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Trading Opportunities in February

Posted on: 01 February 2019 , by: Pepperstone Support , category: Market Review

December Opportunities by Chris Weston and Darren Sinden

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Skip to: Currency recap | Nonfarm Payrolls | RBA interest rate decision | BoE interest rate decision | Eurozone Q4 2018 GDP | Eurozone inflation (CPI)

Currency recap

After the sharp reversal in market sentiment in January coupled with a strong performance in equity, credit and commodity markets, can the positive trend we’re seeing continue in February?

We’ve seen the Federal Reserve unified in their move to a firmly data-dependent and patient stance, putting the bank inline with market pricing, which is positive. The US government shutdown was temporarily postponed, shaving a minor 0.02% off the US 2019 GDP calculation. Despite this, it will raise its head again on the 15th of February, which is when the temporary funding runs out. Markets seem quite optimistic around the government shutdown - it’s the debt ceiling debate which is a far bigger market issue, and that should become a theme later this year.

After a range of different amendments that have affected Theresa May’s Plan B, we head towards the next vote in the House of Commons by the 13th of February at the latest. If rejected, we should see a Plan C, which will be subject to amendments. February will be a critical month for Brexit, and much will be determined by the EU’s position and how much it will be prepared to concede. However, they have stressed it’s very little, especially when it comes to any legal assurances on the Irish backstop.

The move in GBPUSD from 1.25 to 1.32 was premised on the market pricing out a no-deal Brexit scenario. Whether GBPUSD can push into 1.35, and above, will be down to clarity that a deal can be found, likely after Article 50 is extended – this remains the markets base-case. For GBP bulls, the probability of a second referendum or general election would be the scenario that keeps 1.40 a longer-term target.

GPBUSD chart

The biggest issue facing market participants is global growth concerns. At the heart of this is the broad feel to proceedings in the US-Sino trade negotiations, which will require close attention. However, many feel the damage already inflicted is irreversible with economic data points in Europe and China looking particularly vulnerable. This should see markets like the EUR and AUD particularly sensitive should economic data miss to the downside.

In Australia, there’s evidence that falling house prices and the drawdown in equity markets (through Q4) is affecting consumer confidence and business conditions, and the feedback loop is real. Rates markets have priced a 70% chance of a cut (from the RBA) over the coming 12 months in response, so we look forward to the 5th of February RBA meeting to see if they open the door for cuts and adopt an easing bias. With the markets already pricing a degree of policy easing, we question if the rhetoric marries with market pricing. The AUD will be sensitive to this.

In a world where it's hard to make a compelling case for real upside in any G10 currency, gold continues to trade as an alternative currency. Indeed, at this point, gold looks strong in AUD terms (XAUAUD) and EUR terms (XAUEUR), as well as the more heavily traded USD gold (XAUUSD). The trend is true, and it’s hard to see these bullish dynamics changing too readily.


Key Economic Events

Nonfarm payrolls

December 7th 13:30 PM GMT (15:30 pm Server Time GMT +2)

US Nonfarm PayrollsUS Unemployment Rate
Forecast 168,000  Previous 312,000 Forecast 3.9%  Previous 3.9%

February begins with a look at employment in the USA with the release of January’s Nonfarm payrolls report, which records private sector job creation in the US.

We saw more than 300,000 new jobs created in December, well ahead of even the most ambitious forecasts. The January data is expected to come in around 168,000 new jobs. 

Markets will be watching for any clues about how many of December’s new jobs were seasonal or temporary. The unemployment rate in the US currently stands at just +3.9%. This number has been as low as 3.7% in recent months and may rise again after a month-long government shutdown, which was starting to affect the real economy. 

The chart below compares the unemployment rate with the number of job vacancies in the United States, which fell by around 800,00 to 6.54mn in November 2018 and could also apply pressure to the unemployment rate.  

US Unemployment vs US job vacancies

This month's Nonfarm payrolls are even tougher to predict than usual as several leading indicators that often provide clues aren’t released until after the jobs data. Having had a blowout number in December, we anticipate a number more inline with forecasts, give or take 20,000 jobs. 

By the time the payrolls are released, traders will have fully digested the statement made by the Fed at its interest rate meeting on the 30th of January. Markets have come to terms with the notion that US interest rates will only rise slowly during 2019 if at all. Only another forecast-busting job creation number is likely to change that view or influence Fed policy.

However, the dollar could still strengthen versus the euro as long as the NFP data shows signs of growth. Recent data from Eurozone has also been poor and the economic outlook there is increasingly gloomy. The opportunity could be to take a contrarian view and look for the euro to weaken against the US dollar, retracing some of its recent gains and resuming its longer-term downtrend, perhaps testing back to 20- and 50-day exponential moving averages found just above 1.14.



RBA interest rate decision 

5th of February 03.30 GMT (Server Time 05.30 GMT +2)

Decision-makers at the Reserve Bank of Australia will gather to consider what the next move in Australian interest rates will be. Throughout most of 2018, traders believed that the RBA was becoming more inclined to raise interest rates thanks to an improving economic backdrop. However, a slew of disappointing data and increasing concerns about global trade forced the market to think again into the New Year, with some commentators suggesting that the next move from the RBA would be to cut interest rates, as it did back in July 2016. 

We can see this change of heart among investors in the chart of the yield curve which plots the future cost of government borrowing. The yellow line shows the cost of money as the market saw it in early 2018, while the magenta line shows what the markets think now, the gap or differential between these lines is the change in outlook over the last year. 

At the short end of the yield curve, which is borrowing between three months and one year (see the left-hand side of the chart), current lending costs are higher than they were a year ago. Note how the magenta line then slopes downward between one and three years, implying that borrowing costs or interest rates will be lower in this period. 

The situation is further complicated by commercial banks recently raising the cost of variable mortgages to between 5.36% and 5.38%, more than three times the current base rates.

That matters because, as seen in the chart above, Australian households have some of the highest debt levels among the developed economies, even as house prices in Australia continue to decline. This tightening of credit conditions is a concern that could force the bank to cut borrowing costs during 2019.

What we expect

Having sat on its hands over interest rates for two and half years, the RBA is unlikely to rush into a decision, particularly in cutting rates if it believes such a move might need to be quickly reversed. The bank can take some heart from Q4 2018 inflation data, which printed inline to slightly ahead of forecasts, as well as from the most recent unemployment data that came at 5.0%, a six-and-a-half-year low, and job creation rates above expectations. Against that business confidence, the country remains depressed at just 50% of its long term average. 

The RBA is likely to keep rates unchanged at this meeting. However, markets will pay close attention to any comments or statements that accompany the decision and to the meeting minutes, which are to be released on February 19th. This is because some sections of the Australian money markets believe there is a 50% chance of a rate cut by year end 2019. 

As a result, anything that the RBA says that deviates from that view should be positive for the Australian dollar. Market expectations about the future level of interest rates are one of the most important drivers of FX prices, so if the RBA can dispel or diffuse rate cut concerns the Aussie dollar could make decent gains, after all it was trading at 0.7393 versus the US dollar back in early December.



BoE interest rate decision

7th of February 12.00 GMT (Server Time 14.00 GMT +2)

The Bank of England meets to decide on the level of UK interest rates. No immediate changes are expected from the UK central bank, which is unlikely to move until we know what form the UK's departure from the European Union will take.
Alongside its interest rate decision, the bank will release the minutes of its meeting. The minutes record the thinking of the bank's monetary policy committee and what risks if any, they see to the UK economy. 

The pound strengthened against both the dollar and the euro during January and the cost of borrowing from the markets for the UK government actually fell over the month, which we see as a vote of confidence in the UK economy despite Brexit uncertainty.  

US bank, JP Morgan, believes that UK interest rates can rise if a no deal Brexit is removed from the equation. It says record employment in the UK and annual wage growth of +3.4% per annum justify such a move. 

The chart below shows UK average weekly earnings against UK interest rates over the last four years.

Central bankers are cautious and the Bank of England will likely wait until the 29th of March or after, before showing its hand. 

What we expect

The Brexit process continues to overshadow the UK economy, however, there’s a growing feeling that if the ‘cliff edge’ can be avoided, then the UK could be among the best performing economies in Europe in 2019/2020. 

While that remains the case, the pound can continue to appreciate against its major rivals. A stronger UK currency may not be good news for the UK 100 index. Many of the stocks that make up the index earn their living overseas, and stronger GBP exchange rates make the goods and services they sell more expensive to foreign buyers, which can drive the UK 100 index lower. That means good news for the pound is likely to be negative for UK equities and vice versa.   



Eurozone Q4 2018 GDP

14th February 10.00 GMT (Server Time 12.00pm GMT +2)

The performance of the German and Eurozone economies during the final quarter of 2018 will be in focus on the 14th of February. Both economies are feeling unloved by the markets and for a good reason: the Eurozone and its German flagship have been underperforming. 

German GDP growth dipped into negative territory during Q3 at -0.2% after almost a decade of growth. The Eurozone as a whole grew at a rate of just +0.2% in Q3 2018. Since then, PMI data suggests that it has cooled further. 

GDP is a measure of all the activity within an economy, and given the sheer scale of the task in recording it, is published in arrears as a lagging indicator. PMI data is survey based and can be gathered quickly making PMIs a leading indicator. 

If we combine the two, we get a pretty clear picture about what's happening inside an economy. 

This slowdown in Europe comes as the ECB stops buying bonds to stimulate the eurozone and an admission by Mario Draghi that, without central bank QE, some areas of the Eurozone would have experienced no growth at all over the last decade. Germany may avoid a technical recession - two consecutive quarters of negative growth - while the Eurozone would do well to maintain growth at +0.2%. 

Looking back over seven years of data in the chart below, you can see that GDP tends to follow forward-looking PMIs. 


What to expect

German Q4 GDP data comes out three hours before the Eurozone data, providing some insight into how that data will stack up. In the unlikely event that we see a strong German GDP number, that will bode well for the Eurozone data. However, that positivity could be derailed by a weak showing from Italy and any disruption caused to French economic growth by the ongoing yellow vest protests.

Though it's hard to be bullish, we should recognise that any positivity could see the euro rally, particularly if that news allows the market to contemplate even a token interest rate rise from the ECB, during 2019. 



Eurozone inflation (CPI)

22nd of February 10.00 GMT (Server Time 12.00 GMT+2)  

A week following the GDP data, we’ll get a look at levels of inflation across the Eurozone with the release of CPI inflation data. One of the reasons the ECB spent billions of euros each month buying Eurozone government and corporate bonds were to encourage the reinvestment of sale proceeds, which should have stimulated inflation. 

Despite trillions of euros worth of purchases, inflation remains well below levels seen in 2010 and the ECB's own target of +2.0%. Broader measures of inflation stand at +1.6% and core measures which exclude items such as food and fuel are currently at +1.0%.


When we think about inflation, we tend to think about rising prices. We can also view inflation as a measure of excess demand. Inflation is a good thing because its presence tells us that the economy is experiencing growth and that demand is leading supply, which needs to work harder to catch up.

This is the inflation that ECB was trying to create through its bond-buying programs. The chart above plots the broad measure of Eurozone inflation against the growth in the ECB balance sheet during QE. This shows us how much the ECB spent and what effect that spending had on inflation. As we know, that stimulus has now been withdrawn.

What to expect 

The ECB has recently reduced its inflation expectations for both 2019 and 2020 based on the poor performance and weak data seen in the Eurozone. The central bank has said that risks to the Eurozone are now to be found on the downside. 

As with the GDP data, the market has priced in much of the bad news and that means that Eurozone assets like the euro and equity indices such as the Germany 30 and EU stocks 50, should be more sensitive to positive news. If the data is inline with expectations, markets will be mostly unmoved, but if we see data that bucks the recent trend and beats forecast, then they should warm to that. 


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