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Currency Market Analysis

Jan 17, 2020 | Currency Market Analysis

Global Themes

What we learnt this week

• US/China trade deal not a game changer
• USD remains the highest yielder
• Europe is failing to rebound 

US/China trade deal not a game changer

NZD/USD got a mild pick up last night with the improved risk sentiment emanating from the signing of the US/China trade deal. But ultimately the pair looks set to close around where it opened this week. Focus will now be set on when and how “Phase Two” will be enacted, with the long and short of that likely to be after the conclusion of the US Presidential election in 2020.

The US is essentially trying to tackle an economic issue (being a large trade imbalance) with political measures. In the 1980s it tried to tackle similar problems via currency, through an attempt to reset the USD/JPY rate in the Plaza Accord. Ultimately that failed and we rather think they may fail this time around as well. The difference for currencies however, is that on this occasion FX markets are more of a sideshow rather than a lever used to address that imbalance. Yes we have seen some recovery in AUD, USD and most noticeably CNY but overall this isn’t an FX game changer. If Kiwi pairs are going to surge much higher from current levels it’s going to have to be on more than just a positive vibe from what is effectively a formalised trade truce.

USD remains the highest yielder

Retail sales data out of the US came in as expected last night, up 0.3% for December in a rather “middle of the road” number. That’s emblematic of how the US consumer has powered the American economy over the last two years, and ultimately that’s been USD supportive.

Looking ahead to 2020 HSBC Head of FX Strategy, David Bloom, is predicting a “triple egg” for Dollar naysayers, who he says have got egg in their face in 2018, repeated the dose with weak Dollar forecasts last year and are lining up for the “triple egg” this year. Speaking on Bloomberg TV he labelled the Dollar a “bad hotel”: you gather your luggage and go to leave but then there is so much garbage outside you just head back into your room. That garbage is the rest of the FX world where lower yields in less liquid currencies just don’t offer a long term attraction. To back up his case he cites a lower foreign ownership of Kiwi and Aussie bonds. Of course further rate cuts for the Fed this year can risk this view but we think Bloom offers a pretty watertight case as to why upside in NZD/USD and AUD/USD might be rather limited in the first half of 2020.

Europe is failing to rebound

The other side of Bloom’s argument is weakness in the Eurozone. We get another test of that with inflation numbers due tonight from the EU. Annualised CPI is expected to be a mere 1.3%. During the week Swiss Bank UBS labelled the Euro’s underperformance “remarkable” and suggested that asset allocation rather than fundamentals continue to drive FX preference, and with the Euro remaining the cheapest funder then it continues to remain weak. UBS suggests that outlook however ignores “data surprises” and “reserve diversification”, which should win out over time, boosting the Euro. We agree that the data can’t be as bad as 2019, but it’s still not a conclusive case to hold a negative yielding Euro over USD.

To close the week stay tuned to a slew of Chinese data today. GDP, industrial production and retail sales are all due out at 3pm NZ time. We also have UK retail sales tonight. A weak print could ink in a Bank of England rate cut in a fortnight’s time and keep NZD/GBP on a formative bias.

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