Headwinds for USD Continue Overnight

Headwinds for USD Continue Overnight    

• USD: Headwinds for USD continue overnight from: (1) More evidence of slowing US economic momentum with US December ISM services coming in lower than expected at 57.6 versus 58.5 consensus and 60.7 prior; (2) Political tensions continuing to escalate within US as President Trump is set to deliver a prime-time address on the border wall tonight with talk he may declare a national emergency on the southern border to divert funds from the Pentagon to build a wall. The move likely faces a legal challenge from House Democrats. (3) Further unravelling of USD safe haven flows as US – China trade tensions de-escalate - US-China trade talks kick off overnight with reports Chinese Vice Premier Liu He (President Xi’s top economic adviser) unexpectedly attends the meeting - indicative of the high importance China attaches to the talks.

• Focus this week is on US - China trade talks and while Citi analysts do not expect a material resolution of trade tensions yet, we note that markets are also simply not positioned for any positive developments on this front. Later this week, the FOMC minutes from the December meeting will also garner attention. Citi analysts expect repetition of the theme that subdued inflation means officials can be “patient” and flexible. Discussion of low inflation expectations however would likely be dovish. That said, Citi Research still expect two hikes in 2019 though risks are now skewed toward fewer and later.

EUR & GBP: Data weakness limiting euro upside for now but medium term prospects bullish; Sterling better supported as “No Deal” odds fade                                    

• Short term data euro zone data weakness notwithstanding, Citi analysts are now turning more hawkish on ECB rates in H2’2019 as (1) they do not see compelling evidence that the euro area is at risk of recession in H1’2019. (2) There now being clear evidence of euro area wages picking up even as core HICP inflation remains stuck at ~1% YY. However, it is perfectly normal for wages to run faster than prices, but for the gap to stay wider on a sustainable basis it would require a positive productivity shock.
  That is hardly in sight at the moment.

• This leaves two scenarios for 2019: (i) either underlying price pressures start to pick up more meaningfully as firms pass on higher input costs, or (ii) the 2018 wage acceleration turns out to be a mere one-off adjustment. Citi analysts believe in the former and now see the bar to rate normalization is probably lower than markets currently discount, partly because of the arrival of new (and likely less dovish) board members. Unless euro zone inflation expectations were to deteriorate noticeably and GDP growth to disappoint, the team believes that a less dovish ECB Executive Board might be more likely to lower the bar to a small rate hike in late 2019 than markets currently discount.

• In the UK, Citi analysts see "No Deal" Brexit risks as overpriced and the likelihood of the Withdrawal Deal eventually passing (even if not on the first attempt on January 15th) as underpriced. There remains only one deal on the table and passage would require some combination of Tory/DUP/Labor opponents to vote in favor (or at least abstain). If the deal fails, Citi analysts expect Parliament to seek an A50 extension (a request to the EU) or indeed revoke it, as the March deadline approaches, while a new referendum or new elections would also become much more likely in that scenario, too. Such an outcome could see an initial sterling rally but with subsequent major uncertainties limiting the gains in scope.

Commodity bloc: Resilient commodity prices to support sentiment; BoC seen lowering growth/ CPI forecasts but likely to be cautiously optimistic                                    

• Reports overnight suggest the Saudis may be mulling more cuts in oil production, likely contemplating a cut of 800k barrels a day from November levels and hoping for Brent prices to rise to USD80.

• This week’s BoC board meeting is the key event within the commodity bloc and is likely to see lower Canadian growth and inflation forecasts accompanied by some cautious optimism coming against the backdrop of Canadian rates now discounting just 8bp of BoC rate hikes in 2019. This compares to Citi's expectations for 2 – 3 hikes even if they are delayed (commencing in April) and more gradual.

Asia EM: China growth still slowing but RMB bearishness starting to fade

• USDRMB has gained some 1.7% since hitting a 6.9772 high in December. But despite the economic slowdown, China seems unwilling to let RMB weaken above 7.00 during trade negotiations with US. Corporate sentiment also seems to be turning less bearish as demand for RMB likely grows ahead of the Chinese new year while the Chinese government itself is also seen to potentially undertake measures to control resident outflows while pursuing policies to encourage offshore portfolio inflows.

This is an extract from the Daily Currency Update, dated 8th January 2019. Please approach a Citigold Relationship Manager if you would like more information.