For the summer months, three main drivers will dominate the FX macro; One, the divergence and relative success of lockdown 'exit strategies'; Two, sub-zero interest rate policies; Three, how far the combination of US election risk and blame game on coronavirus leads us down the trade war slope.
The Chinese Yuan
USD-RMB is being driven by the ebb and flow of US-China trade tensions.
The rise in China trade tension sees USDCNH getting caught in the crossfire. However, both parties have shown restraint from resuming a full-out tariff war like we saw in 2019. Indeed, China has taken steps to encourage more purchases of US goods, hence any massive RMB depreciation is unlikely particularly with portfolio inflows strong. These inflows are needed to support the domestic rebound, so weaponizing the Yuan is not in China's interest.
But that won’t stop President Trump from poking the hornet's nest as a hardline view on China will be the primary focus on President Trump’s re-election campaigns.
As the trade winds blow fair and foul, so will the course of the Yuan. But at this stage of the pillow fight it’s unlikely the PBoC will remove the countercyclical efforts any time soon – especially with the President touting the benefits of a strong dollar.
The central scenario is now a U-shaped recovery, but if a V shape is what you need to remain pliable, the apparent winners would be the traditionally "risk-on" currencies that have weakened the most in recent months. NOK, AUD, NZD, CAD, SEK and GBP would all likely fare very well in the initial stages, at the expense of the USD, JPY and CHF.
At this stage, a V shape recovery is an unlikely scenario which opens the following trades.
The Japanese Yen
The abnormally sizeable Japanese capital outflows were supporting USDJPY, even though US interest rates have plunged close to Japan's levels. The Yen now has a favorable balance between a currency that’s cheap on most metrics but doesn’t have a cost of carrying disadvantage acting as an anvil on its back.
The closer we get to 105 – which is widely seen as the low end of the current range – the higher the chance for Japanese hedge ratios to increase on USD assets. This will drive the USDJPY lower as, in this complex chain of events, it will result in a virtuous circle for the Yen.
The New Zealand Dollar
In a full-blown risk-off scenario the list of losers could be huge, but currency frailties exposed by central bank policy means the Kiwi could very well be the biggest loser.
The RBNZ Governor Orr is keeping an "open mind" to debt monetization, challenging what he has described as a "taboo" in central banking circles while seemingly intent on delivering a lower currency to aid the economic recovery. That should be a strong enough signal to send the NZD back into the mid 50's.
Current NZD levels do not look overly attractive for fresh shorts so, in the near-term, we could look for opportunities to sell on rallies. But in the second half, if the global economy continues to struggle, it’s bound to see AUD/NZD quickly rise above 1.10 and NZD/USD shift to the low-50s.
President Trump and the Dollar
You can read President Trump's latest comment on “a great time to have a strong dollar” in two ways. On the one side, the US Administration wants to portray that dollar strength as a clear sign that they’re open for business and that US assets and US exceptionalism is running high.
On the fiscal side, these deficits need financing now so a healthy or more stable US dollar is probably in the US administration's best interest. On the speculative side, the market has to buy into the idea that the Fed's action does not carry a significant inflation threat debasing the Greenback.
Of course, this narrative can and likely will change. When calmer times return, President Trump would probably revert to a push back against the USD's strength, hoping this would boost net exports.
These are odd times when one needs to look before jumping as currency level needs to be relevant as far as boosting trade, but at the same time the administration doesn't want to give off any ringing endorsement of inflation – especially in the US’s case with a substantial deficit to finance.
Will it change the way I trade the dollar next month? Probably not, but it make me think twice for a couple of weeks if I decide to go hog wild shorting the dollar.
As we transition from a world where central banks' primary function was inflation control to the new world order where their primary purpose is to finance government spending, many investors are logically exiting all forms of fiat currency.
Gold rallied despite modest risk-on investor sentiment. In Asia, Chinese data showed a pickup in production, but Germany's economy fell into recession in Q1.
Gold again made its big move in US trading. Neel Kashkari, President of the Minneapolis Fed, said a V-shaped recovery is "off the table" (Bloomberg). Out of all the possible recovery scenarios, a V-shaped recovery would likely hold the most bearish implications for gold as it would imply a robust recovery.
A raft of horrible data supported gold. US April retail sales contracted -16.4% m/m with core sales down -4.6%, according to the Commerce Department. April Industrial production fell -11.2%, according to the Commerce Department. The data show that industrial output fell the fastest in 100 years.
The market pushed above the year-to-date high of USD1,746/oz. The recent run of weak data is not surprising, but when the official numbers are released the low or negative data provides a stark reminder of how bad things are and punches golds ticket higher. The negative data highlights a contracting global economy, a contracting economy kills investment opportunities, gold's status improves and money on the sidelines finds its way into bullion.
Surging oil prices are also helping with the inflationary side of the gold trade and pressuring real interest rates lower.
What about silver?
Silver may offer the best leverage on a multi-year horizon as it’s a less expensive alternative to gold, is under-owned relative to gold and performed better than its more illustrious sibling during the 2008/2011 rebound. Of course, it’s more volatile than gold so that needs to be a consideration on your investment horizon.
Since March 20, the day before the Fed’s unlimited QE announcement, here are the percentage changes in fiat hedges:
The gradual lift of lockdowns is supporting the increase in oil demand that’s already been visible since mid-April as driving is picking up around the world, and the most significant improvements continue to be in gasoline road transportation led by the Chinese and US markets.
Crude prices have shown some signs of stabilization and traders are betting that sharp supply cuts will pull the oil market out of surplus and into deficit before too long. However, the market will need to work through a significant inventory overhang before the bull market fully kicks in. So, while price action might continue to be bumpy, it’s not too late to punch your ticket on the rally bus.
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US equities continue to welcome any high-risk event being put in the rear-view mirror – especially when rates markets look prime to consolidate lower