Via Kit Juckes at SocGen:
A mixed bag of data overnight (Japan deflation poor PMI in Korea, marginally better one in China, solid UK consumer confidence) but gloom is returning to markets. Our rates strategists have thrown in the towel on short duration trades, and that’s leaving FX is a mostly directionless mess.
No help from Japanese data or European financials for yen shorts, but NZD is slipping. FX weekly is below, and lays out longer term thoughts about the Euro. It’s going nowhere but the downside is increasingly limited and the danger of a spike at some point is growing.
The Euro continues to trade sideways, mirroring range-bound bond yields and a lack of economic surprises. This uninspiring cocktail can remain in place for a while, but the balance of longer-term risks is shifting. Further US dollar strength is more likely to come at the expense of other key currencies such as the Chinese yuan and Mexican peso, which together account for over a third of the dollar’s trade-weighted basket. The Euro’s downside has narrowed from the Fed’s caution and the ECB’s lack of policy manoeuvre.
The Norwegian krone has been one of the top performers among G10 currencies. The bounce in crude oil prices from the lows in 1Q16 paved the way for the krone to revalue from cheap levels. A combination of resilient growth, persistent inflationary pressures and booming housing sector has also compelled the Norges Bank to switch to a more neutral policy-setting. We expect the krone to continue to do well in coming months and quarters.
Vol: Get ready for a USD/JPY rebound
: Since June, USD/JPY has bounced off the 100 level four times, but the technical picture is now suggesting a large move either way by mid-October. We favour the topside, as the FX rate is lagging US yields, and the BoJ stance will weigh on the yen. Also, massive yen longs may be discouraged as the OPEC surprise is risk-friendly and the options’ skew is sending a softening signal. Buy a 3m digital call with a strike at 105, cheapened by a KO at 100 (leverage close to 7x). The level has been eagerly defended, and should not be tested if the bounce scenario materialises imminently.
EM – Latam FX divergence on politics
Latam FX has led the EM sell-off since Bernanke’s taper tantrum. Latam FX performance this year has been mixed despite the broad commodity rally, and the divergence can be attributed to politics, in our view. Major political events – impeachment of ex-President Rousseff in Brazil, the US presidential race, and the historic peace accord in Colombia – have affected various currencies significantly. We continue to see scope for differentiation, and single out BRL and COP as most likely to outperform in Latam, while the trigger for an unwinding of political risk premium in MXN remains subject to high uncertainty.
NZD/USD is showing signs of exhaustion in its rally with important near-term support at 0.7230/0.7200, and a break below would open the way to 0.6950. EUR/NOK meanwhile has confirmed a head-and-shoulders pattern with the projected target at 8.55/8.50.
The quant portfolio remains long carry and EM positions. The biggest longs are in NOK, AUD and NZD, while the most sizeable shorts are in USD, EUR, SEK and CAD.