Research Division   

The Week Ahead
Monday, October 16, 2017 -Friday, October 20, 2017


What to look for in the week ahead

The Week Ahead--Week of June 2nd, 2013
FX return analysis
The markets have been very choppy this week. Stock markets sold off after reaching record highs in the US, The Nikkei is down more than 10% in recent days and Treasury yields rose to their highest levels since early 2012. The markets are extremely jittery as they try to second guess the timing of the end of QE3 from the Fed.
In the FX market the dollar was the big loser in the G10 space last week, falling against most other currencies, and only barely able to hold onto gains versus the NZD and JPY. However, as you can see gains were fairly minimal and ranges persist. So, although the markets are jittery and volatility has picked up, it hasn’t been enough to cause any significant breakouts in any of the major crosses. The SEK was the top performer, gaining more than 1% on the week after stronger than expected GDP data in Sweden for the first quarter. In a week of second tier economic data, the EUR and the GBP were virtually unchanged versus the USD. The AUD managed to claw back some of its recent losses, although gains were capped at 0.9700. We mentioned last week that the Aussie was starting to look oversold and could have been due a pullback as we approached the key 0.9580 support level. Next week has some major fundamental events including an ECB meeting, a US labour market report and lots of Fed speakers, which should get the markets moving.
After a mostly range bound week in the FX space, the monthly returns are largely unchanged. The commodity currencies remain weak against the dollar along with the yen. But if dollar gains continue to slow, then we could see more medium-term shifts in trends, but for now the strong dollar is still profitable. The risk is the EUR; if we get a less dovish ECB on Thursday then we could see a sustained move higher in EUR.
Fundamental Preview: waiting for payrolls
After a fairly quiet week for economic data things get more interesting this week with the release of some major economic reports in the US and an ECB meeting. Friday’s US labour market report will be one of the most eagerly awaited for months as it could influence the timing of the end of QE3 from the Federal Reserve. Right now the market seems to think that the Fed could start tapering purchases in September, but this will hinge on labour market data between now and then. The market currently expects Non-Farm Payrolls to expand by approximately 160k in May, at a similar pace to April’s gains. It is not only the NFP number that traders need to watch, also keep an eye on any revisions to prior months. There have been some large revisions of late, which have significantly improved the outlook for the US economy.
Essentially a strong payrolls number, say 200k plus, would make QE3 tapering in September more likely, while a weak number, say 150k or less, might see the prospect of QE3 being put on ice. But how might the markets react? Expect a lot of volatility. The FX market has not been able to decide, as yet, if the end of QE3 is positive or negative for the dollar, and likewise for stocks. Added to that, although Treasury yields have been rising in the last week, in the past yields have actually dropped in the lead up to the end of QE 1 and 2, and the dollar has fallen. If the payroll data supports the end of QE3 then we may see some volatility in the dollar, however, we ultimately think that strengthening Treasury yields are dollar positive and the strong dollar theme can continue in the medium term. This may be bolstered by good news from the ISM reports for manufacturing and services that are also released this week.
As you can see in figure 3, the dollar tends to peak with a lag to Treasury yields. The end of QE1 and 2 did not cause yields to spike, in fact they tended to drop as the market priced in the prospect of weaker growth in the future.
There is a packed economic calendar in Europe this week. The UK and the Eurozone have central bank meetings, Europe releases the final readings of May PMI surveys, while the UK will also release May PMI readings. The Bank of England meeting is expected to be a non-event and no change in rates or asset purchases are expected. This is Mervyn King’s last meeting as Governor, from next month Mark Carney takes over as head of the BOE. We believe that after this MPC meeting things will start to get interesting. Until then GBP is likely to be driven by external factors rather than domestic ones.
The ECB meeting and President Draghi’s accompanying press conference on Thursday will be extremely important and it could be a key medium-term driver for the EUR. The ECB is expected to keep interest rates and deposit rates (the rate charged to banks for keeping money at the ECB) at 0.5% and 0%, respectively. There is some speculation that the Bank may cut deposit rates to zero. We think that the chance of any policy action at this meeting is slim, for a few reasons: 1, the ECB cut the base rate to 0.5% last month; the ECB is traditionally a very conservative central bank and does not alter policy lightly. 2, Inflation has picked up in April after falling sharply in March. Inflation in Germany rose to 1.7%, from 1.1% in March, thus the ECB, and the Bundesbank in particular, may not want to risk stoking inflation in the currency bloc’s largest economy. While the PMI surveys may show that the Eurozone is stabilising, the economy is still weak, and we think that Draghi will remain cautious. He may also point to potential future policy support after April loan data showed a further contraction in lending to the private sector. Overall, if the ECB remains on hold this week we think that it could be mildly EUR bullish, although gains in EURUSD could be capped around 1.3200. We could see a larger move higher in EURGBP in the short term, especially if the BOE remains on hold as expected. Key resistance levels in EURGBP include: 0.8600 then 0.8690 and 0.8750 – the high from March.
The RBA may elect to sit on the sideline for now
The RBA elected to cut the official cash by 25 bps in May, thereby dramatically decreasing the likelihood of a rate cut in June. Economic data since the RBA chose to ease monetary conditions hasn’t been significantly bad enough to suggest that the bank needs to follow-up with another cut on Tuesday, nor has it been good enough to suggest that May’s cut was a one-off for that matter. Furthermore, a significant devaluation of the Australian dollar last month removed some of the onus on the reserve bank to cut rates, although the dollar is still fairly high. We therefore suspect the RBA will remain on hold for now as it waits to fully assess the impact that prior easing will have on the real economy.
From a data perspective, strong employment figure for April and a somewhat encouraging Q1 capital expenditure report helps to tip the scales in favour of no action by the RBA on Tuesday. Australia’s unemployment rate dropped to 5.5% (prior 5.6%), although it’s still broadly trending upwards, underpinned by a surge in both full-time and part-time employment. In total over 50,000 jobs were added in April, which is a very strong number. While business investment was less than expected in Q1, the prospects for capital expenditure later this year and early next are encouraging, although the real test will be whether the forecasts live-up to actual expenditure. The housing market also continues to power ahead, with home loans rising 5.2% m/m in March and building approvals increasing 9.1% m/m in April.
Furthermore, in recent times one of the biggest hindrances to domestic growth has been the persistently high Australian dollar. Some of the pressure on trade exposed sectors has been removed by the recent deprecation of the dollar. However, the AUD may be one of the biggest threats to growth going forward if it significantly increases in value again. In fact, even around current levels it’s still somewhat detrimental to the country, especially with non-mining parts of the economy are looking like they are going to struggle to fill the gap that an anticipated peak in mining investment will leave in GDP. Thus, we still think the bank will maintain its dovish tone and may cut interest rates later in the year. This time around, however, the focus will be on the tone of the bank. A more dovish than expected statement from Governor Stevens could see the Aussie lose ground, while a more neutral stance could push the commodity currency higher.
Has the Nikkei reached a tipping point?
In around two weeks the Nikkei 225 fell around 13%. While the initial trigger of the sell-off may have been from offshore, concern about the feasibility of Abe’s economic recovery plan added weight. Overall, nervous sentiment led to profit taking which was exasperated by the hype surrounding Japanese equities this year. Hence, it’s possible to classify the recent sell-off as a natural correction after a period of prolonged gains, especially when we consider that the last few days of the sell-off looked to be led by shorter-term investors.
In the long-term we favour further gains for the Nikkei 255 on the back of Abe’s third arrow and other measures aimed at ending deflation and boosting growth. The charge into Japanese equities this year was driven in-part by offshore investors, and they are still broadly holding strong. Also, the idea that Japan’s public pension fund, which has around $1.1 trillion under management, alters its investment mix away from fixed income and into equities spurred a comeback in the Nikkei last week, albeit a small one.
From a domestic standpoint, Abeonomics appears to be gradually bolstering growth and easing deflation. Late last week a rate of CPI data showed that while consumer prices aren’t yet rising across the board, they are falling less. At the same, there have been other positive signs from within Japan, including a surge in industrial production in April. A recent spike in bond yields and the yen is concerning, but yields aren’t yet at a point where they’re overly detrimental to the economy and the yen remains above 100.
On balance, we think the bias is higher for the Nikkei 225 in the long-term, although short-term corrections to the downside cannot be ruled out, as recent price action has indicated. Form a technical standpoint, the index is between two key levels – its 50day SMA on the downside and its 21day SMA on the upside. A push above its 50day SMA may suggest that the correction is over for the time being.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.