June: platform for interest rates to head lower through 2019
While politics dominated throughout May, the month will be remembered in part for the S&P 500 hitting a new all-time high, and the ASX 200 trading to the highest levels since 2007. We also saw punchy moves in oil, bonds and FX markets. The stage is now set for a volatile June.
Brexit uncertainty: a new general election or second referendum?
The big mover in G10 FX was GBPJPY, which fell 5.8% — the biggest monthly fall since June 2016 (where it fell 14.3%) — having faced a storm of renewed Brexit concerns, amid a broad bid in the JPY, as uncertainty increased through financial markets.
G10 FX returns against the USD through May, e.g., GBPUSD fell 3.1%. (Source: Bloomberg)
Brexit is an isolated issue in the sense that the Brexit tail risk hasn’t impacted markets much outside of UK assets. But it’s consumed FX traders, who have been drawn to the daily range expansion and trending conditions. GBPUSD and the GBP crosses were arguably our most traded currency pairs in May, and it feels as though it’ll continue to be as we focus on the process of finding a new Tory party leader as well as the growing realisation that the UK is facing the reality of a new general election or a second referendum. One thing we’ve also learned from the European Parliamentary elections is that the centre model no longer holds appeal with voters. Both the Tories and Labour will need to take a defined view on “no deal” or “no Brexit.”
We’ve seen strong AUDUSD and AUDJPY flow through May, with AUDUSD finding buyers off the lows of 0.6865. The surprise victory for the Australian Liberals proved more an equity story than it was for Aussie bonds or the AUD. But along with macroprudential easing from housing regulator APRA, calls for more stable times in house prices are growing. While Philip Lowe, the governor for the Reserve Bank of Australia, laid the foundations in his speech on 21 May in Sydney, the RBA delivered the highly anticipated 25bps cut Tuesday. What's more, interest-rate markets expect the next cut to play out in August.
Trade tensions and slowing growth dominate the world’s financial markets
Arguably, the overriding theme has been the US-China relations. As we roll into June, the relationship between Mexico and the US has also come into question. Trump is seemingly taking on all comers, and it’s interesting to see the huge moves in US interest rate pricing, with the market now expecting the Federal Reserve to be the most aggressive developed-market central bank in 2019. With the world’s economy slowing down, and global manufacturing into the contraction for the first time in years, some are arguing the rise in trade tensions will be the trigger to set off far more aggressive central-bank action.
The rise in gold into $1,326 is perhaps telling us that gone are the days where Europe or China was the dominant concern — we should be more readily concerned with the US economy. Should this theme mature, which we’ll potentially see play out through June, it could be a real headwind for the USD and, in turn, will have huge implications for global markets.
Chart to watch
EURUSD (daily chart) — It’s hard to be long EURUSD with the ECB meeting in play, but the price is currently testing the neckline of the double bottom (1.1264). With triple divergence playing out, this could tactically be suggesting a move above 1.1400 shortly. This could have far-reaching implications for global markets.
Looking ahead at the key risk events for June
ECB rate decision: 6 June
In reality, no one expects the European Central Bank to change interest rates, but we could easily see Mario Draghi once again push out the banks forward guidance on when rate hikes are expected to go up. Currently, the bank has committed to keeping interest rates at current levels until at least the end of 2019. But the risk is that this guidance is pushed out into 2020, or we could even see the calendar-based guidance removed altogether. A failure to push out its view on rates could nonetheless be seen as a EUR positive.
EURCHF weekly: Will this bounce off or crash through key support?
If we look at EU inflation expectations (an input the ECB look at closely; see chart below), we can see expectations have fallen to 1.31% — the lowest levels since 2016 — so one questions how the ECB can be anything but dovish. It’s a growing consideration for the ECB, with the market questioning if we get colour on the ECB’s appetite to restart its asset purchase program. There will also be focus on any further clarity on the targeted liquidity program to European banks.
The ECB aggressively lowered its growth forecasts in the March meeting to 1.1%, so it’d be surprising if they downgrade expectations again. The market, however, will still be keen to assess any new changes to its growth and inflation forecasts.
June Nonfarm payrolls: 7 June 12:30 GMT
US Nonfarm payrolls
US unemployment rate
Traders always anticipate the US Nonfarm payrolls report as a potential volatility event. Given the growing calls for tougher economic conditions in the US, the last thing the USD bulls want to see is an unexpected deterioration in the labour market. We can see that the consensus estimate sits at a healthy 183,000 net jobs created in May (economist range 215,000 to 80,000), which is a slight discount to the six-month average of 209,000 and one-year average of 214,000. As always, the magnitude of moves in the USD and US equity markets will be driven by the extent of the beat/miss relative to this consensus figure.
Daily chart of the USD index/USDX. (Source: MT5)
The unemployment rate is probably the more influential variable to the Fed given the importance of the labour market for Fed thinking. Again, it seems unlikely to concern traders too much unless the unemployment rate comes in above of 3.8%, which would be a surprise and one would then have to consider the influence of the participation rate here. The fact that the US unemployment rate sits at a multi-decade low is simply not resulting in significant wage pressure, which is the backbone of the Fed’s assessment of inflation. With this in mind, keep an eye on average hourly earnings, which is expected to remain at 3.2%. Again, if this comes in hotter or colder, it could have an influence on the USD.
- White histogram – Net monthly change in US payrolls
- Red line – Average hourly wages (YoY)
EU Summit: 20 June
With Mario Draghi due to step down as ECB president on 31 October, there is much speculation as to who could be Draghi’s replacement. The market has seen time and time again that when it comes to producing dovish surprises, Draghi wears the crown as king of the central bank doves. It’s become almost too predictable that the EUR will fall in the wake of Draghi’s speeches. There’s some market chatter that we could get an announcement of Draghi’s successor at this EU Summit, with monetary hawk Jens Weidmann considered a front runner. Perhaps this summit could prove to be a volatility event for the EUR and German DAX. With genuine concern that the ECB lacks the monetary toolkit to navigate the eurozone through another major economic downturn, who leads this organisation really matters to FX pricing.
G20 Summit: 28 – 29 June in Osaka, Japan
With trade relations at the epicentre of markets, and Trump seemingly taking on all comers, the market is looking for a circuit breaker and an excuse to cover shorts and put risk back on the table. While it hasn’t been confirmed, there’s much speculation President Trump and Xi could meet face to face on the sidelines, with the risk skewed that we finally see some convergence in the narrative and a bond to achieve a deal. At this stage, Trump’s action is breeding huge uncertainty not just in markets, where the talk has moved from if to when we’ll see the first rate cut in this cycle from the Fed. More prominently at a corporate level, however, how the interaction between Trump and Xi will play out also makes this event a must-watch.
OPEC meeting: 25 – 26 June in Vienna, Austria
Oil markets have been savaged since 23 April, with traders focused on poor China demand indicators, amid the backdrop of broad negative financial market sentiment, better supplied US inventories, and supply dynamics driven by risks in Iran, Libya and Venezuela. Compounding the poor sentiment towards crude, Russian authorities have raised concerns about its ongoing commitment for production curbs.
With WTI crude (XTIUSD) eyeing a possible test of $50, and Brent $60, the market will be keen to assess if OPEC tries to get in front of the move lower and support prices. How crude tracks from here will not just have huge implications for equities. In FX markets, a lower oil price means headwinds for the NOK, CAD and a lower USDJPY, given the impact that oil has on US inflation expectations, and vice versa.
June Federal Reserve meeting: 19 June
Arguably the marquee event through June, and an event risk for most of our tradable markets, it’s incredible how quickly things have deteriorated, with US interest rates now pricing 2.5 rate cuts this year. While some would say the move in rates pricing has gone a little too far, we head into the June FOMC meeting with the implied probability of a cut now set at 20%, although it feels far too early to really expect a cut. We’ll also be looking at the 31 July FOMC meeting as a truly “live” meeting, with expectations for a cut currently at 62%.
The influence US interest pricing is having on USDJPY
- Red line – Interest rate cuts (basis points) priced between June and December 2019
- Yellow line – USDJPY
Fed Vice Chair Richard Clarida offered insight in a speech on 30 May that the US economy “is in a good place.” However, he did caveat by saying that should inflation remain below target and global conditions change, then the Fed should assess its policy stance. St Louis Fed President James Bullard went further with narrative on 3 June that "a downward policy rate adjustment may be warranted soon to help recentre inflation and inflation expectations at target, and to provide some insurance in case of a sharper-than-expected slowdown."
Importantly, we’ve also heard from Fed Governor Jerome Powell on 4 June, who said that, "We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we’ll act as appropriate to sustain the expansion, with a strong labour market and inflation near our symmetric 2% objective.”
The idea the Fed will act as “appropriate” is interesting.
While it doesn’t suggest the banks are looking at cutting anytime soon, if economics do respond, we’ll then see cuts. The June FOMC meeting should explore this in more detail with the help of additional data.
Trade setup of the month
USDCHF – We’ve focused on EURCHF, but USDCHF is one to watch that’s firmly on the radar. On any valuation metric the CHF is considered by far the most overvalued currency in G10 FX. Valuations tend not to matter if traders are seeing increasing reasons to be risk-averse, and we see outperformance from US Treasuries, gold and the JPY. In this environment, we see the CHF working well. As we discuss below while assessing the event risk through June, the setup and feel to this cross make it well worth putting on the radar.
The trend is clearly down. We can see that defined by the fact rallies (in price) are contained by the five-day exponential moving average (EMA), and traders have worked sell orders into this short-term average. With US Nonfarm payrolls — a near-term risk event — a weak number here will accelerate USD outflows as traders speculate the Fed cut in the July – September window. We should see volatility kick-up, and this will only benefit the CHF. That said, we can see huge defence of the 0.99 level and, by the price action, through late March and then on Wednesday. So, a daily and, preferably, a weekly close through 0.99 would be significant — it could suggest the pair is headed into 0.9750/00 or perhaps lower. In this case, waiting for price to confirm it's ready to head lower is prudent.
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