Strategy Thoughts – US inflation risk, Tariffs, AUD/NZD cheap, Brexit
Higher US inflation risk
We sold additional NZD/USD today after the USA payrolls report. Our thoughts are that wage growth may be picking up, and this will raise the pressure on the Fed to continue to raise rates.
US yields have risen today; 2yr swap rates up 7bp to 2.89%, revisiting the year’s high, widening The USD yield advantage across all currencies.
10-year yields rose 6.6bp to 2.94%.
Yields retained their increases on the day despite a fall in US equities, consistent with the market seeing the potential for the Fed moving to a restrictive policy stance at some stage.
Higher US yields, and potentially a peaking in US equities is likely to keep downward pressure on global emerging markets, and a stronger USD against EM and commodity currencies.
Waiting on Tariffs
Today, the further gains in the USD against Asian currencies, including most dramatically the AUD, appears to be linked more to tariff risks.
Around mid-day Trump off-handedly said that after tariffs proposed on an additional $200bn in goods, he is ready to move on a further $267bn in goods; which sounds like tariffs on all Chinese goods imports.
We are still waiting to hear if he plans to move on tariffs on the first $200bn of goods. China has said it is prepared to respond if the US moves. This threat continues to hang over the market.
There is scope for both further weakness in Asian currencies on an escalation of the trade war, or a significant relief rally if the US and China come to some agreement.
I don’t think we can say that the extension of tariffs has been priced into markets, and if the trade war concerns remain elevated or increase, and US yields creep higher, and/or US equities start to roll over, then we see potential for ongoing upheaval in EM currencies. China may continue to allow the CNY to weaken if the US keeps pushing on trade.
AUD/NZD looking cheap
I chose to sell NZD rather than the AUD because the Australian economic data looks stronger, and this may show up in the Australian employment data next week. Australian commodity prices are also rising, despite the Chinese economic risks. This may, in fact, reflect use of commodity futures in China as a hedge against a weaker CNY, and/or expectations that China will boost fiscal spending or ease credit conditions.
AUD/NZD is looking cheap relative to its interest rate and commodity price spreads; we are looking at potentially buying this cross towards 1.0850. Milk futures prices have fallen since March 2017.
EU cutting UK some slack
We still have a short GBP position. It appears that EU leaders are becoming more willing to make concessions to UK PM May. Perhaps because they can see how vulnerable she is to a challenge by hard-Brexiters in her own party. And they can see the risks of political and economic chaos in the UK that may have significant repercussions for the EU.
I sold GBP because I thought that PM May had little hope of passing any deal through her parliament and political turmoil was increasingly likely. And that UK businesses were starting to respond now to the approaching turmoil, such that even if the UK gets an extension to come to an agreement with the EU, it may be too late, and UK business activity would weaken anyway.
We have seen the GBP bounce significantly in recent sessions on the EU appearing to consider giving ground to PM May on a deal that she can take back to her government. In the near term, it is possible that the GBP recovers further on signs of agreement with the EU
However, we have decided to stay with our short position, on a view that any compromise that May may be able to find with the EU will still not be good enough for the UK parliament. And the ongoing risk that a leadership challenge for PM is announced.
Positions
Short half unit GBP/USD at 1.2918; s/l 1.3058; t/p 1.2388 (Capital at Risk 0.58%)
Short half unit NZD/USD at 0.6679; s/l 0.6633; t/p 0.6388
Short half unit NZD/USD at 0.6564; s/l 0.6633; t/p 0.6388 (Capital ar Risk 0.62%)