Risk Appetites Curbed, US Leadership Awaited in FX

<br /> Risk Appetites Curbed, US Leadership Awaited in FX – Marc to Market<br />


Overview: The
euro initially reacted positively to the EU Parliament elections. The
populists did not do quite as well as many expected.  The two main
groupings failed to secure a majority, but with the help of the Liberals, and
possibly the Greens, that did well throughout Europe, a new European Commission
will be forged.  The heads of state meet later today, but no real
decisions are likely.  The horse trading will likely take most of the next
few months.  With the PP securing the most seats in the new EU Parliament,
its candidate Weber is the odds-on favorite to succeed Juncker, but Macron is
pushing Barnier’s candidacy. Still, the likelihood of a Germany EC President
means that Weidmann, who with a fortnight of the next ECB meeting, where
details of the next TLTRO is expected, said there was no need for additional
measures, is unlikely to replace Draghi in October. France is pushing for one
of their own (either the current Governor of the French central bank Villeroy
De Galhau or ECB board member Coeure.  Two other developments saw the
dollar strengthen:  President Trump indicating he was not ready to make a
deal with China and news that the EC may take action against Italy as early as
next week for its excessive debt.  The dollar is narrowly mixed against
the major currencies.  Sterling has been the worst performer, shedding
about 0.4% between yesterday and today amid fears of a no-deal Brexit. 
The MSCI Asia Pacific index edged higher for the third consecutive session, the
longest advance in five weeks.  Europe’s Dow Jones Stoxx 600 gained both
last Friday and yesterday but in the early going forward is struggling to
extend the advance.   US shares are trading with a heavier bias in
Europe.  Meanwhile, the bond market rally continues.  The US 10-year
yield is pushing below 2.30%. The 10-year German bund yield is minus 15
bp, while Japan’s benchmark is near minus nine bp. 
Italian bonds are the notable exception.  The 10-year yields are a couple
basis points higher to bring the two-day rise to 15 bp.   The
prospect of Syriza being turned out of office and a return of the conservative
New Democracy lifted Greek bonds yesterday, with yields tumbling over 20 bp
yesterday.  The Greek bonds a bit heavier today.  
Somewhat belatedly, the US recognized that Japan’s Prime Minister
Abe is in no position to make trade concessions ahead of the July upper house
 US officials had
sought a quick agreement to extend the agriculture deal that had been
negotiated with the TPP and EU to US farmers, who are being hurt by the
retaliatory tariffs.  However, with steel and aluminum tariffs still
levied on Japanese producers and threats of auto tariffs unless Japan violates
the WTO and agrees to “voluntary export restrictions,” there is a
limit on Abe’s ability to satisfy Trump.  Separately, and more stridently,
the EU also rejected quotas, voluntary or otherwise on auto exports to the
There are three Chinese developments to note.  First, contrary to speculation that China
would devalue the yuan to ostensibly offset the US tariffs and provide economic
stimulus, officials continue to resist pressure on the yuan in both word and
deed.  The head of regulation of banking and insurance in China warned
that if speculators are “shorting the yuan, they will inevitably suffer
huge losses”  The warning comes amid interest in options that would
benefit if the dollar rose through CNY7.0.  The yuan edged higher. Second,
for the first time, Chinese officials included economic issues as a “core
interest.” These are red lines for China, so to speak, that in the past,
included strategic issues, like Taiwan and Tibet.  This represents an
escalation and hardening of China’s position. Third, as the consequences
of the US action against Huawei ripple through supply and distribution
channels, China is drafting legislation that blocks doing business with foreign
(US) tech companies on national security grounds. 
For a third session, the dollar remains on JPY109-handle. A break of JPY109 would signal a move
toward JPY108.50-JPY108.60. Resistance is now seen in the
JPY109.65-JPY109.75 area. There is no significant option expiry today, but
there are options for around $2.2 bln that will be cut tomorrow, which are
struck between JPY109.75 and JPY110.00.  The Australian dollar seemed
to carve out a floor near $0.6865 last week and reached $0.6930 today before
meeting sellers.
  It returned to its session lows near $0.6915 in the
European morning.  Nearby resistance is seen near the 20-day moving
average (~$0.6945).  It has not traded above the 20-day moving average in
a little more than a month.  The Chinese yuan firmed against the dollar
before the weekend and yesterday but surrendered these gains today.  The
dollar finished the onshore session at a seven-day high near CNY6.9125.  
May led the Tories into a third electoral defeat, each more
stunning than the previous one.  
She first lost the Conservative majority in the House of
Commons.  Most recently, the Tories took a drubbing in the local
elections. In the EU Parliament elections, the Tories came in fifth
place.  The lesson many, if not all, the Tories are drawing is the UK
should leave the EU with or without a deal by the end of October. The
inability of Labour to capitalize on the Tories’ woes and its dismal showing in
the EU Parliament election is unlikely to topple Corbyn, but it may push him
further toward a second referendum.  However, Northern Ireland voted for
parties that want to remain in the EU, making it difficult for the DUP to
support Tory PM that would leave without an agreement. Without the DUP’s
support, national elections seem more likely than the Tories finding another
coalition partner.  If national elections are necessary, the end of
October deadline puts the new government in a bind, even if the EC was willing
to negotiate. While speculation of Draghi’s successor is in full bloom, May’s
resignation may change who replaces Carney at the end of January 2020. 
The nominations close at the end of next week. 
The populists in Europe did not show the surge that many had
  Overall, they got
a fraction less of the larger turnout than in 2014.  From a political
vantage point, Europe is in tatters.  The Austrian government, racked by
corruption in its anti-immigration coalition partners, collapsed over the
weekend. Belgium who held national elections on May 26 will take some time to
form the next government.  Spain, where the Socialists did well, are
struggling to form a government and is Finland.  The Greek government has
been widely trounced in local and EU Parliament elections is bringing forward
its national election.  The likely return of the New Democracy was cheered
by investors on Monday. The Yellow Vest demonstrations continue in France,
and Le Pen edged ahead of Macron’s En Marche.  Italy’s populists, as
represented by the Five Star Movement, have been outflanked by the
anti-immigration nationalists in the League.  Salvini-led the League to
more than 30% plurality.  Their share of the vote nearly doubled from
2014.  The further-right Brothers of Italy took 6% of the vote. This
may embolden Salvini to precipitate a political crisis.  He no longer
needs the M5S, and indeed, it is preventing him from being Prime
Minister.  At the same time, Salvini is feeling his oats, the EU is
contemplating fining Italy for the lack of progress on its debt, which it had
After an impressive recovery from almost $1.11 to $1.1215 before
the weekend, the euro has drifted lower.  It reached almost $1.1175 in the
European morning.
  There is a 540
mln euro option at $1.12 that will be cut today and may be deterring the
upside.  Last week’s short-covering rally appeared to have been led by US
accounts, and their leadership is awaited now. In that short-covering
squeeze, sterling recovered about a cent and a half from testing $1.26. Between
yesterday and today, sterling has shed two-thirds of its gain to return to the
$1.2650 area.
  Resistance is now seen near $1.2680.  Before last
weekend, the euro’s streak against sterling was stopped at 14 sessions, during which
time it rose from GBP0.8500 to GBP0.8850.  It rose yesterday and more
today to return to the highs. The GBP0.9000 beckons.   
The recent string of US data has been particularly dour.  One US bank cut its growth forecast for Q2
to 1%.  The New York and Atlanta Fed trackers are a little higher. 
This week’s April trade, inventory, and personal consumption expenditures see
further adjustments.  While China’s tariffs will be increased on June 1,
Canada and Mexico are lifting their counter-tariffs as the US ended its steel
and aluminum tariffs on them.  
One way that the Federal Reserve bolsters its case to be patient
is that it suggests the decline in inflation is temporary.  That warns of
an asymmetrical reaction to the PCE deflator to be reported on May 31.  A
soft report will be looked passed given the Fed’s bias. A strong report
can see a more dramatic market reaction.
The Bank of Canada meets on May 29.  There is little doubt that policy is on
hold. The Q1 GDP that will be released two days later will illustrate why
Canada is not easing rates.  While the market is aggressively pricing in
Fed cuts, it has the Bank of Canada steady.  The economy likely validates the
central bank’s confidence. The median forecast is in the Bloomberg survey
calls for a 0.7% increase after a 0.4% expansion in Q4 18.  

The US dollar remains rangebound against the Canadian dollar on
the CAD1.34-handle.
  A little less
than a third of the sessions have seen the range violated on an intraday basis
only to return back into the range by the end of the day.  In the
short-term, the broad risk appetite (proxy S&P 500) seems to be the key to
the Canadian dollar’s direction, within the range.  At the end of last
week, the dollar found support near MXN19.00. It is testing the MXN19.10
area now and could test the MXN19.20-MXN19.25 area if equities head


Risk Appetites Curbed, US Leadership Awaited in FX
Risk Appetites Curbed, US Leadership Awaited in FX

Reviewed by Marc Chandler

May 28, 2019

Rating: 5

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