Monday, 31 March 2014

FX & Global Macro Strategy - March 31st

G10 FX overview

We've seen a bit of a reversal in some FX pairs recently, with crosses like EURAUD, GBPAUD etc pulling back significantly as the AUD faced some short covering last week. However later in the week, there is the RBA where we could see further rhetoric towards the strength of the AUD, furthermore we have manufacturing PMIs for China which should see some volatility in the AUD. On top of this, we need to be vigilant for end of year JPY flows which should play some part in the USDJPY movement - however if we see Us equity rally and rates head higher - the corporate flow becomes irrelevant.The EZ CPI just hit the wires, coming in at 0.5% vs. 0.6% meaning the ECB later on in the week will be critical.

EZ CPI Y/Y - ECB still sees no deflation risk...

Most importantly we await the NFP at the end of the week, with estimates currently in and around the 200k range... however estimates tend to be very inaccurate. However given the move in short term US rates, I struggle not to be constructive on the USD over the coming few weeks. This, potentially mixed with stronger data could see the DXY trade back towards 81.

NZD - leaning off the highs, looking for downside

The NZD is still storming higher vs. the USD with it recently trading 0.87 matching the 2013 high meaning we are trading just 130 points below the 2011 high (which represents a generational high, only higher seen in the early 80's). However this represents some decent trading opportunities for leaning off these levels.

From a fundamental perspective, I see the RBNZ continuing their rate hiking program, however at a vastly slower pace than the market expects. I see another 25bps likely before a pause to assess the impacts with the OCR rate sitting at 3.00% for a short period of time. This is because the NZD is far above the high end estimates from the RBNZ and this will most certainly weigh on the minds of the governor and fellow voters. With the rate path being pushed back, we should see the NZD give back some of its gains that we've seen year-to-date. The OIS markets have priced in the aggressive rate hikes for some time, and this had fed through to the NZD, but we are still seeing an underlying bid emerge. Most likely as implied volatilty has dropped off significantly and therefore with growing carry, the attractiveness of the NZD keeps increasing as uncertainty (and cost to hedge) decreases.

NZD 3 month Implied volatility

The chart below shows the NZD with various resistance levels, the 3M implied yield (LHS), daily stochastics (P2) and the spread from 200DMA (P3). The latter indicator shows the spot is above thr 200DMA by about 5-6%, which is relatively quite high.

Stochastics show momentum is certainly slowing as we trade up towards the 2013 high. All in all, I'm short leaning on these levels for my stops, targeting a swing lower back to, at first, 0.8550

NZD overview chart

EUR and the ECB

So, we've just literally had the EZ CPI print hit the wires, and the EUR has dropped off a cliff (albeit a small one)

This is because it came in at 0.5% (0.49% to 2dp) vs. Estimates of 0.6%. This puts pressure on the ECB to act later on in the week. However I don't expect anything;

"Short term, only QE (GDP-weighted bond buying) would be a real game changer with enough force to meaningfully reverse the rising trend of EUR/$." - GS

For the EURUSD to meaningfully depreciate we need QE, however, given the fall in CPI is a lot to do with energy prices dropping and seeing the impact on CPI that the Feds QE program had, I find it unlikely that the ECB follow that route.

Furthermore a rate cut is possible, but given the already low yields, 10bps or so won't do anything - both to the markets and the economy. Therefore, lower inflation boosts the real yield spreads between the US and Eurozone, and even though nominal rates are lower in EZ, once adjusted for inflation, EZ rates are higher.

As we can see, EURUSD has been led quite well by real yields, and frankly there seems no change to this relationship going forward. This is why, a lower CPI can in fact be bullish for the EUR, but only as long as the ECB doesn't act on it (QE etc). Since writing, the EURUSD has rebounded 50 points back towards 1.3775 for this very reason.

As such, certain crosses such as EURNZD, EURAUD and EURCAD (less so CAD) look quite attractive at these levels.

NFP preview

We have the monthly Non-Farm payroll reading this Friday, its far from the most important. Given the recent Fed moves, the print seems almost irrelevant, as only a negative value would trigger some real thought about ending the taper program.

Currently estimates sit around 200k, which seems fair given other economic indicators. However I'd argue, as the weather has improved we could see upside surprises to the number. Thus supportive of the USD, and also US rates.

As such I still like being positioned long USD across the board (vis a vis, JPY/GBP/AUD/NZD etc)

Overall however, looking at the rollover on weekly vols, the market doesn't add to much of a volatility premium to the NFP

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