Week Ahead: Parsing Through The Themes, Looking For FX Trades

A number of themes are driving FX markets at present but there seems to be only a handful of FX trades. The most obvious theme – the fear of a Brexit – has sent GBP tumbling already.

Our new positioning indicator – G10 FX PIX – signals that investors are running significant shorts, however, and stretched market positioning could encourage investors to look for proxy trades like short-EUR. EUR should remain vulnerable as fears linger that the centrifugal forces in the EU will intensify from here and investors add to downside bets ahead of the March ECB meeting. Markets are not running significant EUR-shorts at present, making selling EUR/USD attractive.

Another FX market theme is persistent risk aversion on the back of weaker global growth, and the insufficient and ineffective policy response so far. We expect a market-friendly outcome from the G20 meeting over the weekend but it remains to be seen whether this will be sufficient enough to boost sentiment. Our positioning measure suggests that markets are short CAD, and small short NZD and SEK, and they could benefit most from a potential revival of investors' risk appetite.

Yet another, emerging theme is the return of the USD decoupling trade. The latest improvement in US data has gone largely unnoticed amidst the global risk off and investors continued to cut USD-longs. That said, as argued recently, the combination of accelerating wage growth and an improving housing market bodes well for the domestic demand-led recovery in the US. We expect next week's labour market data to confirm the resilience of US consumers and support the USD. To the extent that risk sentiment improves as well, we think that USD/JPY longs could start looking attractive again.

What we’re watching

EUR – Flash HICP estimate a focus as markets looks for further evidence to support further ECB easing at the March meeting.

GBP – Opinion polls suggest the ‘in’ and ‘out’ vote are neck and neck. While, the bookmakers are pointing to a 30% probability of an EU exit. Given the collapse in GBP seen so far, is the market pricing in too much?

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