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RBA on hold, traders get ready for FOMC meeting
AUD consolidates as RBA keeps a low profile
As broadly expected, the Reserve Bank of Australia held unchanged the official cash rate target at a record low 1.50%. The tone of the statement was slightly more positive than a month ago as Governor Lowe highlighted the positive trend in employment growth. Despite a pick-up in headline inflation in the first quarter (+2.1% y/y compared to 1.5% in the previous one), the central bank reiterated its cautious stance as core inflation is still running low and has shown little sign of improvement recently (core gauge printed at 1.5% y/y versus 1.3% in the previous quarter).
All in all, the RBA wants to avoid as much as possible to appear hawkish - mostly to prevent a sharp appreciation of the Aussie - even though it cannot turn a blind eye to the recent improvements, even minor ones. AUD/USD was treading water this morning at around 0.7530. The market is still heavily positioned for further appreciation of the Aussie. Indeed, net long speculative positioning, as reported by the CFTC, reached 39% of total open interest last week, suggesting that the risk is mostly to the downside.
Still bullish on the UK on Brexit
The market continues to make speculative negative bets on the eventual effect of Brexit on the UK economy. This has only heated up since PM May called for snap elections. We remain optimistic, based on Europe and UK mutual beneficial relationships, that the end-result will be significantly less severe than a “hard” Brexit. Within a historical context, the Europe-UK relationship has always had ups-and-downs but interactions have always been a constant. That will not change now. Secondly, both parties benefit from equality from the relationship (including bilateral trade), so threats are really meaningless.
UK domestic demand has slowed (annual retail sales ex auto fuel rose 2.6% vs. 3.8% exp from 4.1%) after a strong rally post-Brexit with many pointing to fears over punitive relocation in the financial sectors and its low productivity growth as the culprit. In addition, the rally in the GBP has removed some currency advantage for exporters and lure for foreign buyers.
We agree that uncertainty will clearly keep investment subdued yet the outright collapse or relocation of the UK’s vital financial sectors is overblown. Also, other key fundamentals remain healthy. The UK economy rose faster than many G10 nations, as Q1 GDP expanded 0.3% (pessimists point to the fact that pace was the slowest since before the referendum) with the annual rate at 2.1%. The breakdown was still optimistic with manufacturing sectors rising 0.5%, construction grew by 0.2% and even the service sector increased by 0.3%. We remain optimists that the final outcome will be a “soft” Brexit and the effect to the UK economy will be manageable.
Strangeness in US Q1 GDP data
The recent US Q1 GDP taken at the headline level suggests a significant slowdown in the economy. However, for years now the Q1 datapoint has under reported the actual fundamental health. This fact is not lost on officials but does get diluted when filtered into the mainstream.
This anomaly has been acknowledged by the Bureau of Economic Analysis, the agency that constructs gross domestic product data. In 2016, BEA statisticians recognized that their efforts to prepare for seasonality had problems, particularly for Q1. We are ill equipped to measure the methodologies but we understand that the markets are seemingly under-pricing the steepness of the Fed’s hiking cycle. This is partially due to the weak GDP read.
While leading data has been disappointing, we still see the US economy as healthy and warranting higher interest rates. Domestic consumption has fallen but after the very strong Q4 read. Perhaps most importantly, the Employment Cost Index (ECI), measuring wages and benefits, jumped 0.8% over the prior quarter. Friday’s NFP is expected to support the rise by increasing by 225k. Given our views on the US economy, we anticipate the Fed will signal a rate hike in June. Until the Fed’s announcement, expect the USD to stabilise around the current policy, but with a hawkish Fed anticipate USD buying on the under-positioning.
Pulpit Trump is making us dizzy
The machine gun-like frequency of US President Donald Trump's policy creation and reversing is making our head spin. Whether it is his administration's unbridled comments on currency, foreign affairs, healthcare, tax or trade policy, the lack of continuity is shocking but also extremely difficult to trade.
At this point we could not tell you if Trump favours a “strong” or “weak” US dollar. We remain consistent that fading the Trump hype and staying focused on fundamentals is the best FX trading strategy. In this regard, global fundamentals [despite China PMI falling to 50.3 for the 4th straight month of decline, it remains in expansion territory] and risk sentiments are supportive. US solid earnings, clearer US fiscal policy and lower European political risk only furthers our view to buy risky assets. We are bullish on Emerging Markets currencies, especially nations with solid domestic consumptions and commodity importers. The current weakness in commodity prices are a function of supply glut rather than demand issues. The breakdown of correlations with equities supports this thinking.
The low volatility environment should support INR, IDR, BRL and PLN despite some marginal idiosyncratic risk. For trades that embrace the volatility, KRW should have further upside but the trade might make your guts turn. The underperformance of high beta currencies in the last two weeks indicates additional upside. We suspect the JPY would provide to be a smarter funding currency due to its additional yields but also the expectation of yield steeping in the US driving JPY lower.