Monetary Policy Coordination: From Global Easing to Global ‘Tightening’

Abstract: An interesting series of central-bank announcements over the past semester confirmed my view of a global central banking monetary policy coordination. The first two major players that hinted in a speech that the central bank might slow down their asset purchases were the ECB and the BoJ; but more recently we heard hawkish comments coming from the BoC, RBA and even the BoE. In this article, I will first review the quantitative tightening (or the Fed balance sheet reduction program), followed by some comments on the current situation in the other major central banks combined with an FX analysis.

Link ==> US Dollar Analysis 2

FX positioning ahead of the September FOMC meeting

As of today, most market participants are getting prepared [and positioned] for the FOMC meeting on September 20/21st in order to see if policymakers stick with their Jackson-Hole hints, therefore I think it is a good time to share my current FX positioning.

Fed’s meeting: hike or no-hike?

I think that one important point investors were trying to figure out the last Jackson Hole Summit last week was to know if US policymakers were considering starting [again] their monetary policy tightening cycle after a [almost] 1-year halt. If we look at the FedWatch Tool available in CME Group website, the probability of a 25bps rate hike in September stands now at 18% based on a 30-day Fed Fund futures price of 99.58 (current contract October 2016, implied rate is 42bps).

CME.png

(Source: CME Group)

In addition, if we look at the Eurodollar futures market, the December Contract trades at 99.08, meaning the market is pricing a 1% US Dollar rate by the end of the year. We can clearly notice that the market expects some action coming from US policymakers within the next few months. However, recent macroeconomic data have shown signs of deterioration in the US that could potentially put the rate hike on hold for another few months. Following last week disappointing manufacturing ISM data that came out at 49.4 below its expansion level (50), ISM Service dropped to 51.4, its lowest number since February 2010 and has been dramatically declining since mid-2015. I strongly believe that there are both important indicators to watch, especially when they are flirting with the expansion/recession 50-level. We can see in the chart below that the ISM manufacturing PMI (white line) tracks really ‘well’ the US Real GDP (Annual YoY, yellow line), and as equity markets tend to do poorly in periods of recession we can say that the ISM Manufacturing / Services can potentially predict sharp drawdowns in equities.

Chart 1. ISM – blue and white – and Real US GDP Annual YoY – yellow line (Source: Bloomberg)

ISM_US.JPG

Another disappointment came from the Job market with Non-Farm Payrolls dropping back below the 200K level (it came out at 151K for August vs. 180K expected) and slower earnings growth (average hourly earnings increased by 2.4% YoY in August, lower than the previous month’s annual pace of 2.7%).

This accumulation of poor macro figures halted the US Dollar gains we saw during the J-Hole Summit and it seems that the market is starting to become more reluctant to a rate hike in September. The Dollar Index (DXY) is trading back below 95 and the 10-year rate is on its way to hit its mid-August 1.50% support (currently trades at 1.54%). What is interesting to analyse is which currency will benefit most from this new Dollar Weakness episode.

FX positioning

USDJPY: After hitting a high of 104.32 on Friday, the pair is once again poised to retest its 100 psychological support in the next few days. This is clearly a nightmare for Abe and Kuroda as the Yen has strengthen by almost 20% since its high last June (125.85). If we have a look at the chart below, the trend looks clearly bearish at the moment and longs should consider putting a tight top at 105. I would stay short USDJPY as I don’t see any aggressive response from the BoJ until the next MP meeting on September 21st.

Chart 2. USDJPY candlesticks (Source: Bloomberg)

USDJPY.JPG

EURUSD: Another interesting move today is the EURUSD 100-SMA break out, the pair is currently trading at 1.1240 and remains on its one-year range 1.05 – 1.15. As a few articles pointed out recently, the ECB has been active in the market since March 2015 and has purchased over 1 trillion government and corporate bonds. The balance sheet total assets now totals 3.3 trillion Euros (versus 4 trillion EUR for the Fed), an indicator to watch as further easing announced by Draghi will tend to weigh on the Euro in the long run. The ECB meets in Frankfurt on Thursday and the market expect an extension of the asset purchases beyond March 2017 (by 6 to 9 months). I don’t see a further rate cut (to -0.5%) or a boost in the asset purchase program for the moment, therefore I don’t think we will see a lot of volatility in the coming days. I wouldn’t take an important position in the Euro, however I can see EURUSD trading above 1.13 by Thursday noon.

Chart 3. EURUSD and Fibonacci retracements (Source: Bloomberg)

eur

Another important factor EU policymakers will have to deal with in the future is lower growth and inflation expectations. The 2017 GDP growth expectation decreased to 1.20% (vs. 1.70% in the beginning of the year) and the 5y/5y forward inflation expectation rate is still far below the 2-percent target (it stands currently at 1.66% according to FRED).

Sterling Pound: New Trend, New Friend? The currency that raised traders’ interest over the past couple of weeks has been the British pound as it was considered oversold according to many market participants. Cable is up 5% since its August low (1.2866) and is approaching its 1.35 resistance. I would try to short some as I think many traders will try to lock in their profit soon which could slow down the Pound appetite in the next few days. If 1.35 doesn’t hold, then it may be interesting to play to break out with a new target at 1.3600.

Chart 4. GBPUSD and its 1.35 resistance (Source: Bloomberg)

GBP.JPG

I would short some (GBPUSD) with a tight stop loss at 1.3520 and a target at 1.3350. No action expected from the BoE on September 15th, Carney is giving the UK markets some ‘digestion’ time after the recent action (rate cut + QE).

USDCHF: For the Swissie, my analysis stands close to the Yen’s one, and therefore I think the Swiss Franc strength could continue in the coming days. I like 0.96 as a first ‘shy’ target, and I would look at the 0.9550 level if the situation remains similar (poor macro and quiet vol) in the short term.

AUDUSD: Australia, as many other commodity countries (Canada, New Zealand), remains in a difficult situation as the deterioration of the terms of trade will tend to force RBA policymakers to move towards a ZIRP policy. However, lower rates will continue to inflate housing prices, which continue to grow at a two-digit rate. According to CoreLogic, house prices averaged 10-percent growth over the past year, with Sydney and Melbourne up 13% and 13.9%, respectively. Australian citizens are now leverage more than ever; the Household debt-to-GDP increased from 70% in the beginning of the century to 125% in Q4 2015 (see chart below). This is clearly unsustainable over the long-run, which obviously deprives policymakers to lower rates too ‘quickly’ to counter disinflation. As expected, the RBA left its cash rate steady at 1.50% today, which will play in favor of the Aussie in the next couple of weeks. One interesting point as well is that the Aussie didn’t react to an interest rate cut on August 2nd, something that Governor Glenn Stevens will have to study in case policymakers want to weaken the currency. There is still room on the upside for AUDUSD, first level stands at 0.7750.

Australia.png

(Source: Trading Economics)

Chinese Yuan: The Renminbi has been pretty shy over the past two month, USDCNH has been ranging between 6.62 and 6.72. The onshore – offshore spread is now close to zero as you can see it on the chart below (chart on the bottom). I don’t see any volatility rising in the next few weeks, therefore I wouldn’t build a position in that particular currency.

Chart 5. CNY – CNH spread analysis (Source: Bloomberg)

CNH spread.JPG

 To conclude, I think that we are going to see further dollar weakness ahead of the FOMC September meeting as practitioners will start to [re]consider a rate hike this time, especially if fundamentals keep being poor in the near future.

The JPY and some overnight developments…

The last development that I found interesting lately was certainly USDJPY breaking out of its [four-month] 101 – 103 range on August 20. Despite US LT yields trending lower (10-year trading below 2.40%) and the BoJ showing no interest of increasing QE even though the economy printed dismal figures (except a strong CPI), the Yen has weakened by almost two figures in the past couple of weeks against the greenback and is now trading slightly below 105.

I was a bit surprised by this breakout as I thought until lately that the JPY had no reason to depreciate against the US Dollar (especially with a quiet BoJ and US LT yields expected to remain low in H2 according to analysts). My thoughts was that the Yen depreciation mainly came from the carry trade positions (‘risk-on’ sentiment) with AUDJPY trading at new highs at around 97.50 (which corresponds to June 2013 levels), and I first assumed that the risk-on situation isn’t fully established and the market was just looking for ST opportunities and that any major ‘bad’ news could potentially trigger some massive carry unwinds as we saw previously (aka Yen appreciation).

However, after a few chats with some FX strategists (who I all thank for their kind answers), a first important thing to notice is the decrease in the 6-month (daily) rolling correlation between AUDJPY and S&P500 from 67% back in mid-February this year down to 47% today. In other words, the Japanese Yen sensitivity to risk-off moves has fallen as you can see it below in the Bloomberg Spread Analysis.Audcorr

(Source: Bloomberg)

Secondly, traders and investors are becoming more confident on a BoJ move later on this year, and further easing by JP policymakers (after Japan dismal figures: July household spending collapsed 5.9% YoY, Q2 GDP shrank by annualized 6.8% erasing Q1 gains, Housing starts down 14.1% in July…) is the main driver on Yen weakness according to analysts.

Eventually, another factor to look at would be Japanese institutional investors switching from bonds to stocks (and international stocks and bonds); we saw strong demand for French OAT from Japan last week. For instance, as you can see it below, GPIF, Japanese 1.2-trillion-dollar retirement fund, reduced its domestic bonds holdings by almost 10 percent in the past 3 years and has gradually increased its holdings of Japanese equities and International Bonds and Stocks. In June this year, it reported that it held 53.36% of domestic bonds and 17.26% of domestic stocks, down from 62.64% and 12.37% respectively back in 2011 (Abe’s effect). As a reminder, GPIF has a 60% target for domestic bonds and 12% for Japanese stocks, with 8% and 6% deviation limits respectively for those assets.

Gpif

Having said that, the 105 level could potentially act as a psychological resistance at the moment, next important level on the topside stands at 105.44, which corresponds to January 2nd high. USDJPY looks a bit overbought as you can see it on the chart below, and I will look for lower levels to start considering buying some more.

JPY-2-Sep(1)

(Source: Reuters)

Aussie pausing as I expected…

The late US Dollar rally (USD index flirting with 83.00, its highest level since July 2013) hasn’t impact the Aussie (that much) and AUDUSD is still trading within its 5-month 0.92 – 0.95 range. The RBA left its cash rate steady at 2.50% (as expected) and looks unlikely to change it for some time, which is what I was assuming (see my article RBA is giving up…). The BBSW rates, which correspond to transparent rates for the pricing and revaluation of privately negotiated bilateral Australian dollar interest swap transactions, are trading quite flat with the 1-month and 6-month bills paying 2.66% and 2.69% respectively.

Despite AU annual inflation approaching the high of the RBA [2-3] percent inflation target range (Trimmed mean CPI came in at 2.9% YoY in the second quarter), AU policymakers noted slack in the job market and rising house prices.

The trend on AUDUSD looks bearish at the moment; I will try to sell some if the pair pops back above 0.9300 ahead of US employment reports on Friday. I’d put an entry level at 0.9330, with a tight stop loss at 0.9360 and a target at 0.9210.

Figures to watch this week:

AU GDP YoY (sep. 3rd): expected to ease back to 3.0% in the second quarter, down from 3.5%.
AU Trade balance (Sep 4th): expected to come in a -1.51bn AUD in July.
US Non-Farm Payrolls (Sep 5th):  expected to print at 225K in August, above the 200K level for the for the seventh consecutive month.

Fighting against the Aussie…

An interesting development overnight was the Australian Q2 inflation data which is approaching the higher band of the 2-3% RBA target range. Australia’s trimmed mean CPI, the indicator the RBA officials look at which excludes volatile items that are included in CPI, rose from 2.6% to 2.9% in the second quarter (expected at 2.7%). The news lifted the Aussie to 0.9450 against the greenback as it slowed down the market’s expectations of another rate cut further this year.

AUDUSD started to recover from its last-week ‘losses’ after RBA Governor Stevens didn’t mention anything about the exchange rate overvaluation at a charity lunch in Sydney on Tuesday. As you can see it on the chart below, the increase in the 2-year AU-US yield spread (in blue) has pushed AUDUSD (yellow bars) to higher levels and the pair is now flirting with its resistance at 0.9460. A breach of that level could easily bring us to the next resistance area 0.9475 – 0.9500 (which corresponds to levels we saw in the beginning of the month).
I remain bearish on the Aussie and I think that a bounce back above 0.9500 could be another interesting level to start shorting the pair with a stop loss above 0.9560. My medium term target remains at 0.9200.

AUD-Spread

(Source: Reuters)

Another graph that I like to watch is AUDJPY. As you can see, the pair is approaching its first strong resistance at 96.00 (currently trading at 95.90). It seems that the market has been rejecting AUDJPY above this level over the pas few months, and for those who are not convinced on the AUDUSD trade, it could be also interesting to enter a short position on AUDJPY at current levels, with a stop loss above 96.60 and a first target at 94.60.

AUDJPY-23Juy

(Source: Reuters)

Markets after Yellen…

There have been some interesting developments for the past few days in the middle of this low-volatile environment. Firstly, Fed Chair Yellen opened two days of testimony on Capitol Hill yesterday, delivering the central bank’s semi-annual report to Congress. With the QE-Taper to end in October (already priced in), the market was waiting for more details concerning the ‘future path’ of the Fed Funds target rate (currently at a historical low of 0-0.25%). Despite strong employment data with Non-Farm Payrolls printing above the 200K level for the fifth month in a row in June (288K) and the jobless rate that edged down by another 0.2% to 6.1% (2008 levels), Yellen clearly stated that the US economic recovery ‘is not yet complete’ with the housing market showing ‘little progress’ but still disappointing this year.

However, she surprised the market a bit when she told the Senate Banking Committee that rates could rise sooner than planned. These comments ‘kind-of’ played in favour of the US Dollar, with USD index trading 80.50 at the moment. Its main component, the Euro (57.6%), broke out of his tight 1.3575 – 1.3675 range and is now trading at 1.3540 (see chart below). The next support on the downside stands at 1.3520, the 38.2% Fibonacci retracement of 1.2750 (July 2013 low) and 1.3992 (May 2014 high).

EUR-16-Jul

(Source: Reuters)

The second interesting development was the higher-than-expected CPI figures in UK that gave a boost to Cable after its last two weeks of weakening momentum. Annual inflation came in at 1.9% YoY in June (vs expectations of a 1.6% print), while CPI MoM increased by 0.2% (vs -0.1% consensus). It reinforced the market’s view that the BoE will be the first major central bank to lift rates. Even though some analysts are expecting a first move from UK policymakers later this year, I personally think that Q1 2015 sounds more reasonable. If we have a look at short-sterling interest rate futures, the March 2015 contracts sold off to 98.91 from 98.97, which means that the implied yield from 103bp to 109bp. Earlier this morning, UK claimant counts fell by 36.3K in June, following a revised 32.8K drop registered in May. The jobless rate edged down to 6.5% as expected.

After it reached a high of 1.7191 yesterday afternoon, Cable remains poised for a break above 1.7200 and is now trading at 1.7125. The first support on the downside stands at 1.7100, followed by 1.7060. A more interesting pair would be EUR/GBP, which is now trading at a 22-month low at 0.7900 and is approaching its next support at 0.7880 (see chart below).

EURGBP-16-Jul

(Source: Reuters)

Another surprise came from New Zealand where inflation accelerated less than expected, easing pressure on the RBNZ to continue its monetary policy tightening cycle. As a reminder, the central bank has increased its overnight cash rate (OCR) three times to 3.25% since the beginning of the year, and the market is still expecting a 25bps rate hike at the next meeting on July 23rd. I felt that the Kiwi strength would probably weigh on NZ policymakers’ decision at the next meeting, therefore I was expecting a correction on NZD (see my last trade short NZD/JPY). It was also interesting to play a technical bear correction on NZD/USD when the pair was flirting with its 3-year high as you can see it on the chart below.

NZD-16Jul

(Source: Reuters)

Quick update on BoJ and the Yen: USDJPY continues to trade sideways after the BoJ decided to keep its monetary policy unchanged (as expected), maintaining its target of increasing the monetary base at a annual pace of JPY60-70tr per year. The central bank cut its 2014 growth prediction to 1.0% (down from 1.1% last meeting and from 1.5% last October), but the board (9 members) unanimously maintained its inflation projection of 1.9% in the next fiscal year. If we have a quick look at the chart below, USDJPY is still trading within its tight 101.00 – 103.00 range. It found support slightly above the 101.00 level last week and seems on its way to test its next resistance at 101.94 (200-day SMA).

JPY-16-Jul

(Source: Reuters)

To finish, another currency AUDUSD that I have been trying to play lately is AUDUSD. The RBA minutes didn’t surprise the market on Tuesday despite AU policymakers’ willingness to see a lower Aussie (the minutes stated ‘the exchange rate remained high by historical standards’). I still think it is interesting to go short AUDUSD if the pair trades above 0.9400, with a medium term target at 0.9200 and a stop loss above 0.9560.

AUD-16Jul

(Souce: Reuters)

Events to watch this week…

1. The ECB meets on Thursday and we don’t expect much from policymakers despite low inflation and ECB M3 figures this morning. We saw that Flash inflation remained poor and steady in June (0.5% YoY), and ECB data on M3 Annual growth and Private Loan continue to disappoint. EURUSD recovered from its May losses and is now trading around 1.3650. The next resistance on the topside stands at 1.3672 (which corresponds to its 200-day SMA), followed by 1.3700. I would try to play the 1.3550 – 1.3670 range for the coming days, with a stop loss 50 Below/Above the range.

2. Tonight, the Reserve Bank of Australia is expected to keep its cash rate at a historical low level of 2.5%. I don’t see anything new; perhaps policymakers will try some more jawboning in order to push the Aussie down a bit. AUDUSD has remained pretty much rangy for the past few weeks, trading between 0.9330 and 0.9440. There seems to be a strong resistance zone at 0.9440/60 on the topside and it may be worth trying to sell some if the Aussie gets back to those levels for a test back towards 0.9330 (tight stop loss above 0.9480).

3. The Swedish Krona may continue to be under pressure this week ahead of the Riksbank meeting on July 3. The market is expecting the central bank to cut its benchmark rate by 25bps to 0.5% after CPI contracted by 0.2% YoY in May. Deflation is a drag and economists see it as a concern as it would only add to Sweden’s record household indebtedness. Even if the market is pretty bearish at the moment, I wouldn’t consider entering now as there is little room left. The SEK has depreciated 4.5% approximately against the Euro and the Dollar, and it may enter in an oversold area.