A New Sheriff in Town

A New Sheriff in Town

The markets are increasingly challenging to define as storylines shift from ECB and BoJ policy normalisation to the problematic US twin deficits and inflation. However, the dollar has remained bid against most G10 currencies of late. As equity markest near another significant inflexion point as bond yields look poised to move higher, however, fixed income was exceedingly bid entering weeks end. Regarding an outright spark in Fixed income, which is driving the bus these days, there are no easy answers. Most are pointing to positioning adjustment ahead of the weekend and other events on the near horizon. Jerome Powells Humphrey Hawkins testimony and the Italian elections do strike a chord, while others point to growing signs that all is not doom and gloom in the bond pits and tactical buying is re-emerging.

Both economic and political worlds collide this week with the lion’s share of attention falls on The New Sheriff in Town, Powell’s testimony, however,  I suspect we will end up with more emphasis on Europe and the Italian elections.

Let’s face it, Italy is not known for political stability, as governments change about as often as the weather does. And on cue, protests have broken out across Italy over the weekend on both sides of the political spectrum. Expect a messy affair, and it will be difficult for any of the primary political parties to form a new government in what is shipping up to be one of the most unpredictable calls.Complicating matters is the high number of undecided votes which could be as high as 45% if current polls are accurate. And while xenophobia runs rampant amongst the electorate, political leader are easing their Euroskeptic perimeters so all may not as bad as it seems. Given Italy’s history of encouraging coalition government, why should we expect anything different?Electoral shocks should be isolated, and the fear of political contagion should remain muted.

But let us not lose sight that On Friday, the postal ballot to ratify the Grand Coalition proposal with Merkel’s CDU/CSU group ends. SPD members, who have the final say on the coalition agreement for Europe’s largest economy, must vote by March 2 in a postal ballot, with results to be made public on March 4.

While the markets should get through these treacherous political storms, but obviously, it’s  wise to respect the fact that any failure to bring the EU political environment into equilibrium could send shockwaves through the union and beyond.

With so much hype over the new Fed Chair Powell’s Humphrey Hawkins testimony, it’s bound to disappoint. The bar is towering for a hawkish surprise as the prepared statement is likely to be salted with familiar FOMC repetition, similar to the recent FOMC Minutes for fear of sending equity market into a tailspin given the bearish bond market overtones.

There is no incentive for Powell to pre-signal any shift in the Fed narrative instead he will probably let traders do the Fed’s heavy lifting this quarter as market risk is becoming more aligned to the reality that fiscal expansion could nudge  US interest rates higher this year. With that said, there little to suggest this new Fed chair will be any less dependent on economic data than his predecessor, so the jury should remain out about a quicker pace of interest rate normalisation as the market remains comfortably parked in the three rate hike camp.

From the Fed’s perspective, there is nothing gained by feeding the volatility beast. But no doubt, some skillfully placed partisan questions designed to trip up the new Chair during Q and A could be useful for a kneejerk or two.

Oil Markets 

Markets are coming off whippy week for crude benchmarks, but conviction and sentiment should continue to rise after a surprisingly robust  EIA  drawdown in oil inventories  However briefly as this may last, the stars are aligning for Oil bulls as U.S. oil production also remained flat while US exports surged.  Also, momentum traders caught an updraft from yet another supply outage, this time from  Libyan  El Feel oilfield closure due to support workers wage disputes.

We continue to get positive news from OPEC compliance cementing the floor at WTI 60.00 per barrel which is creating a positive wave of conviction that investors appear keen to ride.

Uncertainty ahead of Powell testimony could lead to some position adjustments but unlikely to change the current bullish narrative.

From a technical perspective, with the futures markets in backwardation its suggests inventories could run leaner for some time but as we move deeper into global refinery maintenance season, US crude export could face some possible headwinds balancing each others impact.

Gold Markets 

Gold continues to act as less of a haven hedge and more as a proxy for USD sentiment so we could be facing a critical week for Gold prices as the USD will come under the microscope as new Fed Chair Powell takes centre stage.

But with US’s runaway deficit spending train stoking inflationary fears, Gold remains a crucial buy on dip strategy not only to hedge against inflation but also against another untimely correction in equity markets. With uncertainty surrounding the toxic elixir of higher inflation and the expected USD headwinds from record US debt, gold’s  appeal should remain healthy over the near term.

Currency Markets 

On the surface, there is two-way risk heading into Powell’s testimony, but likely nowhere near the level investors are positioning for a hawkish retort. But It would be a massive surprise if he departed from his predecessor script and we should expect a Yellen 2.0 delivery.

Fed Powell’s testimony to the House Financial Services Committee has been moved up from Wednesday to Tuesday at 10:00 EST

In addition to this news, Bloomberg also confirms that his prepared remarks will be released at 8:30 EST Early release is not uncommon and allows both the markets and Congress to digest the statements,

Powell will then hold his Senate testimony on Wednesday.

There will be subtle nuances for the market to digest the day.While prepared remarks might help to establish how dovish or hawkish Powell is, many traders feel that Senators tend to ask more relevant questions for the market than the House. Therefore, the market might shade Tuesday’s remarks with a bit of caution but will react after confirmation from  Senate session on Wednesday.

However, given the policy mess Powell has inherited what should be crucial for the USD is how the Fed moves forward with the unenviable task of QE tapering while massive waves of Treasury notes come online. This burdening task should give the  Chairman more cause to tow current policy lines while avoiding any hawkish surprises. Regardless, it’s clear that most traders are preferring to wait until Powell’s  ” coming out”  to re-engage with USD shorts in size.

Across the pond, ECB President Draghi will deliver his usual testimony to the European Parliament Monday. Softer economic data continues weighing on near-term sentiment, but political considerations dwarf all else.

G-10 Currencies

The British Pound

Most of this mornings focus has been on the pound after  Sir Dave Ramsden sees a faster pace on interest rate normalisation. A bit of departure from usual decorum for a centeral banker to lay his cards on the table with regards to interest rates.But perhaps more significant, until now one of the most active doves on the Bank’s monetary policy committee (MPC). But  The general market drift is to fade  GBP rallies into March EU summit given rate expectations are firmly entrenched, and hawkish expectations could leave GBP vulnerable to Brexit headline noise and the recent soft patch in data. So the markets are tentatively  fading this morning opening  move higher

The Japanese Yen

The Yen traded heavy on Friday, but with everyone watching the intraday support level at 106.60 on a closing basis, the pairs bounced off session lows into the close, finishing the week at 106.90.  Although the reappointment of dovish Kuroda should keep YCC tweak rumours at bay, for now, the   USDJPY was trading with higher sensitivity to US yields ahead of Powell testimony so it should be interesting to see if this holds true later in the week. But we expect today’s session to be more about position prepping ahead of Powell testimony

While the focus is squarely on Jerome Powell this week, but with the recent decoupling of Yen’s  movements to US  10 year bond yields, the market could be looking for different triggers.  While uncertainty over equity market keeps dollar bulls at bay, the USD selling requirements from exporters as we near Japanese fiscal year end and bond funds looking to adjust dollar hedges against the prospect of a broader US dollar sell-off could pressure the USDJPY  despite the possibility of higher US interest rates. As we pointed out last week, the supply of dollars to go between 107.50 -90 remains large and while this continues to be the case, USDJPY shorts should stay in favour.

The Euro

It’s tough trading the Euro with much conviction these days ahead of the Italian election as the market remains very wary of building longs ahead of the vote. And while the short-term market is favouring the propensity to sell EUR  on rallies, the lack of downside break out makes jobbing the Euro even less appealing.

The Australian Dollar 

 The USD doesn’t want to give it up yet, and while the small uptick in quarterly wage growth was encouraging for Aussie bulls, the markets quickly deduced this would not alleviate RBA’s concerns. Overall the USD should continue to dominate near-term price action, but the prospects of another equity market wobble should keep topside Aussie momentum in check. But longer term and given the likely hood for dollar weakness to re-emerge as intense focus falls the duelling twin US deficits, interest rate differentials will be a  less significant part of the equation, and the Aussie will outperform on a weaker USD narrative alone.

Asia FX

Stronger local FX and stable US treasuries are providing some breathing room for regional investors and providing a bit of a relief rally in equities. On the currency front, there was a rapid unwind of freshly minted US longs as regional capital market returned to form on the softer US yields.

The threat of US trade sanctions was brushed off as more bark than bite and had muted impact on markets

On the tariff and trade front Liu He, the Chief Economic advisor to the Gov and of the most potent advisors in the Politburo will visit Washington sometime between 27th Feb and March 2nd with their primary task of defusing trade agitation

The Malaysian Ringgit 

Bonds are consolidating at current levels, but unless there a robust unexpected move in US rates this week, we should expect higher foreign interest as the local bond yields are at some attractive levels. The next MGS auction is   Feb 27 where 3.5bioMYR go up for sale. With  MGS 10y yields at 4.08 %, so long as US bond market remains in check, the MYR should get a boost from foreign demand given the attractive returns.

Oil prices should remain firm given OPEC’s production cut compliance which  should continue  to provide a boost to the Ringgit’s fortunes

The Chinese Yuan

Given the upcoming trade meeting in Washington, the Pboc will be more inclined to temper the RMB complex upside if the USD exhibits any strength this week. But local traders will likely remain in stasis ahead of The National People’s Congress (NPC) will start on March 5. Premier Li will present a draft of his work plan for 2018 on March 5, which will be discussed and revised at the NPC.

The Philippine Peso

The current account weakness has been the primary driver of Peso’s underperformance a surge in imports, which has led to a widening of the country’s trade deficit and helped push the current account into the red. But with the markets more worried about the BSP falling behind the curve, shaving the countries RRR reinforced that sentiment and this has been the primary driver for the last leg of weakness. But with the Philippine central bank call to action last week by selling dollar to curb excessive peso volatility, perhaps the view of a hands-off central bank may be changing.But for those that follow my blog, you should know my long-standing belief when it comes to centeral bank intervention to curb local currency weakness; it accomplishes little more than eroding precious reserves while providing the market with better level to buy the dollar after the broader long USD Macro positions unwind.

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