Tue, May 18, 2021 @ 11:01 GMT
Home Action Insight Special Topics

Special Topics

Near-Term Economic And Political Divergence Fueld EURUSD Rally

USD's slump accelerated as increasing political uncertainty, accompanying disappointing inflation data, has intensified concerns over the country's growth outlook. Four consecutive days of selloff, accumulating loss of over -2%, has sent the DXY index to a 6-month low of 97.33 before recovery. Leading the rally against US dollar was the euro. With removal of one political risk after the French election, the market has turned its attention to the region's economy of which the development have been encouraging. Rebound in inflation and positive sentiment indices have raised speculations that the ECB would add some hawkish twists in its forward guidance. EURUSD has rallied as much as +2.7% over the past 4 trading days. The sustainability of the single currency's strength depends on the tone of ECB and FOMC meeting statements in June.

Macron Becomes French President In Landslide Victory

Centrist independent Emmanuel Macron has won the French presidential election in a decisive victory. With virtually all votes counted, Macron has taken 66% of votes in the second round runoff, compared with far-right populist Marine Le Pen's 34%. While the election outcome had been suggested in the pre-election opinion polls, financial markets still reacted positively as defeat of Le Pen signaled a diminished risk of Frexit, a real concern haunting politicians and investors across the globe after the surprising Brexit referendum and Donald Trump's victory in US presidency. Despite her loss, it is the highest number of votes that far-right parties have ever received in modern French history. As she noted in the concession speech, she was 'designated the leading opposition force in this second round', Turnout of this election was 65.4%, 6.6 percentage points lower than that in the 2012 runoff and the lowest since the second round of the 1981 election. The total number of abstentions and spoiled votes, at 12 million, was greater than 10.7 million received by Le Pen, underpinning the general public's discontent over the current political and economic environment in France.

Australian Dollar Dived On Concerns Over China’s Iron Ore Demand Outlook

We view the recent decline in Australian dollar as a catch-up of the selloff of the iron ore price from its February peak. Spot price for 62% benchmark iron ore slumped more than 30% in 2 months after reading a peak of US$90/tones on February 21. During the period, AUDUSD had been trading within a broad range and dropped around -2%. The relatively resilience in Aussie was likely driven by the broad-based weakness in the greenback as soft dataflow had diminished expectations of a rate June rate hike. Recall the selloff of iron ore prices accelerated in March, after China's pledge reduce steel capacity. The tighter liquidity conditions in China's money markets have reinforced concerns over the government's efforts to crack down the steel industry.

Trump’s Latest Lumber Tariff Helps Little on US Deficit. Political Implication can be Huge

USDCAD consolidated after a brief break about 1.36, following US' announcement to impose anti-subsidy tariff on softwood lumber imports from Canada. US Commerce Secretary Wilbur Ross indicated that the "countervailing duties" would range from 3-24% and would be imposed on 5 Canadian lumber exporters including West Fraser Timber Co., after concluding that Canada subsidizes its industry in a way that hurts the US. Ross added that the move is a sign to other trading partners that the US is planning stricter enforcement of trade laws. Canada responded by saying that the tariff is "unfair and punitive".

French Election: Macron And Le Pen Enter Final, Euro Soars Across The Board

With 97% of the vote counted, Emmanuel Macron and Marine Le Pen would enter the second and final round of the French election, scheduled on May 7. The election result of the first round came in largely as projected in opinion polls. Yet, the market was thrilled with the euro soaring to the highest level in 5 months, rallying as much as +2% at one point. Indeed, the strength in the single currency was broadly based. EURJPY jumped more than +3% before retreat while both EURGBP and EURCHF have risen over +1%.DJIA futures also soared, reflecting improving sentiment. The market was relieved as Macron is believed to have higher chance to win eventually and thus a Frexit referendum could be avoided. Besides, the market reaction also reflected how tight the race was. The market refrained from relying on opinion polls as the supports for major candidates were close and the percentage of undecided voters was high. Meanwhile, the predictive power of opinion polls has be doubtful after the surprising results of Brexit referendum and US presidential election

UK Prime Minister Theresa May Changes Stance and Calls for Snap Election

Are world leaders nowadays keen on breaking their own promises? Just days after Donald Trump's reversal of campaign pledge to label China as "currency manipulator", UK PM Theresa May announced that she would seek MPs' support for an early general election to be held on June 8. The news came in less than a month after her affirmation that "the next election will be in 2020". GBPUSD erased earlier losses and jumped to a 4.5-month high of 1.2755 after the announcement, on expectations that a landslide victory of the Conservative Party would strengthen May's mandate in the 2-year Brexit negotiations.

French Presidential Election: Macron and Le Pen Still Favorite as Melenchon Closing to Limit

With less than a week to go, concerns over two euro-sceptic candidates, far-right Marine Le Pen and far-left Jean-Luc Melenchon entering the run-off have clearly escalated. Support for Melenchon has surged since the second debate held earlier this month. We believe such scenario is still having a low chance based on analysis on trends in polls. And, our base case remains unchanged that centrist Emmanuel Macron and Le Pen will enter the second round. However, following Brexit referendum and US president Donald Trump's victory, there has been increasing doubts over the predictivity of opinion polls.

Euro Trend Driven by French Election and ECB’s Monetary Policy Stance

The most imminent political event in the Eurozone is the French presidential election, with the first round taking place on April 23 and the second and final round on May 7. Polls have suggested that centre-left candidate Emmanuel Macron and populist far-right candidate Marine Le Pen would get the most votes in the first round, but then Macron would win the second and final round, and become the next French president.

Staying Positive In USDJPY Despite Near-Term Weakness

Trump administration's failure to repeal and replace Obamacare has hurt market sentiment, triggering concerns over the feasibility of the president's pro-growth policy agenda. In the FX market, US dollar fell across the board amidst concerns that reflation trades since Trump's victory is over. The DXY index dived to a 4-month low of 98.86 on Monday before recovery. USDJPY also plunged to 110.09, lowest since November 18, 2016, before stabilizing. As we mentioned in the January report, it would not be surprising to see USDJPY correct to 110-112 in 1Q17. Therefore, the current price movement has not yet derailed our forecast although Trump's implementation ability has surprised to the downside. While it cannot be ruled out that the currency pair might break below 110 briefly, we retain the forecast that USDJPY should recover to 115 and then to 117 later this year.

European Yields Remained Dominated by Political Uncertainty and ECB QE Move

Political uncertainty, in particular the French Presidential election, in the Eurozone has unnerved European bond markets. Although far right candidate Marine Le Pen is expected to lose in the second round of the election, the market still finds this tail risk non-negligible. Indeed, recent movements of French bond yields, as well as French-German yield spreads, have been dominated by opinion polls. French yields, as well as French-German yield spreads, climb higher as Le Pen's supports gain, vice versa. For instance, we notice that France's 10-year bond yield has started falling since February 22, after veteran centrist Francois Bayrou surprisingly joined Emmanuel Macron in his campaign. Yields continued to drop, falling to a one-month low of 0.92% today, as the latest polls signaled that Macron would beat Le Pen in the second round of presidential elections in May. Simultaneously, French-German yield spreads fell to around 0.72%, the lowest level in a week.

Swiss Franc To Strengthen Further Despite Negative Rates And Intervention

SNB's sight deposits added +3.81B franc, or +0.71%, to 539B franc, in the week ended February 8. This marks the biggest increase since November when the central bank intervened in the aftermath of Donald Trump's victory. The move this time was, again, to curb the strength of the franc with EURUSD breaking below the support level of 1.0676/84 in late January. There are several reasons that have triggered the recent EURCHF selloff: intensifying political risks associated with upcoming elections in the Eurozone, rising of Swiss bonds yields alongside German ones, and concerns over US' accusation of currency manipulation. We retain our forecast that EURCHF would weaken further. While SNB's intervention would continue, the central bank is likely more tolerable over modest franc appreciation given better domestic economic developments

US-Japan Summit And Yellen’s Testimony Affirm Yen’s Weakness

USDJPY's rally since early February indicates that the correction from the 2016-peak (118.66) made on December 15 is ended at 111.57 on February 7. We remain bullish over the currency pair (i.e. expecting Japanese yen to weaken against US dollar). As we mentioned in our January report, reflation trade, driven by US President Donald Trump's pro-growth policy, such as infrastructural spending, tax cut and deregulations, has driven USD's rally against major currencies since Trump's victory. Hopes that the measures would drive US growth and inflation have lifted speculations on Fed funds rate hikes this year, sending Treasury yields and USD higher. Meanwhile, BOJ's yield curve targeting policy, announced in September last year, would keep the 10-year JGB yields close to 0%. These would help accelerate divergence of Japanese yields from those in the US, pressuring Japanese yen. Recent developments appear to have reinforced such conviction.

FX 2017: CNY – Pressures From USD Strength, Capital Outflows And Growth Slowdown NOT Relieved

Chinese GDP expanded +6.7% in 2016, grabbing the mid-point of government's target of 6.5-7%. Growth is expected to decelerate further, probably reaching +6.5% this year. At the Central Economic Work Conference held last December, top leaders of the Chinese Communist Party indicated the policy would focus on controlling credit and housing risks, compared with stimulating growth in the past year. Yet, growth is still an issue concerning the government, with achieving growth targets a critical factor to ensure smooth leadership transition in late 2017. Meanwhile, renminbi should depreciate further. Besides the broadly-based strength in US dollar, concerns over further renminbi depreciation would continue to lead to huge capital outflow, a behavior that aggravate renminbi's weakness. We expect USDCNY to rise above 7 in 2Q17.

FX 2017: CHF – SNB To Tolerate Modest EURCHF Drop

We expect EURCHF to weaken modestly from current level. Elevated political uncertainty in Europe should maintain demand for Swiss franc as a safe haven, a status which accelerating buying of the franc in several occasions in 2016, including Brexit referendum and US presidential election. While FX intervention is still on, we expected SNB to be a little more tolerable to franc's appreciation than the previous years. Switzerland's economic outlook has improved over the past months with gradual recovery seen in exports and inflation. Meanwhile, strength in US dollar should also allow the franc to weather some appreciation against the euro. In our estimate, EURCHF might drop to 1.05 by end-2014, -2.8% below SNB's unofficial floor of 1.08, after the central bank's removal of the 1.2 threshold in January 2015

FX 2017: JPY – Yield Curve Control To Keep Yen Weak

Recent correction does not change our relatively positive outlook over USDJPY this year. Donald Trump's victory at the US presidential election last November triggered sharp rally in interest rates and USD, facilitated by unwinding of USD shorts and opening of USD longs. Despite a pullback after soaring to a recent high 118.66 in mid-December, reflation trades, hinging on the bets that Trump's administration would drive quicker growth and inflation, remain in play and should push USDJPY higher after consolidation. Yield curve targeting announced in September indicates that BOJ would strive to keep the 10-year JGB yields close to its target by buying sufficient amounts of bonds. This, together with the sharp rise in US yields, helps accelerate divergence of Japanese yields from those in the US, pressuring Japanese yen. We do not feel surprised if prices corrects to 110-112 in 1Q17. Rather, it offers a buying opportunity for a resumption of recent rally. Risk to USDJPY's strength is slower-than-expected and/or milder-than-expected implementation of Trump's pro-growth policy.

FX 2017: GBP – Brexit Uncertainty Haunting

British pound was the most volatile G10 currency last year with the trade weighted index plunging -15% on annual basis, despite a -5% rebound from the October low. Sterling fell about -16% against both US dollar and the euro for the year. The huge volatility was mainly driven by political reasons: Brexit referendum, resignation of David Cameron, as succession of Theresa May, as Prime Minster, as well as May's announcement to trigger Article 30, followed High Court's ruling that MPs must be consulted before triggering Brexit. In 2017, political risks should continue to haunt UK's economic developments as Brexit negotiations are prone to begin. The market has recently priced in higher BOE rate expectations due to rising inflation outlook and solid dataflow. Yet, we do not believe any rate hike would be adopted. The central bank would stand on the sideline, maintaining the bank rate at 0.25%, throughout the year. We are bearish over sterling, forecasting it to depreciate against USD and be range-bounded around current levels against the euro, which has been pressured by elevated political risks

FX 2017: EUR – Political Uncertainty And ECB’s Dovish Tapering Continue To Weigh

Subdued economic growth and unconventional easing measures resulted in EURUSD's third consecutive yearly decline, although the loss was greatly trimmed to about -3%, last year. EURGBP, however, jumped +16% as sterling slumped on concerns over British economic outlook after Brexit. Risk is to the downside for the single currency in 2017 as pressured by elevated political uncertainties and ECB's dovish tapering stance. Recent upside surprises on inflation data would not make ECB less dovish. Core inflation remained weak and should only improve gradually this year, not sufficient for the central bank to commit to tapering. A break below the 1.0463 low in March 2015 has paved the way for EURUSD to go further lower. We expect EURUSD to reach parity by 2Q17, probably after French election.

FX 2017: USD – Fiscal Expansion and Additional Fed Rate Hikes To Extend USD Rally

2017 is year of high uncertainty, mainly hinging on the shift of global political agendas, from the new policy direction under Trump's administration, to the beginning of negotiations between the UK and the EU on Brexit, to the leadership transition in China. On the currency outlook, we remain constructive over USD this year, anticipating Trump's pro-growth policy would drive higher economic expansion and inflation, and facilitate a tighter monetary policy stance. With the market shy of pricing in three Fed funds rate hikes (as signaled in the December dot plot) this year, there is room for USD to rally further should incoming macroeconomic data eventually convince traders that more rate hikes are possible. We are bearish on Treasuries and expect US yields to move higher, especially at the front-end. Monetary policy divergence should bold well for the greenback, especially against the euro.

Recent Yen Weakness And Rising JGB Yields Mainly Driven By FOMC Rate Hike Expectations

The recent selloff in Japanese yen and widening in US-Japan yield differentials have been driven by the FOMC rate hike and expectations of further tightening in US monetary policy. Indeed, BOJ’s action has minimal impact on the phenomena of late. BOJ on Tuesday left its interest rate targets unchanged with the short-term and -10 bps and the 10-year JGB yield at around 0%. The asset purchase program also stays at approximately 80 trillion yen of JGBs annually. The central bank also upgraded its current economic assessment and outlook.

OPEC and Non-OPEC Agree to Cut, but Can This Really Boost Oil Prices?

To the market's surprise, OPEC announced to cut production to 32.5M bpd, the lower end of the target range indicated in the "Algiers Accord" in September. It also represents a -1.2M bpd, or -3.7%, reduction from October levels. Meanwhile, OPEC noted that non-OPEC countries have also agreed to cut output by -0.6M bpd with half of the contribution coming from Russia. Initial market reaction was buoyant with crude oil prices rallying the highest levels in a month. However, performance of commodity currencies under our coverage was not as robust as expected. Indeed, all of aussie, kiwi and loonie ended the day lower after initial rally, mainly due to a stronger US dollar. Higher oil prices as a result of output cut lift inflation expectations, lifting US dollar and Treasury yields.