It is the 25th of February 2020

FX Weekly Preview: Tax Cuts, Rising Debt, Fed Hikes And More "Fake" News; USD Vol Rising

Submitted by Shant Movsesian and Rajan Dhall MSTA

After a week when little other than politics has been 'running' the currency and rates markets, we expect more of the same but with the (now) backdrop of tier one data in the US to look to towards the latter end of this week.  US payrolls is something which will be put on the back-burner as traders and investors alike size up the reaction to the Senate vote on the tax (cut) bill, which will be exacerbated by the retraction of the ABC story on Michael Flynn.  The initial release on Friday reported the former national security adviser was ready to testify that Donald Trump had directed him to contact the Russians whilst a running candidate, but this was corrected to president elect which is standard procedure in foreign policy.  The reporter, Brian Ross has since been dismissed by ABC, much to the satisfaction of the president, who continues to fight the good fight against fake news.  

There will in all likelihood, be many more twists and turns, and no doubt more news - fake or otherwise - but next week will likely see US equities testing higher again, followed by the carry trade, but to a lesser degree.  USD/JPY took a sharp downturn from near 113.00 levels, before dip buyers contained the sell off to the mid 111.00's, and ending the week above 112.00 is likely to see a return to the highs before the market then starts to evaluate the effective gains of the tax cut bill, which has yet to meet agreement between House and Senate.  The president expects to sign off this legislation by year end.  

Back to the economy, where we will need to see continued improvement in order to underpin the 3 Fed hikes anticipated next year, and US factory orders on Monday kick off the week, followed by the ISM non manufacturing indices on Tuesday. Then it's all eyes on the Nov payrolls report on Friday, where the consensus is for a 200k rise in the headline number, but hourly earnings seen tailing off from the 0.5% seen in Oct.  We continue to see 2.50% capping 10yr yields, and as a such, the upper end of the USD/JPY range looks even less likely to exceed 115.00.  Japanese GDP for Q3 due out on Thursday, but at 1.5% expected, is hardly going to light the fire under the JPY.   Growth is picking up pace however, and provides food for thought further down the line when considering longer term (JPY) undervaluation. 

This will and has underpinned EUR/USD on any major setbacks; the recent downturn bottoming out towards the lower end of the 1.1550-1.1600 support zone. The latest attempts to regain fresh momentum for 1.2000+ again have been met with stern selling interest and this will likely develop into sideways trading into year end, as continued caution by the ECB should restrain any aggressive fresh appetite in achieving levels closer to longer term fair value.  

That Germany is calling for an end to QE beyond Sep 2018 is cause for concern, not least of all due the political limbo domestic parliament finds itself in, but also on the united front on appropriate policy.  At a time when populist movements are gaining traction - everywhere - the governing council is looking to sing from the same hymn sheet, but the Bundesbank et al are wary of rising inflation in Germany so once again we are back to the argument on 'one policy does not fit all'.  

In the meantime, EUR/JPY could see some fresh upside interest, and the daily charts suggests we are consolidating inside 131.50-134.50 for the next phase higher.  

A mix of data to contend with, including German factory orders, industrial production and trade as well as EU wide services PMIs and Q3 GDP on Thursday, but all this will be overshadowed by the Eurogroup meetings to discuss their collective stance on Brexit.  

Theresa May flies to Brussels this week with a view to put the final offer to the EU in order to persuade the '27' to agree passage onto trade talks, and tomorrow was said to be the deadline according to Donald Tusk.  Let's see.  Jitters could see the Pound opening the Asian session a little lower, and given some of the opposition (back home) to the numbers being touted - around £50lbn, there is good reason to be sceptical on the latest optimism which has lifted Cable above 1.3500.  The 'Leave means Leave' group, which includes ex cabinet member Owen Patterson and ex Brexit minister David Jones, are calling for the settlement bill to come with an agreement in principle on free trade as well as cessation of ECJ jurisdiction in the UK amongst other caveats, and have drafted a letter to the PM outlining these 'demands'. 

Nevertheless, optimism has also led to a sell off in Gilts, and this saw the 10yr up close to 10bps in the aftermath of the reports from the Telegraph and Times suggesting progress on the divorce bill and Irish border respectively, aligning with fresh calls for the next BoE rate hike to come in Aug-Sep of next year.  Domestically, the data has been holding up, but once again, we feel it is way too early to suggest the worst is behind the UK.  UK manufacturing PMIs were exceptionally strong - released Friday - but all eyes will be on the services component on Tuesday, from which the Treasury derives the bulk of its revenue.  Manufacturing data at the end of the week should be healthy based on the PMIs, but will likely be academic at that point.

We continue to watch how EUR/GBP plays out the first half of the week, and could define some potential limits across the board (strong turnaround in GBP/CAD), with strong demand already seen here just under 0.8800.  

Central bank time in Australia and Canada, and the AUD should play catch up to the CAD in the volatility stakes with a host of data releases to accompany the RBA's latest take on the economy.  On Friday though, we saw USD/CAD nose dive from circa 1.2900 levels after both the GDP and payrolls numbers beat on expectations, and this was largely down to the impulsive buying looking to break the resistance north of the figure.  True the BoC have reined in their hawkish tone, but this doesn't mean we ignore rising employment and higher Oil prices, which will maintain upward pressure towards full output which is still in the BoC's expectations.  Having spent the best part of the week pushing up towards the highs without regard for external factors (including broader USD weakness), it was no surprise to see USD/CAD reversing so sharply.  Trade data on Tuesday is the only notable release before we hear from gov Poloz and dep gov Wilkins after they keep rates unchanged, as is widely anticipated. 

For the AUD perspective, most of the data releases come after the RBA make their rate call (also unchanged) and statement, where we expect more of the same - steady recovery but sluggish wages and inflation.  We see Q3 current account and Oct retail sales a few hours before gov Lowe makes his announcements, but we get the GDP number the day after followed by the Oct trade stats on Thursday.  Much like Canada, we expect higher prices in the underlying commodities - industrial metals - to eventually feed through and revive the pace of economic growth and activity, and whether this takes a while to feed through to real wages, it is perhaps reason enough to end the persistent pressure on AUD/USD which is clearly supported ahead of 0.7500.  Household debt continues to cause concern among investors however, just as it has in Canada, but sustainability is deemed comfortable for now, despite the comparatively higher percentages to GDP to some of their economic peers.  

Nothing of note apart from the Fonterra dairy auctions in NZ, but last week's marked drop in business confidence suggests industry is not at ease with the new government, with little fresh news on policy intent apart from the reform to the RBNZ mandate in which full employment is now being proposed.  NZD/USD could be a soft target for USD bulls accordingly, but AUD/NZD will likely be a more viable route based on the price action in spot rates.  

The SEK is back on the front foot against its NOK counterpart as the cross rate eyes parity again.  Swedish industrial production has had the potential to move the SEK in the past, and may provide the prompt it needs to see this tested - or not.  Looking at the respective spot rates, there are conflicting signals on the daily charts, which also point to a stronger breakout in the cross rate - manufacturing production in Norway also of note on Thursday.  

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