Except for some minor commotion here and there as risk sentiment continued to yo-yo, markets have been hushed overnight as caution takes hold, ahead of Donald Trump speech tonight. The US curve closed flat, despite some choppiness at times, but overall US 10Y’s traded in a very narrow range and ended the day unchanged from the previous settlement at 124-25 or 2.38% in yield.
However, the same cannot be said for the commodity complex, which has seen the WTI plummet due to an increase in US and Canadian drilling, offsetting the planned OPEC production taper. There was also little support for oil prices as API inventory data reported 1.5 million barrel inventory, slightly higher than the consensus of 0.9 million.
Much of this impact was offset by surging industrial metals on the back of yesterday’s cracker of a China PPI print.
As for President-elect Trump’s presser tonight, traders will be viewing the speech with a high level of scrutiny, as the market’s exhilaration over “Trumpenomics”. Initially, euphoria gave way to a more calculated approach to the USD as we entered year end, and that has now morphed into a degree scepticism over the proposed US infrastructure spend.
Trump Watch
Tonight, President-elect Donald Trump will hold his first news conference since his election win and may shed some light on this trade protectionist stance. The two traditional trade protectionism proxies are MXN-USD and USD-CNY, both of which stand to suffer if Trump’s campaign anti-globalization rhetoric becomes policy.
Regarding the CNY/CNH, traders will also be on guard for currency manipulation comments. On cue, we have also seen USD/MXN jump to a new all-time high of 21.6227 overnight, while USD/CNH is on the climb briefly breaking 6.91 level.
Australian Dollar
The China reflation theme was front and center, as PPI came in much higher than expected at 5.5% YoY, providing a much welcome inflationary bump in China and the rest of APAC.
Iron ore prices soared on the print and were the primary driver for the surging AUD, despite weak retail sales print announced earlier in yesterday’s session. Therefore, the tug of war narrative between anticipated narrowing of AUD/USD interest rate differential and surging commodity price story continues to unfold.
While a tougher slog against the USD, AUD price action is very constructive of late, and provided commodity prices remain on the boil, we may see further momentum in the Aussie, but more so crosses, as I expect the long AUD/USD will continue to be a source of frustration given the Hawkish Fed outlook.
The reflationary trend continues to drive market sentiment, which is providing a boost to bulk commodity prices. However, if we get any hint or confirmation of the proposed US fiscal and infrastructure spend, I would expect US yields to soar. The prospects of accelerating inflationary pressures in the world’s two largest economies will likely suggest the market is mispricing the Fed with less than four hikes over the next two years, which should cause a sharp move higher on the US STIRT curve and drive the greenback considerably higher.
Japanese Yen
While USD/JPY is still the primary focus in G-10, external drivers dominate sentiment and with the USD yield softening, so is the trader’s appetite for dollars. Recent price action indicates that we are in consolidation mode with traders doing little more than trading the edges of the current range. Near term 115.00 offers strong support. I suspect the direction outcome from the eventual retest of the 116.25-75 congested order zone may provide some hint of a trend if all things remain constant. However, given the reluctance for dealers to add to USD longs at current levels, the top side appears capped also.
Yuan
Last week’s funding squeeze has done little to dissuade dealers yuan depreciation expectations, but will likely be viewed as a blight toward China’s ultimate goal for internationalization of the RMB.
With the ever growing number of restrictions, whether in the form of capital controls, covert intervention in money markets, or direct involvement through state-owned banks, the offshore market is hardly a market-friendly spot to conduct business. Fortunately, tight funding conditions have abated, but all too frequent interventions will sour international investor sentiment.
Overall, I see a sooner-rather-than-later test of the 7 level, which could occur after the Lunar New Year break, when Interbank dealers will likely stoke their depreciation engines.
Today the market is in Trump watch mode.
There has been lots of action on the EUR/CZK, as sentiment is growing that the Czech National Bank will remove the EUR/CZK floor at 27, as a positive domestic outlook all but assures a test of the bank’s 2% target early to mid-2017.
While some comparisons are being made to the Swiss National Bank moment, the possible market impact could be nothing further from the truth. Market positioning was massively long EUR/CHF, as there was no forward guidance from the SNB, while in the case of the EUR/CZK floor, the market is going short, so no SNB meltdown redux is expected.
The one thing to be cautious of is the crowded trade mentality with everyone going the same way along the interest rate and forward currency curve.
