My Top Currency Charts

My macro & FX analysis is premised on both a detailed qualitative assessment of Emerging and G20 fixed income markets and economies and a rigorous quantitative analysis of data, trends, policy decisions and global events too often taken at face-value.

A picture can say a thousand words and a well-constructed and timely chart can shed light on often complex economic and market developments and challenge engrained assumptions.

Ideally, a chart will be forward-looking and a valuable tool in helping forecast economic and market developments and ascertain whether possible market mis-pricing may trigger turning-points or corrections.

There are of course limits to what even the best chart can do, with in particular the line between correlation and causation sometimes blurred. One should also be weary of reading too much into sometimes limited or patchy data sets and underlying data sources can add to or detract from the chart’s credibility.

Moreover, a chart can lose its potency over time, so while on average my research notes include about a dozen charts and tables I am constantly adding new ones.

I have re-published and updated below a small cross-section of the currency-specific charts which continue to play a central part in my narrative and forecasts, including:

  1. Global Nominal Effective Exchange Rates (NEERs)
  2. Euro and government bond yield spreads
  3. Sterling NEER
  4. Sterling NEER and annual pace of appreciation/depreciation
  5. The Renminbi NEER
  6. Renminbi NEER and monthly pace of appreciation/depreciation

 

I will in coming weeks expand on other notable charts and for a more detailed analysis I would refer you to my previously published (hyperlinked) research notes.

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Broken Records

The past year has been remarkable with political precedents set in the US, UK and France, still record-low central bank policy rates in most developed economies and financial markets and macro data at all-time or multi-year highs (and lows).

The US presidency is fraught with problems but markets are turning a blind eye…for now. The UK is still on course to be the first ever member state to leave the European Union come 29th March 2019, at least on paper. French elections have repainted the political landscape and present many opportunities but old (fiscal) hurdles still need to be cleared.

Central bank policy rates remain at record lows in the majority of developed economies, including the Eurozone, UK, Japan, Australia and New Zealand and I expect this to remain the case for the remainder of the year. Loose global monetary policy is likely to continue providing a floor to risky assets, including equities and emerging market currencies.

A number of central banks have hiked 25bp in recent months, including the Fed, BoC and CNB, in line with my year-old view that rate hikes would gradually replace rate cuts. But in aggregate the turnaround in developed central bank monetary policy is proceeding at a glacial pace and I see few reasons why this should change.

The Bank of England has not hiked its policy rate for 526 weeks – a domestic record – and I continue to believe that this stretch will extend into 2018.

In contrast to the Dollar and Sterling, the Euro – by far the most stable major currency in the past seven years – has appreciated over 7% since early April.

While the ECB may want to slow the current rapid pace of Euro appreciation, it is unlikely to stop, let alone reverse, the Euro’s upward path at this stage. For starters, Eurozone growth and labour markets continue to strengthen. The German IFO business climate index hit three consecutive record highs in June-August.

Perhaps the most obvious record which financial markets have broken is the continued climb in US equities to new highs and volatility’s fall to near-record lows.

Emerging market rates continue to edge lower in the face of receding inflationary risks and I see room for further rate cuts, particularly in Brazil given the pace of Real appreciation.

Non-Japan Asian (NJA) currencies continue to broadly tread water, in line with my core view that NJA central banks have little incentive to materially alter their currencies’ paths.

Year-to-date emerging market equities have rallied 24%, twice as fast as the Dow Jones (12%) which has rallied twice as fast as EM currencies versus the Dollar (6%). Read more

H2 2017: Something old, something new, something revisited

As we head towards the second half of 2017 and the one-year anniversary of the UK referendum on EU membership, many themes which have pre-occupied financial markets in the past 12 months are likely to continue dominating headlines.

These include Donald Trump’s US presidency and its longevity, merits and scope for tax reforms and infrastructural spending, Brexit negotiations which officially started on 19th June and the resilience of the ongoing recovery in global GDP growth.

Global GDP growth rose modestly in Q1 2017 to around 3.12% year-on-year from 3.06% in Q4 2016 and a multi-year low of 2.8% yoy in Q2 2016, according to my estimates.

But the global manufacturing PMI averaged 52.7 in April-May, down slightly from 52.9 in Q1 2017, suggesting global GDP growth may not have accelerated further in Q2. This could in turn, at the margin, delay or temper policy rate hikes and/or unwinding of QE programs.

Non-Japan Asian currencies have in the past month been even more stable than in the preceding month, in line with my expectations, but a more pronounced policy change – particularly in China – remains a possibility.

Other themes, such as the timing and magnitude of higher policy rates in developed economies and falling international oil prices, have recently come into clearer focus and will likely be of central importance in H2.

For the UK, I am sticking to my view that a 25bp policy rate hike this year is still a low probability event and I see little chance of an August hike.

The uncertainty over the MPC’s interest rate path and the government’s stance on Brexit complicate any forecast of Sterling near and medium-term but I continue to see the risks biased towards further depreciation.

In France, the hype surrounding Emmanuel Macron’s presidential and legislative election victories is already giving way to whether, when and how smoothly the LREM-MoDem rainbow government can push through its reformist agenda.

Finally, while most European elections are now thankfully behind us, European financial markets are likely to attach great importance to the outcome of Germany’s general election on 24th September.

Conversely, the burning topic of rising European nationalism and future of the eurozone/EU has lost traction following recent presidential and/or legislative elections in France, the UK, Netherlands and Austria. Read more

GBP – Hawkish Surprise Presents Selling Opportunity

Financial markets in the past week have had to contend with two UK-borne shocks: The ruling Conservative party’s loss of a majority in last Thursday’s general election and three MPC members voting in favour of a 25bp hike at today’s Bank of England policy meeting.

Sterling, which sold off sharply after the election result, has recovered this week and the more hawkish than expected MPC meeting has given the modest rally further impetus.

Confirmation of an alliance between the Conservatives and DUP, which is expected in coming days, may see Sterling strengthen further, particularly with markets digesting the implications of two further MPC members calling for higher rates.

This would, in my view, present an opportunity to short Sterling versus the dollar or euro, for five reasons:

  1. Conservative-DUP marriage is not one of choice and arguably not even one of convenience;
  2. Question of which type of Brexit is unlikely to be answered any time soon;
  3. MPC has become more hawkish but rate hike still unlikely near-term;
  4. Concerns over falling wages are at the heart of a UK economy which remains at best soft; and
  5. EU/eurozone growth slowly picking up and European nationalism on the back foot

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Politics suspected of interfering with economics and markets

In the US, political intrigue, seemingly lifted straight out of a John Le Carré novel, has reached a crescendo and there are now multiple investigations running concurrently.

If we assume these investigations will run over weeks/months, the question is whether and to what extent this political backdrop is likely to impact financial markets, US government policy-making, the US and global economy and Federal Reserve monetary policy.

US equities have corrected lower, volatility has spiked and markets are seemingly ignoring positive data surprises

It has all been rather orderly so far but it is difficult to see how at this juncture, with major policy initiatives likely kicked down the road, US equities can launch another meaningful rally. If anything big data misses are likely to further pressure stocks. 

The Dollar’s performance has been mixed in the past month, posting its biggest loss against the euro in line with the fundamentally bullish euro view I expressed in December and April.

Capital inflows into the eurozone allied to a 2% of GDP current account surplus, a pick-up in economic activity and receding political risks following the French presidential elections are likely to extend the euro’s current rally near-term.

However, the ECB’s stance on its quantitative easing program will be key in shaping the euro’s medium-term path.

US economic indicators paint a blurry picture while solid global GDP growth is seemingly struggling to make further gains.

The Fed and US rates market have the unenviable task of making sense of these macro trends and a quickly changing political landscape.

The apolitical Fed will of course stay above the political fray, even if markets do not with pricing for the probability of a 25bp hike at the 14th June policy meeting continuing to oscillate between 60% and 75%.

My core scenario is that the Fed will hike rates only once more in 2017 although I acknowledge that this is not a high conviction call. The market seems still on the fence, pricing in a further 32bp of hikes in the remainder of the year.
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The Ultimate Guide to the 2017 French Elections – Part III

The first round of the French Presidential elections is due to be held in 17 days (on 23rd April), with the likely second round two weeks later on 7th May. The eleven presidential candidates yesterday took part in the final televised debate before the first round.

Weighing their performances remains fraught with difficulty and the key question remains whether the centre-left candidate Emmanuel Macron and National Front leader Marine Le Pen are still likely to make it to the second round.

This in-depth four-part Election Series examines all core elements of the upcoming presidential and legislative elections and takes a quantitative and qualitative approach.

In Part III, I tackle five questions, looking at past presidential elections where appropriate:

Q1: At this stage can we predict with any accuracy the eventual winner?

The media would suggest that we cannot and there is certainly scope for surprises. At the very least opinion polls could be under or over-estimating candidates’ chances. But if Macron and Le Pen make it to the second round, Macron looks set to be elected President based on opinion polls.

Q2: Are French presidential opinion polls reliable?

They accurately predicted the outcome of the 2012 and 2007 presidential elections and the eventual winner of the 2002 election. But opinion polls under-estimated support for Jean-Marie Le Pen in the first round in 2002.

Q3: What are French opinion polls currently predicting?

Macron and Le Pen are neck and neck in the first round on about 25% but these polls do not account for undecided voters and turnout.

Q4: Do French regional elections tell us anything about candidates’ chances?

The December 2015 regional elections suggest that while Marine Le Pen will do well in the first round, she will struggle in the second round in the face of concerted political opposition.

Q5: What are the odds of a left-wing candidate becoming President?

While Mélenchon is likely to come a credible fourth, based on current opinion polls, neither him nor Socialist Party candidate Hamon are likely to get even close to making it to the second round.
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Chinese Renminbi – Squaring the Circle

China’s exchange rate policy is one of many significant uncertainties or “known-unknowns” for 2017 (as it arguably was in 2016 and prior years).

The market’s focus is still very much on the rise in USD-CNY but Chinese policy-makers are keen to emphasise the importance of the Renminbi’s performance against a basket of currencies – the CNY Nominal Effective Exchange Rate (NEER). This comes as no surprise.

The monthly pace of CNY NEER appreciation or depreciation has rarely exceeded 3% in the past seven years, suggesting that policy-makers have sought to control the Renminbi’s rate of change.

Large (and well documented) capital outflows from China have been the main source of Renminbi pressure but China’s current account surplus-to-GDP ratio has also edged lower to around 2.5% due to a rising deficit in the services balance. This perhaps dents the argument that the Renminbi is still materially undervalued.

Moreover, despite the Renminbi’s gain in competitiveness in the past year, China’s trade surplus has somewhat counter-intuitively shrunk, not increased. This may be due to price effects outweighing demand-effects (for exports) and still strong credit-fuelled Chinese imports.

In response to quarterly capital outflows of between $100bn and $200bn since late 2015, the PBoC intervened in the FX market to the tune of about $280bn in January-November.

This strong commitment likely reflects the perceived economic and geopolitical benefits of limiting the Renminbi’s depreciation.

Near-term, I think the PBoC may continue to see some value in a broadly stable Renminbi or only very modest CNY NEER depreciation. If capital outflows re-accelerate this would likely require the introduction of further capital controls and aggressive FX intervention. This is certainly an option in the short-run.

If capital outflows stabilise or recede, the PBoC may be able to slow or even stop FX intervention. This is not a totally unfeasible scenario if global yields stabilise and a slightly stronger CNY attracts capital back into China or if capital controls take greater effect.

In the more unlikely scenario whereby China experiences capital inflows, which last happened in Q1 2014, I would expect the PBoC to have limited appetite for rapid and/or sustained Renminbi appreciation and instead use this opportunity to rebuild FX reserves.
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Paradox of Acute Uncertainty and Strong Consensus Views

There appears to be a quasi-universal belief that 2017 will be characterised by acute uncertainty, with the list of difficult-to-predict economic and political variables growing exponentially in recent months.

These include the paths which Donald Trump will tread in the US and Theresa May in the UK, the Fed’s reaction function, the future of the eurozone and EU with European elections looming, the perennial question of China’s exchange rate policy and outlook for oil prices.

And yet, there is already it would seem a set of strong consensus views about the direction which economic variables and financial markets will follow in 2017.

US reflationary policies are expected to rule, boosting already decent US economic growth, inflation and US equities, in turn forcing the Fed to adopt a far more hawkish stance than in 2015-2016 and pushing US yields and dollar higher.

At the same time, President-elect Trump’s penchant for protectionism, alongside a strong dollar and higher US yields, are seen as major headwinds for indebted emerging economies reliant on trade and by implication for emerging currencies, bonds and equities. These seemingly include the Mexican Peso and Chinese Renminbi.

Moreover, the consensus forecast is that at the very least EUR/USD will fall below parity, having got close in December.

The perception of acute uncertainty is not totally incompatible with seemingly well-anchored forecasts but they do make uncomfortable bed-fellows.

Some of the uncertainties which have gained prominence can be put to rest, for now at least. At the same time, some of the sure-fire trades currently advocated may struggle to stand the test of time, in my view.

Marine Le Pen is very unlikely to become the next French President, the Italian banking sector will not be allowed to implode and the euro may end the year on a strong note.

Emerging market currencies have showed greater poise in the past few weeks, with a number of central banks showing both the appetite and the room to support their currencies. This should be borne in mind. Read more

EM currencies, Fed, French elections and UK reflation “lite”

Rising US yields, stronger dollar, FX outflows from emerging markets into US equities, President Trump’s still uncertain policies regarding global trade and country-specific concerns continue to weigh on EM currencies.

But the pace of depreciation in EM currencies has abated, with a number of central banks hiking their policy rate and likely intervening in the FX market. China is manipulating its currency but perhaps not the way that US President Trump thinks.

With the market having almost fully priced in a December Fed hike, it will focus on FOMC members’ likely further downward revision to their forecasts for the appropriate policy rate.

Commentators are making a number of assumptions about next year’s French presidential elections and the potential impact on the euro. Some seem reasonable, others less so.

The first assumption is that Fillon will beat Juppé in the second round run-off of the Republican primaries on 27th November. This is indeed the most likely outcome.

The second assumption, which I agree with, is that no presidential candidate will clear the 50% threshold required in the first round of the elections on 23 April to become President.

The third assumption, now seemingly hard-baked, is that no Socialist candidate stands even a remote chance of making it to the second round of the presidential elections on 7th May 2017. I would argue that it is too early to write off that possibility.

The fourth assumption, which I believe is still far-fetched, is that Front National leader Marine Le Pen could win the second round to become President, which in turn would precipitate France’s exit from the EU and pressure the euro.

UK markets’ mixed reaction to Wednesday’s Autumn budget was in line with my expectations of higher yields and stronger Sterling.

Chancellor Hammond’s modestly stimulative package reflects the realities and uncertainties which the UK economy has faced since the June referendum. This is still the over-riding theme markets will have to deal with in the near and potentially long-term.

Hammond had one hand behind his back and a moving target to hit. He has backloaded spending to 2018-19 and beyond with a focus on infrastructural projects to boost languishing UK productivity. Read more

Sterling: The lady’s not for turning (yet!)

There are multiple factors behind Sterling’s collapse in the past fortnight to decade lows and the question remains whether these factors will reverse any time soon.

At the top of the pyramid of causes for Sterling’s demise, in my view, is not the UK’s large current account deficit or Bank of England (BoE) policy but the stance on EU membership which Prime Minister Theresa May has adopted.

So while Sterling’s greater competitiveness may eventually drive FX inflows into the UK and help Sterling to recover, financial markets and investors are likely to continue to take their cue from the British government near-term.

Simply put, if Theresa May continues down of the path of “Hard Brexit”, however ill-defined, Sterling is likely to remain under pressure.

However, history shows that while EU leaders have a tendency to drag their feet over key issues, they are able and willing to eventually find some kind of compromise.

Moreover, Theresa May will be subject to the will of her own Conservative Party – which on the whole supports membership of the UK or at least a softer form of exit from the EU – and of the people.

While the BoE would prefer a more stable currency and lower yields, there is probably little than it can (or should) do near-term beyond trying to reassure markets, investors and households. Read more

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