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AUD in free fall, ECB poised to gradually hint at tapering
AUD tumbled amid disappointing inflation data
The Australian dollar tumbled another 0.50% this morning amid disappointing first quarter inflation data. This report was the straw that broke the camel’s back as investors have been betting heavily on a pick-up in inflation that would have forced the RBA to revise its dovish stance. The headline inflation gauge rose 2.1%y/y in the March quarter, compared to 2.2% expected and 1.5% in the December quarter of 2016. This sharp increase has been mostly fuelled by the recovery in commodity prices. The core measure - that excludes the most volatile components - increased to 1.5%y/y from 1.3%, well below the central bank target range of 2%-3%.
This disappointing report suggests that the RBA’s next move will likely be a cut rather than a hike. AUD/USD lost more than 1.30% since Monday and is about to test the key support that lies at 0.7474 (low from April 12th). If broken, the door is wide open toward 0.7145 (low from May 2016). The risk is heavily skewed to the downside as investors will likely start to unwind their long AUD speculative positions - speculative net long positioning in the future market reached 37% of total open interest last week, according to data reported by the CFTC. In addition we likely see the resurgence of short US bonds positions as Trump’s reflation trade is making a comeback against the backdrop of investors who are desperately willing to believe in an upcoming growth boost in the US. We believe that the USD debasement is coming to an end and the Aussie is the first in line for the sell-off.
Turkish rate decision expected as lira has room to head higher
While the French Presidential elections are still taking the major attention from markets, central banks are also coming back. The Turkish Central Bank will likely announce early this afternoon that it will maintain its stance on the rates.
The Benchmark Repurchase Rate should be maintained at 8% to mitigate inflation risk. According to the national Turkish institution, the inflation rate climbed to 11.29 y/y from 10.13%. In addition, the Central Bank Governor Murat Cetinkaya is expected to have a current account deficit of 4% for 2017, which would mean that a recovery is actually happening. Currency-wise, the Turkish lira remains at an elevated level, although not weaker than the level of 3.87 liras at the end of January.
In our view, the geopolitical and political uncertainties are one of the greatest driver of the currency at the moment. President Erdogan won the constitutional referendum and this increases his power and he main remain in office until 2029. Diplomatic relations with the EU though are at a low point. We believe that USDTRY has some room to head even higher in the medium-term.
Big risk in FX markets, hint of tapering
We are heading towards a structural shift that will profoundly change drivers in the FX market. However, we remain six months away from that reflection point. In the autumn, due to momentum in inflation data, we anticipate the ECB and BoJ will acknowledge the need for tapering of emergence measures and then head towards monetary policy nominalizations. In our view, getting the timing right of this point will be critical for success in the FX markets. But for now, traders should watch the ECB and BoJ to avoid any communication suggesting tapering.
For the ECB, we suspect it is way too early for tapering hints despite growing pressure from the German membership of the governing council. We expected the result of the BoJ two-day meeting to maintain its current monetary policy strategy. The pace of JGB purchased will remain at ¥80trn per year. With Japanese inflation a long way from the 2% target, there is not a current pressure to discuss policy adjustments, especially considering any hint of tapering will have a strong effect on USDJPY, which has only recently regained a bullish trend from an April correction.
With US short end yields heading higher on the back of President Trump's tax reform (is the Trump trade back in play?) and solid signals from the US economy (including yesterday's impressive New Home sales data) markets will begin repricing Fed rate hikes, which now sits at two. In the short term, we are cautiously bullish on USD especially against G10 currencies. Elsewhere, Canadian retail sales are expected to disappoint (0.0% from 2.25% m/m) putting additional pressure on the CAD.