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The Countdown to the Year End: What to Trade this Month

Posted on: 05 December 2018 , by: Pepperstone Support , category: Market Review

December Opportunities by Chris Weston and Darren Sinden

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Skip to: Currency Recap | BoC Interest Rate Decision | Nonfarm Payrolls | FOMC Rate Decision | Political Opportunities

Currency Recap

November saw the USD index close 0.2% higher, although the USD bulls had to express a bullish USD view on a far more selective basis than September, and it wasn’t all one-way traffic for the US currency. I would argue the greenback would be lower if it weren’t for the fact Europe has been such a disappointment in 2018 with slowing growth, while Italy has faced a political showdown with the European Union on its 2019 budget. At the same time, traders are keen to buy the GBP (it’s ‘cheap’), but the Brexit playbook is just too hard and we could still be facing a ‘hard Brexit’ or a general election and the potential for a Corbyn-led Labour government.

As mentioned, the USD didn’t have it all in its favour, and NZDUSD was the star performer in the G10 FX with a 5.5% gain last month. AUD followed closely with a 3.3% gain. Unsurprisingly, given the collapse in the crude price, the petro-currencies (i.e. the CAD and the NOK) fared poorly, but that may change with OPEC looking to address the supply imbalance.

Providing a tailwind to the AUD’s appreciation was the emerging market (EM) currencies, where we saw the TRY, ZAR, IDR rally 7.1%, 6.6% and 6.3% respectively. The rally in EM FX should be on the radar, as this space has found better inflows of late and is benefiting from a more nuanced Federal Reserve, who have been strong communicators in acknowledging the current symmetrical risks to the US economy. It’s clear that the Fed have moved away from a calendar-based guidance around when rates were expected to go up to one where they’re now purely data-dependent. We may get one hike in 2019, we may get three, but it will be driven by the US, and to a lesser extent global data flow. The USD will now be very sensitive to key economic data releases.

What we expect 

Trading opportunity - Gold is a buy through $1238 Trading opportunity- Gold is a buy through $1238

November has given us a peek at what 2019 could look like, and it appears the USD may struggle. The November FOMC minutes acknowledged the weakness in residential and business investment while putting a greater focus on tighter financial conditions. A quick look at the US bond market and the flattening yield curve may see a pause in the Fed’s tightening cycle and a weaker USD should see the unemployment rate tick higher. A weaker USD is one thing, but when the GBP is shrouded in political mystery, while Europe has too many issues to go over and there are clear issues with commodity and petro-currencies, where do you go?

The JPY offers some appeal, as do select EM currencies, but I’m leaning towards precious metals, which could benefit from being the best of the rest. To complete the holy trinity of gold tailwinds, we also need a sustained bout of market volatility and lower ‘real’ (or inflation-adjusted) bond yields. A close above $1235/38 is my trigger to start accumulating gold positions, as this will tell me the market is on board with this view and it is beginning to play out.

Key Economic Events

Bank of Canada's Interest Rate Decision

December 5th 15:00 pm GMT (17:00 Server Time GMT +2) 

Canadian interest rates have been rising steadily since July 2017. The Canadian economy enjoyed strong GDP growth rates, having dipped into negative territory midway through 2016. While it's true that growth rates have subsequently moderated once more, unemployment has started to move lower in mid-2018, and the inflation rate remains above 2.0%. House price growth, which the bank of Canada endeavours to keep under control to limit excessive inflationary pressure, has moderated. However, the metric remains highly elevated when compared to levels seen just a few years ago. 

Canada New Housing Price Index

Uncertainty about Canada's trading relationship with the USA and its membership of NAFTA made it difficult for the Bank of Canada (BoC)to have any real visibility about the overall economy going forward. However, those two issues have been agreed upon in principle as new tripartite trade terms between the US, Mexico and Canada since September. With that uncertainty mostly removed, there is scope for the BoC to raise rates on a regular basis. This thought is unlikely to take action at this meeting, though the central bank may hint at what's to come in 2019. Markets are pricing in a +0.25% rate rise for January, one of four rates rises predicted to take place in 2019, by analysts at Goldman Sachs. BoC has suggested that it could raise rates over time to 3.5% versus their current levels of 1.75% but it hasn’t been specific about how long the intervening period will be. Canadian money markets suggest an additional quarter-point hike in July 2019 from the BoC. However, they have yet to become as hawkish in their views as the US investment bank. Wll the BoC provide any more clarity over the timing of future rate rises and the catalysts for them at its December meeting?

What we expect 

Similar to USA, Canada’s job vacancy rates are climbing as unemployment is falling. Consumer spending also appears to be rising at a faster rate than wage growth, suggesting that consumers are feeling optimistic about the future and are prepared to live beyond their means or at least in the short-term. All of the above helps bolster the bullish case on Canadian interest rates. Meanwhile, there are growing concerns that the pace of US interest rate rises will slow in 2019. If those disparate views are reinforced by the data, then the stage could be set for Canadian dollar gains versus its US rival, with 1.31 and 1.30/1.2970 as the obvious near-term targets in USDCAD. 

 

November Nonfarm Payrolls 

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

US Nonfarm PayrollsUS Unemployment Rate
Forecast: 205,000 Previous:250,000 Forecast 3.7% : Previous 3.7%

Job creation in the USA during October came in at 250,000; a number that was 60,000 jobs over the forecast figure of 190,000 and deviated some +31% from it. That may have been a function of seasonal factors such as the bad weather on the East Coast during September, working their way out of the system and providing a boost to the October data. Whatever the root cause, the data was welcomed because it broke a downtrend in NFP numbers that had persisted since the February 2018 peak at 313,000 new jobs. Despite the bump in job creation during October, the unemployment rate remained unchanged at 3.7%, perhaps reflecting the decline in job vacancies registered during the previous month. That said, there were still over seven million vacancies in the US job market as of the September data. Recent flash PMI data in the US has been suggestive of somewhat slower growth in the US economy. According to IHS Markit, the data is said to be consistent with Q4 GDP of +2.5% and a November NFP figure of 185,000 new jobs. It's interesting to note that the PMI data is very strongly correlated to the new jobs forecast, though it has a relatively weaker correlation to the GDP figure. However, the +2.5% figure tallies precisely with the current Atlanta Fed GDPNow forecast, which derives its forecast from a series of leading indicators and other data inputs. The chart below plots the US GDP growth rates, a lagging indicator against the Markit Composite PMI (a leading indicator).  

US GDP GROWTH RATE US COMPOSITE PMI

 

Another leading indicator, as far as the NFPs are concerned, is the initial weekly jobless claims data. In our second chart, we plot this metric against the unemployment rate from January 2017 to date. Since September 2017, the two metrics have been tracking lower in tandem. However, initial jobless claims have recently been ticking higher which could lead to a softer NFP number in November, with no change or even a slight rise in the overall unemployment rate as well.

US INITIAL JOBLESS CLAIMS US UNEMPLOYMENT RATE

What we expect

We need to keep a sense of perspective about the performance of the US economy and remember that it has enjoyed almost a decade of unfettered growth. This expansion is likely to be at a very late mid-stage or early-to-late stage in the cycle. That suggests that a more gentle trajectory or glide path for the economy is likely. Under those circumstances, +2.5% GDP growth and job creation in the mid 180,000 should be considered impressive. However, markets can be demanding and can often price for perfection. As such, I think they’re likely to be more sensitive to the downside on this occasion. Weaker Jobs, unemployment data and other suggestions of slowing wage growth are all likely to be seen as being dovish on interest rates and therefore negative for the US dollar into the close of the year, notwithstanding the FOMC meeting on the 19th of December. 

 

The Federal Reserve December Interest Rate Meeting 

December 19th 19:00 PM GMT (21:00 pm Server Time GMT +2)

As we’ve noted above, there’s a growing sense in the markets that the outlook for US interest rates will not be as clear-cut as was previously thought. The most hawkish observers had forecast four or five rate rises in 2019 that would put US rates a full +1.5% above their current levels. However recent comments from FOMC members and a slew of weaker US macroeconomic data, have called that viewpoint into question. That softening in outlook has been reflected in the money markets with Fed Funds Futures for December showing declining expectations of a +25bps rise at the upcoming FOMC meeting. As I write, markets are pricing in a 75.8% chance of a December rate increase, though that number has dipped to as low as 68.89% in recent weeks. So while a December rate rise remains likely, it's not quite the ‘shoe in' it was once thought to be. 

Target Rate Probability History for Federal Reserve Meeting on 19 December 2018

If we look ahead to March 2019, we find the jury remains very much out, with a 44.1% probability of no change after a December rise, and only a 38.1% expectation of a further 25bps rise by the end of Q1 2019. The picture in June 2019 is even more fragmented, suggesting that the market is genuinely unsure about the path of rates in the second quarter of next year. For its part, the Fed, which asserted its independence in the wake of calls from Donald Trump to slow the normalisation of monetary policy, could take a pragmatic attitude and use the uncertainty in the markets to pull back from its hawkish course and talk a good game on rates in 2019, whilst raising them less frequently. After all, central banking is nearly always about balancing conflicting concerns. 

What we expect

Markets are still pricing in a rate rise at the final Fed meeting of 2018, and it would be a genuine shock if the open markets committee failed to push interest rates higher. However, markets will want to look beyond the headlines and try to tease out clues about the mindset of the committee members going forward from both the accompanying statement and press conference that follows thirty minutes later. The trade-weighted dollar, or dollar index, has been driven higher by rising US bond yields, reflecting concerns about rising government borrowing costs. Any hint that the Fed is considering slowing the pace of rate rises going forward should soften US Treasury bond yields and send dollar index lower as a result.  
 

Political opportunity 

The political clouds are clearing and even offering small rays of sunshine to traders, with the Italian-EU budget standoff looking like it’s coming to an end, while the market seems fairly comfortable with the US political environment, for now, anyhow. We’ve even seen a calming of US-Sino relations, with the agreement to revisit trade tariffs after a period of negotiation and consultation. That leaves Brexit for traders to navigate, but that in itself fills many with fear.

The vote in the Commons on Theresa May’s Brexit plan on the 11th of December 2019,is widely expected to fail, but it’s from this point that clarity is needed. That said, should we get the ultimate surprise and see parliament vote this through, then GBP will undergo one of the biggest rallies in living memory.

Concerning the playbook, a failed vote opens up the prospect of a hard or no deal Brexit, a second referendum, a no-confidence vote and even a general election, although this would only really come if a ‘no-confidence’ motion was called against the government. We could also possibly see Theresa May look to re-open talks with the EU regarding a reworked deal, but this really depends on the number of Tory MPs who vote against the deal and we haven't seen the sort of appetite for this from any of the key players. That said, in politics, it’s always the art of the deal, and we can’t rule out a reworked deal that would possibly pass a second vote.

What we expect

All of these outcomes have differing impacts on the GBP, and it’s no surprise most institutional funds have simply given up on trading the GBP. In my mind, the GBP is the most interesting currency to be watching, especially for those who can respect and harness volatility. It feels like the calm before the storm, and things are about to get very real for the GBP and FTSE 100.  

 

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