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Swiss trade data jumps, oil sell-off continues
Switzerland’s trade activity picked up in May
After the usual March-April contraction, Switzerland’s trade surplus bounced back in May amid a sharp recovery in exports. The trade surplus rose to CHF 3.4 billion in May from CHF 1.96 a month earlier. Exports - in real terms - increased 2.9% m/m while imports eased to 2% m/m.
Exports to China passed the CHF 1bn threshold to print at 1.16bn while imports reached 1.02bn, leaving a trade surplus of CHF 139 million. Trade activity with the European Union also accelerated substantially with exports and imports rising 1.47bn and 2.12bn respectively, adding evidence that the European economy is on the right track.
It was quite a pleasant surprise for the Swiss watch industry as exports rose 9% last month compared to a contraction of 5.7% in the previous month. The sharp recovery was mostly driven by a surge in exports to Hong Kong, China and Italy, while Gulf countries reduced sharply their imports amid falling oil revenue and geopolitical uncertainties.
All in all, the report showed that the Swiss economy is still right on track but continues to suffer from the strong CHF. The recovery pace is solid especially given the slower than expected recovery in Europe and the United States. Swiss companies already optimised their functioning and no more gains can be expected on this side. Investments have been reduced to the minimum, costs have been cut. Economic improvement of Switzerland’s main trading partner is more necessary to see a substantial growth acceleration.
Load up on EM risk
Time to make hay while the sun is shining. We are highly constructive on EM FX risk given the current environment. The summer doldrums have hit but conditions are ideal for carry trading. EM economic outlook remains positive, spearheaded by improving trade data (US and EU economic momentum is more balanced). While in the G10 a soft inflation backdrop will keep monetary policy supportive, driving yields seekers in to EM, finally political noise such as President Trump's pro-growth agenda and rising protections threat has subsided.
Idiosyncratic domestic risks in Romania, Venezuela and Brazil to name a few have shown no hint of sparking broader contagion. We are focused on the growth differentials rather than just interest rates differential for FX carry selection. Depreciation of oil prices and negative price outlook has us avoiding crude-linked currencies like RUB, COP and MXN. In addition we have shifted away from USD as the primary funding currency due to the expectation of higher rates and political uncertainty driving rogue volatility, preferring JPY, CHF and even CAD due to bearish outlook for oil.
Looking forward there is scant scheduled events in July and August that could likely derail the EM carry trade. Political developments in UK-EU Brexit discussions are likely to slow while there are not enough US data points to decisively determine a recovery in 2H and firm repricing of the Fed interest rate path. Time to load up on EM carry risk.
Probability of November BoE hike increases
We continue to suspect that markets are underpricing the probability of a BoE policy adjustment. We suspect that as with the Fed, the threshold of removal of emergency measures is significantly lower than standard interest rate hikes. While interest rates in the UK never went negative, it's difficult for MPC members to justify ultra-easy policy given the economic momentum. BoE Governor Carney’s Mansion House speech dented our expectations of a 2017 rate hike.
However, BoE chief economist Haldanes indicated that marginal data would suggest hikes in 2H (most likely November). This is not the first time Haldane's view diverged from the MPC, but it will put the markets on alert for shifts in doves Broadbent and Vlieghe and improving data. Markets are now pricing in 12bp of hikes by end of 2017. To materialise our constructive GBP view, we see long GBPCHF as the ideal position.
Oil prices continue to slide; back below $40 within a few weeks?
Since May 23, oil has been in short-term decline. Crude oil is now testing its 1-year low mark around $42. We believe that the decline is set to continue. Since the Qatar diplomatic issue, there are growing concerns that other OPEC members will not respect the production cut and therefore oversupply.
Will the decline continue? When looking specifically to Saudi Arabia, the largest oil exporter in the world, we may believe this bearish trend should continue. The Arabic country really needs to have higher oil prices. Fundamentally speaking, its FX reserves have declined 27% from its 2014 peak. Just in 2017, it has diminished by $36 billion.
Current oil prices seem way too low for Saudi Arabia, which is in return obliged to liquidate its FX reserves to assume its running costs. On top of that, Saudi Arabia is willing to let investors buy 5% of its oil reserves. Yet, at the current oil price, this seems like a deal for bullish buyers. In our view, that means Saudi Arabia is concerned about future oil prices. In addition, the US shale gas industry is booming back and is putting deeper downside pressures on oil. We believe that the oil price should go back below $40 within the next few weeks.