Market Views For 2016 - page 6

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Goldman Sachs: Our '10 Commandments' For 2016 FX Market It is becoming something of a ritual that markets are especially uncertain in the first quarter. Part of this has to do with seasonality in US data, which tend to look weak around the turn of the year. But other things are exacerbating the risk sell-off. These are fears that China is in the midst of an uncontrolled run on its currency, a view we strongly reject, and concern that the ECB and the BoJ are backing away from their pursuit of higher inflation.

With so much uncertainty, this is a list of core “truths,” which we think will prevail and dictate market direction this year.

1. Much more US outperformance than priced. Behind all the short term worries lurks one meta-fact that is overlooked. The Dollar has appreciated 26 percent versus the majors over the last two years, but US growth has stayed above trend. There is little doubt that net exports and inflation have suffered, but the resilience of the economy suggests that underlying momentum on both the growth and inflation fronts is better than priced, especially now that front-end interest rates have priced out so much tightening.

2. The ECB and BoJ will ease more. In the wake of recent disappointments, markets worry that the ECB and BoJ are reneging on their commitments to boost inflation, which has been weighing on risk. Both central banks have progressively cut their 2016 core CPI forecasts, fanning fears that they are “terming out” their inflation targets. Indeed, our European economics team forecasts core HICP at 1.0 percent this year, below the 1.3 percent ECB forecast, an illustration of the downside risk to an already low number. For both the ECB and BoJ, we expect more stimulus as opposed to reneging, which is the basis for our 12-month view of $/JPY at 130 and EUR/$ at 0.95.

3 central banks will get over their fear of floating. Fear of floating among the G-3 central banks has a price, which is that it de-stabilizes risk, inadvertently tightening financial conditions. One example is the September FOMC, which exacerbated market anxiety over China with its focus on financial conditions. Another is the December ECB, where concern over excessive Euro weakening was reportedly one driver for not taking more aggressive action. Both times, equity market declines caused financial conditions to tighten, making efforts to manage G-3 exchange rates counterproductive. We see the G-3 central banks accepting more Dollar strength as the lesser of two evils.

4. Low inflation for longer in the Euro zone. Much of the discussion over low inflation in the Euro zone revolves around global themes, including falling commodity prices and the slowdown in EM. But ongoing structural reforms in periphery countries mean that price and wage levels are likely to keep falling, imparting a deflationary bias to the region, which is distinct from global developments.

5. The BoJ is the ultimate QE warrior. Quantitative easing aims to boost growth via a portfolio shift out of the safe haven asset into risk assets. The QQE program has aggressively flattened and stabilized the JGB yield curve, encouraging that shift, such that $/JPY sees “autonomous” moves up when risk appetite is good, for example in the summer of 2014 (the move from 102 to 109) and May 2015 (the move from 120 to 125). EUR/$ has not benefitted from similar portfolio shifts because Bunds – the safe haven asset in the Euro zone – have been too volatile.

6. Negative interest rates are over-rated. We estimate that a 10 bps (surprise) deposit cut is worth two big figures in EUR/$, based on intra-day moves when surprise deposit cuts were announced (Sep. 4, 2014 and Oct. 22, 2015). This means that the bulk of the decline in EUR/$ stems from ECB balance sheet expansion and long-term interest differentials not front-end rates. Our forecast for EUR/$ down anticipates a shift in emphasis back to asset purchases from depo cuts.

7. The Dollar is a “risk-on” safe haven currency. The correlation of the Dollar with risk has flipped from negative to positive in recent years. This switch reflects rate differentials, rather than a loss of safe haven status. Negative growth shocks, real or perceived, cause markets to price out monetary tightening in the US, such that rate differentials move against the Dollar. The positive correlation of USD with risk is therefore really a reflection of US cyclical outperformance.

8. Near term pain, long term gain for USD from low oil. Falling oil prices have negative fall-out on economic activity in the short run, weighing on the Dollar by way of rate differentials. But the US remains a net oil importer, so that low for long in oil prices is fundamentally a Dollar positive, once near-term effects drop out. By way of illustration, it was the oil super cycle that derailed the Dollar-positive impulse from rising rate differentials in 2004-08.

9. China's balance of payments is under control. There is a lot of anxiety that the pick-up in capital outflows represents a run on the RMB, making a large devaluation all but inevitable. However, a key reason that outflows were so large in 2015 was that August and December saw the RMB fix weaker, which caused (heavily expectation-based) outflows to pick up. With a current account surplus of perhaps as much as $400 bn this year, China’s balance of payments can absorb a sizeable level of outflows before reserve drawdowns become necessary.

10. It is not in China’s interest to destabilize the world. China is a net exporter, i.e., it depends more than other countries on sound global growth. It is therefore hardly in China’s interest to unsettle markets and derail the world economy. Recent developments most likely point to a greater desire to see flexibility in the exchange rate and a closer link to fundamentals (which includes a shift in focus to a trade-weighted exchange rate), rather than unilateral devaluation.

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Goldman Sachs sees far more upside in USD/JPY Goldman Sachs Macro Markets Research

The BOJ surprised markets by introducing a negative interest rate of -0.1%, implemented by a move to a three-tiered interest rate system for reserve accounts at the BoJ.

Our base scenario called for additional easing at end-April, with today's move seen as our risk scenario. The Bank called this move "Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate" and it was passed with a 5-4 majority vote.

We think the BOJ intended to cause a strong announcement effect on the forex market in particular, by implementing the measure Governor Kuroda had explicitly denied the idea of resorting to until now, when financial markets remaining volatile and macro data poor. The Bank said it is prepared to lower the interest rate further into negative territory if it decided this was necessary.

 

Latest poll has UK voters wanting to stay in the EU So says a ComRes poll carried out for the Daily Mail newspaper published today

Yes vote 54%

No 36%

Undecided 10%

The Yes vote in this survey, of 1006 adults between 22-24 Jan, is down 2% down from a similar poll conducted in December, while the No vote is up 1%.

Other recent opinion polls in Britain have suggested that out of those voters who have already made up their minds about EU membership, more people favour leaving the EU than remaining in the bloc.

Given the debacle of the UK election polls any of these are to be treated with cynicism if not downright contempt, but it all adds to the referendum backstory and uncertainty.

PM Cameron is continuing to negotiate EU reforms ahead of the next summit on 18-19 Feb with another summit scheduled for 17-18 March. Earlier this month I reported a story outlining why a referendum is unlikely to be held before September but there have reports before, and since, of a possible date being pencilled in for June.

Either way we can expect the pound to remain undermined on the uncertainty and the conjecture on what exactly Cameron will bring back to the table from Brussels.

 

EUR To End The Year Below Parity But Don't Sell It Outright - BofA Merrill Themes: ECB trying to get ahead of the curve again: Following the market disappointment from the December meeting and even lower inflation data, the ECB almost pre-committed in the January meeting for more policy easing, most likely in March. This is consistent with our view that the ECB will be forced to do more this year and, if anything, it is happening even sooner than we had expected. However, the market does not seem impressed. A 10bp deposit rate cut was already priced in for this year. Following the December disappointment, investors seem skeptical whether the ECB could really overwhelm with decisive further action. The Euro, as a funding currency, is finding support in the risk-off market environment so far this year. And the market has also priced less Fed hikes after weak manufacturing data in the US.

Positioning in the vol space may have also kept EUR/USD within a range after the ECB. We remain bearish EUR, but expect the path to remain choppy. If anything, the price action so far this year validates our strategy of selling EUR rallies, rather than being short EUR. More ECB easing and Fed rate hikes should eventually drive the Euro down, but a gradual ECB approach and a cautious Fed in response to mixed data suggest that EUR/USD may not weaken substantially yet and that the path will not be smooth.

Forecasts: EUR to end the year below parity: We continue to expect EUR/USD to end the year at 0.95. This projection is consistent with our adjusted equilibrium estimate based on the large difference between the output gaps of the Eurozone and the US. Our projection also assumes more ECB easing and three Fed hikes this year. We have only marked to market our Q1 projection, to 1.05 from parity, taking into account the price action so far this year.

Risks: mostly to the upside Despite expecting more ECB easing, the risks to our EUR projections are tilted to the upside. If the global market sell-off intensifies, or US data outside the labor market does not improve, the Fed may stay on hold for most of the year. The strong USD seems to be affecting US manufacturing data, which could force a Fed reaction. Moreover, investors are currently focusing on the risk sell-off and the collapse in commodity prices, which puts the theme of diverging monetary policies on hold for now.

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Key Levels In AUD/USD, EUR/USD, USD/CAD - Morgan Stanley In its technical FX charts of the week, Morgan Stanley provides some insights on the key levels in AUD/USD, EUR/USD, and USD/CAD.

"AUD/USD breaking above 0.72 this week has brought it back into the trend channel formed since August 2015 and opened room for further upside. The pair will find resistance in the consolidation area around 0.74, then at 0.76, which is the upper end of the channel. This is a tactical rebound, which hasn’t formed an impulsive sub-structure. The RSI doesn’t suggest any signs of being overbought.

EURUSD may also see some further upside, after the break of 1.0960. Extending the trend channel from March 2015 suggests that the lower end of the channel is around 1.1430. EURUSD could find it difficult to move above the August high of 1.1714. Our tracker suggests that the market is fairly neutrally positioned on EUR.

The USDCAD retracement is almost over, we believe. Looking at the technicals, the pair has almost reached the 61.8% retracement level at 1.3542 of the move since October. We used the dip to buy. However, USDCAD is in the middle of a longer-term channel. Should it break lower then levels to watch to the downside are a break of 1.345, the September high, and then 1.2382, the next low," MS clarifies.

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Morgan Stanleylooking for 1.1714 on EURUSD and they were shouting parity till 2 days ago?

Fantastic

 

USD: 2 Hikes This Year, EUR: Reverse Strength - Barclays USD: The January employment report sent mixed signals about the state of the US labor market, as the below-consensus change in nonfarm payrolls was overshadowed partially by the firming in wage growth. The weakness in services sector employment will be a source of concern for the FOMC, however, and we now look for only two rate hikes in 2016. We remain confident about the health of the labor market and believe the economy will withstand the hikes.

The market is pricing a very shallow path for interest rates, and repricing of the hiking path should support the USD in the months to come. In this environment, the market will be looking for clues about the pace of the tightening cycle.

Fed Chair Yellenwill appear before Congress on Wednesday and Thursday to deliver the semiannual Monetary Policy Report, and the market will be paying attention to her remarks.

In terms of data, this week, attention will focus on the American consumer. On Friday, we expect an increase in retail sales (0.1% m/m, versus consensus 0.1%), core retail sales of 0.4% m/m, and an above-consensus print of 93.0 for University of Michigan consumer confidence (versus consensus of 92.8).

 

USD Strength To Resume Even If This May Not Be Immediate - Deutsche Bank

Policy divergence (hiking Fed, other central banks easing) was to drive strong dollar this year.

Instead, the dollar has weakened, despite signals of further ECB easing in March and the BoJ’s surprise rate cut into negative - Euro near strongest level since Oct-2015, yen strongest since Nov-2014

Less scope for FX moves to be driven by ECB, BoJ policy surprises. - Dollar-specific stories now more important.

The dollar should strengthen from here, even if this may not be immediate:

− Upside risks to market pricing of Fed hikes

− Better US news and shift in focus to non-US risk concerns − Structural drivers still in place (e.g., persistent outflows from Europe; Brexit referendum, large fiscal tightening to weigh on sterling).

In China,after recent stability yuan weakness vs. the dollar should continue at a gradual pace in 2016

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Revisiting Our '10 Commandments' For 2016 FX Market - Goldman Sachs

Over the past month the market has put the USD under substantial pressure, and the DXY has fallen almost 4% since the end of January. The market has all but eliminated Fed rate hikes from the US curve for the rest of 2016, and the USD is lower versus both the EUR and the JPY as risk sentiment has suffered. This sell-off has stopped us out of our 2016 Top Trade recommendation to be long USD vs EUR and JPY.

In response to this uncertainty, last month we published a list of core ‘truths’, which we think will prevail and dictate market direction this year. We revisit and update these below following the BoJ’s January easing, and even more market turmoil in recent weeks.

1. Much more US outperformance than priced. Behind all the short-term worries lurks one important fact that is often overlooked. The Dollar has appreciated 26% versus the majors over the last two years, but US growth has stayed above trend. There is little doubt that net exports and inflation have suffered, but the resilience of the economy suggests that underlying momentum on both the growth and inflation fronts is better than priced, especially now that front-end interest rates have priced out so much tightening.

2. The ECB and BoJ can and will ease more. In the wake of recent disappointments, markets worry that the ECB and BoJ are reneging on their commitments to boost inflation, which has been weighing on risk. Both central banks have progressively cut their 2016 core CPI forecasts, fanning fears that they are ‘terming out’ their inflation targets. Indeed, our European Economics team forecasts core HICP at 1.0% this year, below the 1.3% ECB forecast, an illustration of the downside risk to an already low number. In our view, the January BoJ meeting demonstrated the BoJ’s ongoing commitment to its inflation target, even as the market has come to doubt the efficacy of its move to negative rates. For both the ECB and BoJ, we expect more stimulus – in addition to their recent easing steps – as opposed to reneging, which is the basis for our 12-month view of $/JPY at 130 and EUR/$ at 0.95.

3. G-3 central banks will get over their fear of floating. Fear of floating among the G-3 central banks has a price, which is that it destabilises risk, inadvertently tightening financial conditions. One example is the September FOMC, which exacerbated market anxiety over China with its focus on financial conditions. Another is the December ECB, where concern over excessive Euro weakening was reportedly one driver for not taking more aggressive action. Both times, equity market declines caused financial conditions to tighten, making efforts to manage G-3 exchange rates counterproductive. We expect the G-3 central banks to accept more Dollar strength as the lesser of two evils.

4. Low inflation for longer in the Euro area. Much of the discussion over low inflation in the Euro area revolves around global themes, including falling commodity prices and the slowdown in EM. But ongoing structural reforms in periphery countries mean that price and wage levels are likely to keep falling, imparting a deflationary bias to the region, which is distinct from global developments.

5. Negative interest rates are not a QE substitute. We estimate that a 10bp (surprise) deposit cut is worth two big figures in EUR/$, based on intra-day moves when surprise deposit cuts were announced (September 4, 2014 and October 22, 2015). This means that the bulk of the decline in EUR/$ stems from ECB balance sheet expansion and long-term interest differentials not front-end rates. Our forecast for EUR/$ down anticipates a shift in emphasis back to asset purchases from depo cuts. In the case of Japan, negative rates have augmented rather than substituted for existing QQE measures, and the impact has been to push JGB yields much lower. While the sell-off in risk assets has flattered JPY through interest rate differentials, we expect that ultimately this fall in the JGB curve will push JPY lower via portfolio rebalancing, as in point 6 below.

6. The BoJ is the ultimate QE warrior. Quantitative easing aims to boost growth via a portfolio shift out of safe-haven assets into risk assets. The QQE program has aggressively flattened and stabilised the JGB yield curve, encouraging that shift, such that $/JPY sees ‘autonomous’ moves up when risk appetite is good, for example in the summer of 2014 (the move from 102 to 109) and May 2015 (the move from 120 to 125). EUR/$ has not benefited from similar portfolio shifts because Bunds – the safe-haven asset in the Euro are – have been too volatile. And, as above, in Japan negative rates have not been introduced as a substitute for further QE, but as an augmentation.

7. The Dollar is a ‘risk-on’ safe-haven currency. The correlation of the Dollar with risk has flipped from negative to positive in recent years. This switch reflects rate differentials, rather than a loss of safe-haven status. Negative growth shocks, real or perceived, cause markets to price out monetary tightening in the US, such that rate differentials move against the Dollar. The positive correlation of USD with risk is therefore really a reflection of US cyclical outperformance.

8. Near-term pain, long-term gain for USD from low oil. Falling oil prices have a negative fall-out on economic activity in the short run, weighing on the Dollar by way of rate differentials. But the US remains a net oil importer, so that low for long in oil prices is fundamentally a Dollar positive, once near-term effects drop out. By way of illustration, it was the oil super cycle that derailed the Dollar-positive impulse from rising rate differentials in 2004-08.

9. China's balance of payments is under control. There is a lot of anxiety that the pickup in capital outflows represents a run on the RMB, making a large devaluation all but inevitable. However, a key reason that outflows were so large in 2015 was that August and December saw the RMB fix weaker, which caused (heavily expectation-based) outflows to pick up. With a current account surplus of perhaps as much as US$400bn this year, China’s balance of payments can absorb a sizeable level of outflows before reserve drawdowns become necessary.

10. It is not in China’s interest to destabilise the world. China is a net exporter, i.e., it depends more than other countries on sound global growth. It is therefore hardly in China’s interest to unsettle markets and derail the world economy. Recent developments most likely point to a greater desire to see flexibility in the exchange rate and a closer link to fundamentals (which includes a shift in focus to a tradeweighted exchange rate), rather than unilateral devaluation.

source

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