25 November 2018

FX weekly: Pikachuain’t no hobbit

Martin Enlund | Andreas Steno Larsen

We find increasing evidence that the tightening of financial conditions in Asiais spilling back on developed markets. Is it time for further softening fromPowell and Draghi this week? We also need to consider our good friends HIA,SOMA and REBA.

Table 1: Our current list of convictions

China’s ZEW outcome made for worrisome reading this month. While the gauge has not existed for that long,ZEW crashed to its lowest level ever – even lower than in 2015. And back in 2015, China PMI manufacturingwas around 48 rather than 50+. The past week has also seen South Korean exports disappointing, a signthat world trade growth will keep slowing. We’re generally seeing more and more evidence that thetightening of financial conditions in Asia is spilling back on developed markets. In the US, durable goodsorders recently disappointed, for instance.

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Chart 1: Tighter financial conditions in Asia is bad news for ISM orders

Tighter Asian financial conditions suggests ISM new orders may fall to ~50 over the next few months. ISMcan’t stay this lofty then! China’s PMI details suggests the same (and that at current China PMI levels whichare probably set to fall).

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Chart 2: China PMI imports corroborating financial conditions story

Still, despite bad news the ADXY index has bounced o support. And USD/CNY remains contained. This maybe related to hopes that we could get some trade relief from the G20 summit in Buenos Aires, or it may berelated to the notion of the Fed taking a pause already in H1, 2019.

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Chart 3: Stability in Asian currencies vs the USD – likely due to Fed relief

The Fed’s rhetoric next week will be key. If Powell corroborates the story told by the Fed Funds curve (only~two more hikes priced-in). ISM remains lofty and the labour market remains tight, sure, but most forward-looking indicators suggest a distinct slowdown is coming. Headline inflation could read 1% next year acrossthe G10. Break-even inflation rates are collapsing. The 5y5y inflation swap could head to 2.15% by year-end given current oil prices, and they seem to be trending lower. The oil price drop will eat into capex. Thehousing market is clearly weakening. Credit markets are looking wobbly, as does risky assets – now thatthe FAANG has gone BANG. What would you do if you were a central banker? Some of the above youwelcome, but all of it?

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Chart 4: US excess liquidity showed the way yet again – credit markets feeling the QT pain

On the one hand, if the market snis out that Fed is taking a long pause after the December hike, US10y yields could drop to 2.8% - a veritable receiva-palooza. This would likely trigger a relief rally in riskyassets, or at least prevent further downside in equities as more signs of a US and global growth slowdownbecome evident. On the other hand, it’s not as if data is yet clearly pointing that things will go that badly, atleast not on the models typically used by central bankers…

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Chart 5: Number of Fed hikes over 2018 and 2019 vs the 10y yield

Historically, CHFAUD or CHFNOK are good performing crosses when the Fed has taken a pause. And if FedPowell does soften, we would consider accumulating JPY.

The week ahead also brings plenty of ECB talk, as Draghi, Coeure and Praet will appear in front of thecameras. Draghi speaks in front of the European Commission in Brussels – the exact location of his “vigorousinflation is coming” speech. Draghi could sound less dovish than anticipated by many again this week, as heusually does so in front of the commission. You don’t go tell your employer (as the EC eventually is), that youare not able to full-fill your policy targets. Expect Draghi to sound optimistic on inflation again.

Couere and Praet will be more interesting to follow in terms of hint of future monetary policychanges. Just two weeks ago Praet said that financial conditions needed to tighten substantially, for theECB to envisage going to non-conventional policy measures again (did he mean TLTRO’s?). Last week’s PMIin the Euro zone has to be at least a slight worry for the ECB chief-economist, who has spent most of 2018explaining the loss of momentum in the Euro area with anything from a wave of influenza to distortions in theGerman car industry. Q4 now looks weak as well. Peter Praet didn’t anticipate that.

But besides Powell, Praet and Coeure we have to consider our friends HIA, SOMA and REBA this week.

Our friends HIA, SOMA and REBA

If a company wishes to convert foreign currency into USD before the end of November, it needs to do sono later than November 28 (T-2). For some reason, possibly because of capital repatriation, the USD has

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performed robustly well on such days this year (last year we saw no pattern). For instance, on a close-to-closebasis you’ve had a 90% hit rate for an average move of -0.6% in SEKUSD this year.

Table 2: HIA days are usually good news for the USD – in 2018

An intraday look at the G10 pairs on HIA days support such a conclusion. It’s generally a good idea to sellEURUSD (on average dips 0.3% between 08:00 and 17:15), or buy USDNOK or USDSEK (~+0.5%) on suchdays.

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Chart 6: G10 pairs on all HIA days of 2018

Then we have the SOMA day which again coincides with a REBA day on Friday. On this day the Fed’sholdings of notes and bonds will drop by 12.6bn. The last SOMA day on November 15, i.e. when the Fed’sTreasury holdings shrunk by 17.4bn, this day saw plenty of pollution from the Brexit events on that same day.This serves as a reminder that the SOMA idea of fewer excess dollars triggering a stronger USD is sadly notthe cure-all to FX analysis, sometimes other variables wreak havoc with the conclusion.

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Chart 7: Plenty of Brexit havoc on the SOMA day of November 15

Still, the hit rate of being long USDNOK or USDSEK on a close-to-close basis remains a lofty 92% and 83%(on the SOMA days since February). Interestingly, the now much-loved NZD also shows a hit rate of 83%.

This month, the monthly rebalancing signal though also supports a strong USD in to month-end, at leastversus JPY, GBP and EUR. Overall, we tend to think it is a good idea for short-term players to accumulatesome USDs during the week, as HIA, SOMA and REBA in unison point in that direction.

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Chart 8: Month end rebalancing suggests a strong USD versus JPY, GBP and EUR (lower z-score = bigger buy signal)

SEK is doing fine – but should it?

In the words of Riksbank’s Governor Ingves in 2013 “a high level of indebtedness can cause what one mightcall debt dominance in the economy”, and Sweden has seen its debt rate soar since then (see our thematicpiece). It may thus be interesting to note that i) Norges Bank hiked rates softly in September (partly becauseof elevated debt levels), and ii) forward-looking housing market indicators have weakened quite a bit already!

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Chart 9: Norwegian housing market to weaken – after a mere 25bp hike(!?)

What if the Riksbank takes inspiration from Norges Bank and hikes dovishly in December or in February?When Norges Bank lifted its key rate in in September, here’s what EURNOK did. We see this is a risk for theSEK bulls.

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Chart 10: EURNOK intraday when Norges Bank hiked while flattening its rate path

Other downside risks for the SEK going forward include: i) next week we could see Q3 GDP growth innegative territory (Swedish GDP Q3 preview: Weak or very weak), ii) October was unusually warm – maybethis augurs a retail sales disappointment. In the bigger picture, the SEK usually weakens after an inflationdisappointment like the one we got in October, and another disappointment seem likely on December 12.Moreover, EURSEK tends to glide higher ahead of the start of the PPM flows (we’ve been informed thesePPM flows will commence December 12-13, and the amounts will be presented December 6-7). We do thinkit’s interesting that the fixed income collective is almost dead set that the Riksbank will lift rates in December,despite plenty of headwinds, and despite the Riksbank saying it has not changed reaction function. We thinkrisk/reward over the next week(s) favours betting against a hawkish hike in December… HIA, SOMA andREBA concurs.

We stay long EUR/SEK.

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Chart 11: PPM flows a potential SEK-negative in late November / early December

NOK: To suer from a US debt ceiling stand-o?

We have argued in recent FX weeklies that a debt-ceiling stand-o in the US is very likely in Q1-2019 (FXWeekly: The debt ceiling is a USD-ceiling). As the US treasury will have to draw down its cash account withthe Fed by more than USD200 bn in the run-up to March 1. This will create a temporary level shift in theexcess liquidity in the private banking system in the US. More liquidity should lead to a tighter LIBOR/OISspread (approximately 10 bps pr. USD100 bn) and this will carry with it important implications in theScandi-region as well.

Given the relationship between Nibor and Libor/OIS (The truth about NIBOR) you should expect a tighterLIBOR/OIS spread to roughly filter in 1 to 1 into a tighter Nibor risk premium (receive the front-endof the NOK curve?) The relationship is by the way the exact opposite in terms of the eects on Stibor(Market Pulse SEK: A butterfly in US congress, a spike in Stibor).

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Chart 12: Tighter LIBOR-OIS, tighter Nibor risk premium

A tighter Nibor risk premium is another potential NOK negative short-term (on top of housing risks andweak seasonality). While Nibor is probably not THE main driver of EUR/NOK, the correlation between theNibor risk premium and EUR/NOK developments is negative. A tighter Nibor premium should hence leadEUR/NOK higher.

We stay long EUR/NOK targeting at least 9.80.

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Chart 13: Tighter NIBOR risk premium, higher EUR/NOK (note the reversed left-hand axis)

JPY: BoJ has big obstacles lying ahead

As written above, we consider it a good idea to accumulate some JPY if the Fed softens further up. The bigobstacle for the long JPY bet is though potentially still Bank of Japan. Due to the yield-curve-control regime,it may prove dicult for Bank of Japan to exit the current strategy without having to print a truckloadof new electronic JPY liquidity.

A rational investor would prefer to sell the bond holdings to Bank of Japan ahead of gradual increases in theYCC level (e.g. from 0.1% to 0.2%). When Bank of Japan allowed further flexibility in the 10yr point on thecurve in late July, they ultimately had to step up the purchases markedly in order to defend the yield-curve(see chart 14).

If the market snis out steps towards further normalisation of the YCC-policy, it could hence lead to anacceleration of the purchase tempo. Probably the opposite of what Bank of Japan in such case wouldstrive for. The increased purchasing tempo after the July move towards a more volatile 10yr point on theyield curve, could be one of the reasons for the weakness seen in JPY since.

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Chart 14: When BoJ increased the flexibility in the 10yr point, they had to step up thepurchases

The best way to come about this problem is via a sudden and early abandonment of the yield-curve-control, akin to when SNB abandoned the EUR/CHF floor. This is though probably not a question for theshort-run but only a latent JPY positive tail scenario.

The negative pressure on the JPY from the hot printing press in BoJ is though abating again. As long asBoJ stays credible and warns of unlimited purchases, we tend to think that the purchase tempo can continueto decelerate. A JPY positive scenario.

The global central bank liquidity drought (slowing purchases or outright balance sheet wind downselsewhere) is in general favouring a JPY positive outlook, as i) less global liquidity is negative for risky assets,ii) BoJ has been THE fiercest importer of inflation via asset purchases.

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Chart 15: A decelerating BoJ purchase tempo is a reason to expect risks to the downsidefor USD/JPY

Month-end rebalancing though suggests a weak JPY in the coming week, but JPY is certainly one of thecurrencies that we consider as a bet of the year 2019 (stay tuned).

And we know you have been wondering. Where does the Nordea Strategy Team stand on the question onhairy pokémons? We believe that Pikachu ain’t no hobbit!. So there you have it.

Previous FX weeklies:

·FX weekly: Powell pondering pausing (18 Nov)

·FX weekly: Another SOMA-test of 1.13 (11 Nov)

·FX weekly: 1.13 will hold unless the Republicans keep both chambers (04 Nov)

·FX weekly: HIA, SOMA and REBA-days (28 Oct)

·FX weekly: The debt ceiling is a USD ceiling (21 Oct)

·FX weekly: Volatility makes odd bedfellows (14 Oct)

·FX weekly: No Di-Maio'nnaise for your EURs (yet) (7 Oct)

·FX weekly: Along came year-end (30 Sep)

·FX weekly: Twin deficit scare #2 (23 Sep)e-markets.nordea.com/article/46806/fx-weekly-pikachu-aint-no-hobbit

·FX weekly: The Pope of Nope has spoken! (16 Sep)

·FX weekly: Who wants to impeach a +60 ISM president? (09 Sep)

·FX weekly: It is time to go long Scandis again (02 Sep)

·FX weekly: The Conte-Trump alliance (26 Aug)

·FX weekly: Fat-burning shorts (19 Aug)

·FX weekly: Time to call in Steven Seagal(12 Aug)

·FX weekly: Is the cyclical momentum over-priced? (05 Aug)

·FX weekly: How to trade a cease-fire? (29 Jul)

·FX weekly: What's that curve? (22 Jul)

·FX weekly: The China Factor (15 Jul)

·FX weekly: Take a short trade war breather (08 Jul)

·FX weekly: Trump will never #238 (01 Jul)

·FX weekly: The USD is the best carry currency in the world (24 Jun)

·FX weekly: Dollar to provide headwinds for earning estimates (17 Jun)

·FX weekly: Fire and fury risks for the USD (10 Jun)

·FX weekly: It's not only Italy.. (03 Jun)

·FX weekly: The Sumo SOMA days (27 May)

·FX weekly: EM won't be sprinting, if the Fed is unprinting (20 May)

·FX weekly: The two final nails in the dovish FOMC-con (13 May)

·FX weekly: Is there anything left in the USD bull-run? (06 May)

·FX weekly: Dragon Energy (29 Apr)

·FX weekly: Relative curvature is the new king of FX (22 Apr)

·FX weekly: Why is EUR/USD not trading lower? (15 Apr)

·FX weekly: Like watching paint dry, they said (08 Apr)

·FX weekly: The list of potential USD-positives is getting longer (01 Apr)

·FX weekly: 2 reasons why EUR/USD has decoupled from rates spreads (25 Mar)

·FX weekly: Time to buy a USD lottery ticket? (18 Mar)

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·FX weekly: Taxation mirror on the wall, who is the fairest of them all? (11 Mar)

·FX weekly: Trump's game of chicken (04 Mar)

·FX weekly: Will the market neglect the clutch of canaries? (25 Feb)

·FX weekly: Is the correlation break-down driven by FX hedges? (18 Feb)

·FX weekly: The liquidity tide is ebbing (11 Feb)

·FX weekly: Hawkish spectacles (04 Feb)

·FX weekly: Who will stop EUR/USD from moving higher? (28 Jan)

·FX weekly: Did the Democrats dent the Dollar? (21 Jan)

·FX weekly: Is 1.25 the new 1.20? (14 Jan)

·FX weekly: The euphoria rises (07 Jan)

·FX weekly: Paging Dr. Pangloss (01 Jan)

·FX weekly: The R-star of Bethlehem (24 Dec)

·FX weekly: A numbers game (17 Dec)

·FX weekly: The year-end liquidty shrink (10 Dec)

·FX weekly: Three reasons why EUR/USD isn't trading lower (03 Dec)

·FX weekly: Which currencies to sell if the housing downturn continues? (26 Nov)

·FX weekly: The global industrial cycle is set to weaken (19 Nov)

·FX weekly: Is high-yield a canary in the global coal mine? (12 Nov)

·FX weekly: Is this the end of the inflation convergence trade in EUR/USD? (5 Nov)

·FX weekly: Was that it for the EUR bulls? (29 Oct)

·FX weekly: Hawks in opposition, doves in charge (22 Oct)

· FX weekly:Continued convergence or re-divergence?(15 Oct)

·FX weekly: Thingsdon't matter until they do(08 Oct)

·FX weekly:"October seasonality is strong" (01 Oct)

·FX weekly:“Is 1.20 the new 1.15?”(24 Sep)

· FX weekly:Honey, I shrunk the balance sheet(17 Sep)

· FX weekly: “USD liquidity will turn scarcer, but when?” (10 Sep)

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· FX weekly:“Strong currencies and inflation”(3 Sep)

· FX weekly:“USD in the (Jackson) hole” (27 Aug)

· FX weekly:“Q4 is the USD quarter”(20 Aug)

· FX weekly:“In the year 2525”(13 Aug)

· FX weekly:“EUR/USD ceiling or debt ceiling?”(6 Aug)

· FX weekly:“Elevator up, stairs down “(30 Jul)

· FX weekly:Trump “spices” up EUR/USD(23 Jul)

· FX weekly:Flip-flop?(16 Jul)

· FX weekly:Consolidation time?(9 Jul)

· FX weekly:Hawks R Us(2 Jul)

· FX weekly:Another lowflation week?(25 Jun)

· FX weekly:No Fed put?(18 Jun)

· FX weekly:A bouncy dollar?(11 Jun)

· FX weekly:Heating up(4 Jun)

· FX weekly:Summertime sadness(28 May)

· FX weekly:Special counsel lessens Trumpbulence, while OPEC looms(21 May)

· FX weekly:Are China worries old hat?(14 May)

· FX weekly:Inflation week…(7 May)

Martin EnlundChief AnalystMartin.Enlund@nordea.com

Andreas Steno LarsenGlobal FX/FI Strategistandreas.steno.larsen@nordea.com+45 55 46 72 29

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Nordea Bank Abp, Satamaradankatu 5, FI-00020 NORDEA, Finland http://www.nordea.com

 

   

 

 

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