It’s Never Sunny in Washington D.C.

It’s Never Sunny in Washington D.C.

Last week the US dollar was trying to perform it’s best Lazarus impersonation but fell well short on all accounts not only hampered by dwindling long-term sentiment but also feeling the weight from the latest political fracas in Washington. However, the dollar has not weakened off to dramatically this morning after  Shutdown headlines with USDJPY off about 20 pips to 110.60 at the Wellington Open. Sure the government shutdown remains   in focus,  but it’s not a  significant USD  driver as it presents only a minuscule shock to risk appetite

Not unexpectedly SPD agreed to start formal coalition talks with Merkel; a decision which moves Germany closer to form a new government.By accepting to pursue further discussions and thereby dramatically improving the chances for another grand coalition, a temporary calm should engulf the EU political landscape. However, German political developments were not thought to be a significant disruptor, so the market focus now pivots to this weeks ECB.

A bit of everything for everyone this week with, politics, central banks earnings and Trump in Davos could be this weeks marquee event.

The focus will be on Davos and the World Economic Forum that will take place from Tuesday to Friday with President Trump due to deliver a keynote address on the final day. Anytime Trump takes the podium, especially when he’s the headline event, the chance for market turmoil elevates two-fold. This time around, there are lots of gossips that he could use this platform to up the protectionist ante, but so far other than pulling out of TPP the risk of protectionism under President Trump has mostly proved a red herring. Stay tuned!

However, the  big currency  mover  this morning  was the Turkish Lira as USDTRY moved +1.5 %after Turkey launched airstrikes in Syria against US-backed Kurdish fighters ( My TRY view is  covered at the bottom )

Oil Markets Overview

Trading oil markets these days can be a challenge as the past few session the inter day moves are position related rather than fundamentally driven.   But after rallying at breakneck speed the past four weeks, it was finally time for investors to come up for air and book some profits but the correction has remained rather shallow relative to the recent rally.

Fridays  Baker Hughes reports indicated  US drillers cut oil rigs for the second in three weeks despite soaring crude prices. It begs the question where are the Shale producers ??

AS for weekend geopolitical risk, rising conflict between Kurds and Turkey usually implies that oil prices would move higher due to the (region‘s) strategic position in oil supply routes.

Gold Market Overview

The Escalation of Middle East tensions and the reemergence of US  dollar weakness has Gold market opening firmer today. Indeed, an escalation of geopolitical tension in the Middle East hot pot of unrest bodes well for Gold markets.But gold  will likely track the dollar momentum so as the Greenback turns so does Gold appeal 

G-10

The Euro

Despite heightened EU political noise,  USD weakness and a likely shift in ECB language are to remain the dominant drivers as long-term investors continue to move into at a Euro. Long-term Real Money inflow tends to be a good indicator of Euro future price movements. And if we consider historical correlations that a  50 bp rise in EU 5 years yield could mean  3-5%  ( 1.27 Mid ) Euro appreciation while a 100 bp could lead to 7-9 % appreciation  ( 1.3175 mid). It’s no wonder Real Money investors a pilling into the EUR supporting the narrative for a possible shift in ECB policy. Its ECB policy, not EU politics that  is  steering the ship

With that in mind, this weeks  ECB meeting will draw the most attention with  Draghi’s follow up presser taking the most significant slice of the cake.

But is  so often the case pre ECB meeting, we  may see some  EUR position temporarily trimmed even more so given the markets extended views on the  ECB policy shift

The Japanese Yen

So much for tradition correlation as with Stocks up, yields up USDJPY is still down. But it’s been trading this way for a while, and traders are getting no joy from long dollar bets. However, given that a shift in BoJ rhetoric would boost the Yen well below 110, especially with the USD showing little correlation to higher US yields, the BoJ will most likely stay the policy course. In fact, the pushback could be strong catching some investors off guard even if the BoJ real intentions are to move forward with a more aggressive taper. There is little chance Kuroda will take that leap of faith as the market would  hammer USDJPY mercilessly lower

The Australian Dollar

The market has chewed through 5 significant big figures with nary a care. And bullish sentiment remains high after assuredly conquering the .80 level.Commodity prices continue to pave the way and given the weaker USD dollar narrative which should continue to play out in 2018 we could expect more investor rotation in the AUD to ride the unabated regional risk rally that the Australian dollar will feed off.

But with only twenty-five bp’s of rate hikes priced in STIRT for 2018 and a measly five bp’s baked into May, I think the next significant piece of the puzzle will reveal after next weeks’  CPI ( Jan 31)  which could see rapid repricing on RBA risks.The long Aussie trade continues to resonate with investors as US dollar continues to weaken in the absence of the Greenbacks sensitivity to rising US bond yields.

The Chinese  Yuan

It was evident at Friday’s open traders were under-positioned for the long-term bullish  view, so price sensitivity took a back seat to acquiring position size

The US dollar plunged below 6.40 on Friday reaching its weakest point in more than two years against amidst US dollar broad-based weakness. But that only offers up one side of the calculus.

Toward the end of 2017, what became abundantly clear is that Pboc policy in 2018 would be vastly different from practices of yesteryear as president Xi Jinping was laying the groundwork and seeding ambitious plans to have the Yuan used more openly for international trade.

Also, pre-eminence of the dollar in 2018 as a pricing channel for oil and other critical industrial commodities could come under threat. At the end of the day, China’s trade channels are dominating the supply chain.

The aclivity of the Petro -Yuan could spell impending doom for the Greenback given that Russia, China’s most significant exporter of Oil would be more than happy to be a receiver of  Yuan for oil exchange.

Also with the lack of Pboc meddling interventions of late and the removal of countercyclical mechanisms, its possible investors will not have to stomach increased capital controls, nor the Pboc’s affinity for interventions, thereby removing the most significant barrier for entering China’s capital markets. Currency manipulation!

In fact, it could be time to get rid of the notion that policymakers are prioritising stability versus internationalisation as China has deep enough pockets to take on both issues and come out smelling like plum blossoms.

Asia FX

The Malaysian Ringgit

With absolutely no protest from BNM about the stronger Ringgit, the door is wide open to continued appreciation.

The MYR remains undervalued versus regional peers as expressed through a trade-weighted average which suggests the fair value of the Ringgit should be closer to 3.50-3.70. And with strong exports, Belt and Road initiative increasing Foreign Direct investment, improving oil prices and a weaker US dollar complimented by a hawkish BNM, markets could pivot to that direction.

Taking its cue from the surging Yuan on Friday, the Malaysian Ringgit dove through the 3.95 USDMYR and quickly moved sub 3.94 as investor piled into Ringgit positions ahead of Thursday’s  MPC.

But the move was as much about the BNM’s impending shift to policy normalisation as it was about regional risk sentient that remains off the charts with  Asian equities continuing the stellar start to 2018.

Also, global demand suggests  Malaysian exports will remain firm and therefore support  GDP. With rising oil prices adding to the positive domestic narrative, but also posing an upside threat of inflation, this suggests the market may be underestimating the potential of at least one additional rate hikes in 2018 and lending support to the Ringgit.

However in the build-up to the BNM policy decision, the market will continue to trade sensitivity to the USD dollar, but the bias will most likely be to cover risk on dips

Making a case for  Bank Negara Malaysia Rate hike and stronger Ringgit

It’s hard not remain firmly entrenched in the rate hike camp. After last policy meeting, it became clear as day that Bank Negara Malaysia (BNM ) was preparing to start normalising interest rates policy where during the November meeting there was a shift to a  hawkish bias based broadly on the back of an optimistic outlook for both domestic and external environments.

Last November BNM  left interest rates unchanged not advocating to reverse a surprise reduction by 25bps to 3% in July 2016. So it should come as no surprise that the BNM will remove the monetary accommodation that was concluded necessary at the time by financial markets uncertainties around Brexit. Since Brexit risks have receded, global growth is surging, and the Malaysian economy is firing on all cylinders, it makes sense to get in front of inflation by gradually raising rate while allowing an undervalued Ringgit to appreciate. The recent rally in crude oil prices will drive up headline inflation while core inflation is expected to follow through with domestic demand accelerating. In fact, the BNM could deliver a hawkish rate hike which would assuredly strengthen the Ringgit, and by extension, the stronger MYR efficiently tightens monetary conditions while buttressing inflationary  pressures

With a January rate hike all but certain, the focus now shifts to forward guidance as a more hawkish retort from BNM will increase expectations for a follow-up rate hike(s) in 2018 and the Ringgit will soar.

Bond markets have been consolidating with some investors pairing back short-dated tenors in case the BNM delivers a hawkish surprise, as yields will increase correspondingly.

But given that short-dated local currency denominated Malaysian government bonds are the ideal investment for foreign investors to express a bullish bias on the MYR, we could expect demand to surge post policy decision and lend further support to the Ringgit

EM FX

Turkish  Lira

The market was fearfully focusing on developments on Syria border, and those fears came to fruiting over the weekend.  Turkey launched Airstrikes into   Northern Syria targeting US-backed Kurdish fighters while defying US appeals.  Turkey is now tumbling down the US political frenemy index which has caused USDTRY to gap higher towards 3.83 ( +1.60) at the open. However, Unlike a war of word type scenario which tends to have a little lasting effect, dropping bombs is a different kettle of fish, so I doubt traders will be too eager to reverse this move too quickly until coolers political temperament emerges.

South African Rand

Reports are circulating that ANC will Jacob  Zuma out of office, given the superabundance of Zuma generated political headwinds, his removal will clear the political path for much need reforms and could be the signal for market to by the ZAR

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Stephen Innes

Stephen Innes

Head of Trading APAC at OANDA
Stephen has over 25 years of experience in the financial markets and currently based in Singapore as the Head of Trading Asia Pacific with OANDA. Stephen's market views focus on the movement of G-10 and ASEAN Currencies. His views appear in Bloomberg, CNBC.Reuters, New York Times WSJ and the Economist. His media appearances include Bloomberg TV & Radio, BBC International, Sky TV, Channel News Asia, ASTRO AWANI and BFM Malaysia. Stephen has an extensive trading experience in Spot and Forward FX, Currency and Interest Rate Futures, Money Market Derivatives and Precious Metals. Before joining OANDA, he worked with organisations like Nat West, Chemical Bank, Garvin Guy Butler, and Sumitomo Mitsui Banking Corporation. Stephen was born in Glasgow, Scotland, and holds a Degree in Economics from the University of Western Ontario.
Stephen Innes