth. That the fall in house prices would not unduly undermine financial stability. Household spending would remain solid enough, supported by overall economic growth, demand for labour and employment growth.
That view allowed us to consider RBA rates policy as stable, with possible hike albeit some time down the road. Similar to the RBA view.
However, the market is showing more alarm in recent weeks which has arisen in part from a faster pace of house price falls. The CoreLogic daily house price index is down 9.2% at an annualized rate over the last three months, and the auction clearance rate has fallen to the 40s, lows since 2011/12.
If prices fall more sharply, it could cause some panic, especially from investors, and lead to more significant financial stress and wealth effects, increasing the odds that the RBA contemplates rate cuts and encourages a weaker AUD.
Such concerns have contributed to a downshift in AUD rate expectations that are almost as large as those in the USA.
Overall we will be monitoring the AUD/USD position closely, but have decided to hold it for now.
EUR Comment
The downward revision in rate hike expectations for the Fed has narrowed the EUR/USD yield disadvantage. Obviously, this yield disadvantage is still large, but the EUR/USD appears to have been more connected to the yield spreads and rate expectations this year. We have been looking at a range of yield spreads; including the real 10-year yield spread and forward rate expectations from one-year ahead.
In data published on Friday, Eurozone compensation per employee rose from 2.2%y/y in Q2 to 2.5%y/y in Q3, a high since 2008. This should support the view at the ECB that wage growth is increasing as the labour market tightens keeping them on track to normalize monetary policy (ECB meeting next week).
News around the Italian budget plans appear to be attempting to find an accord with the EU to avoid sanctions. The Italian bond yield spreads have narrowed over recent weeks, and may help support the EUR.
The Brexit vote on Tuesday next week may generate volatility that undermines EUR. However, a no outcome for the vote appears to be widely expected, and thus it should not trigger fresh GBP selling. In fact, a no vote may only increase attention on paths to delay and eventually avoid Brexit through fresh elections and/or a new referendum.
The correlation between EUR and GBP may have increased in the context of broader asset market uncertainty in recent weeks. However, overall the market assigns a much lower risk premium to EUR than GBP in the options market, suggesting that it does not see Brexit uncertainty as a major factor for EUR.
As mentioned above the volatility in US asset markets has the potential to more significantly dampen rate hike expectations in the USA, and make the USD more responsive to hints that the US economy may be losing momentum.
Positions
Long one unit AUD/USD at 0.7232; s/l 0.7157; t/p 0.7445 (Capital at Risk 0.75%)
Long one unit EUR/USD at 1.1398; s/l 1.1313; t/p 1.1594 (Capital at Risk 0.75%)