January 3, 2020

What you may have missed and why it matters

BY Olivier Desbarres

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( 10 mins)

Financial-market post-mortems for 2019 are out and the bottom line is that the trade was to be long pretty much everything – including US and global equities, bonds and commodities (bar natural gas) – but short equity and FX volatility.

Trading FX last year was indeed an exercise in both patience and timing with depressed currency volatility going hand-in-hand with trading ranges in most Dollar-crosses – in particular USD/TRY, USD/IDR and USD/INR – narrowing sharply compared to 2018. The Chilean Peso was the notable exception, with political and civil unrest generating wild swings in USD/CLP.

These themes have broadly held true since the US and China three weeks ago agreed to a Phase One trade deal which they will reportedly sign on 15th January.

US equities have consistently hit new record highs, including on the first trading day of the New Year, and Latin American currencies and the high-yielding South African Rand have outperformed (see Figure 1).

However, the risk-sensitive Turkish Lira has dropped 3% while the safe-haven Japanese Yen and Swiss Franc have both appreciated 1% and the price of gold has surged 4.4% to a four-month high.

Moreover, the price of Brent crude oil, which was broadly stable in the second half of December, has spiked 4.5% in the past 24 hours, as has the S&P 500 VIX, in the wake of a deadly US air strike in Iraq on Iran’s military commander, General Qasem Soleimani.

The Dollar – on a downward trend since early September – hit a five month low on the last day of 2019 but in the past 24 hours has rebounded 0.4% as markets digest the possible implications of the US killing General Qasem Soleimani on neutral soil. US macro data have been mixed in the past fortnight and the Atlanta Fed GDPNow model, as of 23rd December, estimates annualised GDP growth in Q4 at 2.3% qoq, up slightly from 2.1% in Q3.

Sterling, which is down about 2% since its post general election spike, continues to surf unpredictable Brexit waves and a domestic economy which remained weak in Q4.

 

Past year (and past few weeks) not simply a case of “risk-on, risk off”

Financial-market post-mortems for 2019 are out and the bottom line is that the trade was to be long pretty much everything – including US and global equities, bonds and commodities (bar natural gas) – but short equity and FX volatility. Trading FX last year was indeed an exercise in both patience and timing.

This theme has broadly held true since the US and China three weeks ago agreed to a Phase One trade deal which they will reportedly sign on 15th January. US equities have consistently hit new record highs, including on the first trading day of the New Year, and Latin American currencies and the high-yielding South African Rand have outperformed (see Figure 1).

However, the risk-sensitive Turkish Lira has dropped 3% while the safe-haven Japanese Yen and Swiss Franc have both appreciated 1% and the price of gold has surged 4.4% to a four-month high. Moreover, the price of Brent crude oil, which was broadly stable in the second half of December, has spiked 4.5% in the past 24 hours, as has the S&P 500 VIX, in the wake of a deadly US air strike in Iraq on Iran’s military commander, General Qasem Soleimani.

 

What you may have missed and why it matters 8

 

Widespread central bank rate cuts have been a key theme since early May, in line with our forecast over a year ago that “policy rate cuts, which have all but disappeared since the spring, may yet resurface in the second half of 2019” (see Global central bank rate hikes: part solution, part problem, 21 December 2018). This theme has remained broadly intact in the past fortnight. The Mexican central bank cut its policy rate 25bp to a two-year low of 7.25% at its meeting on 19th December and on 1st January the People’s Bank of China announced a 50bp cut to all banks’ reserve requirement ratios, effective 6th January (see Figure 2).

 

What you may have missed and why it matters 9

 

The Riksbank, as expected, has bucked the trend by hiking its policy rate 25bp to 0% at its policy meeting on 19th December. The Swedish, Czech and Norwegian central banks are the only major central banks to have hiked their policy rates in net terms in the past year and central bank policy rates remain in negative territory in the Eurozone, Japan and Switzerland.

 

US Dollar slide has reversed in past 24 hours

The Dollar has been on a downward trend since early September, with markets favouring higher Beta assets. The Dollar Nominal Effective Exchange Rate (NEER) depreciated 0.7% in 2019, hitting a five month low on the last day of 2019 (see Figures 3 & 8). However, in the past 24 hours it has rebounded 0.4% as markets digest the possible implications and repercussions of the US killing Iran’s military commander on neutral soil.  US macro data have been mixed in the past fortnight. The Atlanta Fed GDPNow model, as of 23rd December, estimated that GDP growth had accelerated slightly in Q4 to 2.3% qoq (seasonally adjusted annual rate) from 2.1% in Q3.

 

What you may have missed and why it matters 10

 

  • 17th December: Manufacturing output, which has historically correlated closely with admittedly less volatile US GDP growth, rose 1.1% mom in November – its strongest rate of growth in almost two years (see Figure 4).
  • 19th December: Philadelphia Fed manufacturing index fell from 10.3 in November to a 6-month low of only 0.3 in December.
  • 20th December: Personal Consumption Expenditure rose 0.4% in November, in nominal terms and in real terms growth rebounded to 0.3% mom from 0.1% mom in October.
  • 23rd December: Durable goods orders fell 2.0% mom in November.
  • 30th December: Goods trade deficit (seasonally-adjusted) narrowed further in November to $63.2bn, its narrowest since August 2017.
  • 31st December: Conference Board index of consumer confidence, which fell sharply in September, was broadly unchanged in December (at 126.5) for the third consecutive month.
  • 3rd January: ISM manufacturing PMI, an indicator of economic activity in the US manufacturing sector, was broadly stable in October-November just above 48.0 but fell to 47.3 in December. It is down sharply from around 60 last autumn, with the manufacturing sector feeling the effects of slower global economic growth and the imposition of tariffs on US imports (including from China).

 

Choppy Sterling still surfing unpredictable Brexit waves

Sterling rallied hard in the immediate aftermath of the 12th December general election in which the ruling Conservative Party regained a significant 80-seat parliamentary majority. However, the Sterling NEER has since weakened 2% – the second weakest performer after the Turkish Lira (see Figure 1) – as markets weigh up the risks of a “hard” or “no-deal” Brexit once the UK has officially left the EU (in late-January).

UK macro data also point to domestic economic growth having remained weak in Q4. Final manufacturing PMI data for December were broadly unchanged from the flash estimate but the index has now been below 50 – indicating contracting activity – for eight consecutive months. On the demand size, retail sales contracted 0.6% mom in November (the fourth consecutive month of no growth) and data so far suggest that the festive period retail bounce was modest.

 

2019 was a case of “be long everything…bar currency volatility”

Our measure of global FX volatility fell to a 63-month low in late-November (see Figure 5) and we would point to a number of explanatory factors, including:

i) A lack of currency shocks;

ii) Limited contagion from the collapse in the Chilean Peso to other Latin American and high-yielding emerging market currencies;

iii) A paucity of major macro-data surprises;

iv) Finely tuned central bank FX intervention (particularly in Asia); and

v) Often well-telegraphed rate-cutting cycles.

 

Global FX volatility has picked up slightly in recent weeks, in line with our warning that “the risk is that it will rise in coming weeks”, but remains very low in absolute and historical terms (see Depressed FX volatility allows for few surprises, 22 November 2019). Volatility in most major currencies, including many high-yielding emerging market currencies, remains very close to its five-year lows (see Figure 6).

 

What you may have missed and why it matters 11

 

What you may have missed and why it matters 12

 

Moreover, depressed currency volatility has gone hand-in-hand with narrow trading ranges in the past 12 months (whereas a narrow trading range and high volatility are by definition mutually exclusive, a currency can exhibit low volatility but strong directionality over time). Indeed most Dollar-crosses – in particular USD/TRY, USD/IDR and USD/INR – traded in far narrower ranges in 2019 than in 2018 (see Figure 7).

 

What you may have missed and why it matters 13

 

  • Remarkably the Indonesian Rupiah and Indian Rupee ranges versus the Dollar (about 5%) were narrower than those of the safe-haven Swiss Franc and often dull Euro.
  • The Chilean Peso was the notable exception, with political and civil unrest generating wild swings in the currency. USD/CLP traded in a 28% range last year versus 19% in 2018.
  • The USD/THB and USD/KRW ranges were slightly wider in 2019, with the Korean Won beating to the tune of fluid US-China trade negotiations, but both remained modest in absolute terms at 8.4% and 9.7%, respectively (see Figure 7).
  • The USD/ARS range (63%) was still the widest in 2019 but only half the range recorded in 2018.
  • Among developed market currencies, the Swedish Krona last year posted the widest range versus the Dollar (12.3%) and the biggest loss (-5.4%). Weak domestic economic growth and a negative central bank policy rate battered the Krona which in NEER terms weakened about 4.3% in 2019 (see Figure 8).
  • The GBP/USD and NZD/USD crosses were the joint second widest (both 9.8%) within the developed currency universe, with the unpredictable Reserve Bank of New Zealand often setting the wide boundaries for the Kiwi Dollar.

 

What you may have missed and why it matters 14

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