Safe havens (JPY, CHF & Gold) remain in demand while USD vulnerable to intervention and aggressive Fed easing expectations

Safe havens (JPY, CHF & Gold) remain in demand while USD vulnerable to intervention and aggressive Fed easing expectations     

• China provides some stability yesterday strengthening the Yuan by setting its daily reference rate at 6.9683 and announcing a large bill issuance in HK for next week prior to the daily fix. However, USDCNY still remains above the key psychological 7.00 level at 7.0266 while USDCNH, after  hitting a high of 7.14, has come back down to trade around 7.05. FX traders however continue to look for opportunities to buy USDCNH on dips. China’s move to curb volatility follows the US Treasury Department formally labeling China a currency manipulator yesterday (the first such action in 25 years), while China claims the Yuan movement is a natural market reaction to trade tensions.  

• What it means to be (designated) a currency manipulator - the move by the US Treasury to label China a currency manipulator marks the latest escalation in the ongoing trade and currency dispute and while the designation itself does not trigger immediate US action, it should be viewed as indicative of the hardening US stance ahead of potential further trade negotiations and is likely to see markets price in higher risk of direct US action to weaken USD. This presents cross-currents for USD, but is also a clear negative signal for risk appetite and as such, non-USD safe-havens (JPY, CHF & Gold) are still likely to remain in high demand versus risk currencies (commodity, Asia EM and GBP) while EUR could see some further boost as investors continue to cut EUR-funded carry trades.   

• Fed President Bullard (voter and a dove) retains a calm message; Key highlights of his speech – (1) Fed has already adjusted policy to the fact trade uncertainty will remain high for years to come; (2) Fed should not react to short-term market movements; (3) It is not clear that the Fed wants to "pile on" more accommodation until its clear how moves impact the economy; (4) Elaborating on the last point, he does not see conditions that warrant a 50bp rate cut all at once. The Citi analyst base case is Fed will likely lower rates by 25bp in September, but a more prolonged cutting cycle is unlikely

• The outlook for USD however remains vulnerable to both US intervention (especially following the labeling of Chin as a FX manipulator) and rising Fed easing expectations as the US – China trade dispute rapidly escalates. US rates markets currently discount  almost 3 25bp rate cuts before year-end and a 1.0% terminal cash rate and that leaves USD vulnerable against the safe havens (JPY, CHF and Gold) as well as versus EUR (on possible intervention grounds).    

Markets pivoting towards an early UK election     

• Fueling early election speculation is news overnight that UK PM Boris Johnson has hired a renowned election guru, Isaac Levido as his new director of politics and campaigning at CCHQ. This will likely fuel speculation that an early election is imminent.  This all comes as government departments in Whitehall are given a 48-hour deadline to prove their readiness for a “No Deal” Brexit.

• The early election speculation is also fueled by UK Labor leader Jeremy Corbyn’s confirmation that he will seek to call an "early" confidence vote in PM Johnson. A successful “No Confidence” vote looks to be the best chance the UK parliament has to avoid a “No Deal” Brexit as PM Johnson's stated aim to renegotiate ex-PM May's Withdrawal Agreement is unlikely to succeed.            

Australia set to record first c/a surplus in 46 years but RBA keeps options open; Solid NZ jobs dampens easing talk         

• RBA Board meeting key highlights – (1) No rate cut but guidance remains mildly dovish; (2) Is constructive on domestic growth outlook; (3) But little erosion of labor market spare capacity; (4) Mild downside CPI forecast revision in 2020; (5) Citi analysts still see another RBA rate cut before year-end.

• Australia looks set to record its first current account surplus in 46 years - Another record breaking monthly trade surplus with May’s record trade surplus of $AU5.75bn revised upwards to $AU6.17bn and the June print at $AU8.04bn. Commodity exports rise to a new high (iron ore up +5%, coal up +4%) despite the escalating trade war between US and China. This means Australia’s Q2 current account should print at +0.3% of GDP which further insulates Australia from external downside risks. 

• NZ jobs data shows its best performance in over a decade, making this week’s RBNZ decision a tighter call - Employment rises 0.8% in Q2, almost 3 times the pace expected. Implications for monetary policy - consensus is for RBNZ to cut OCR by 25bps to 1.25% but Citi analysts think it would be better for RBNZ to lower guidance but not rates, citing NZ GDP growth at potential, CPI returning to middle of the target band and likelihood of stronger government spending in future. 

PBOC warns Yuan isn’t a one way bet but further trade escalation would likely weaken it further 

• EM markets remain nervous due to the "Currency Manipulator" designation on China by the US even as China moves to calm markets yesterday by announcing a stronger than expected daily CNY fix at 6.9683 (most model predictions had been around 6.9647) and the PBOC announcement that it will sell 30 billion of yuan bills in Hong Kong next week to lift rates (making it expensive to short CNH).  

• •That said, the RMB may weaken further – the above measures may be intended to dampen one-way CNY depreciation expectations and help contain capital outflow risks. However, if external pressures escalate, Citi analysts believe PBoC may be willing to see a weaker RMB, given narrowing domestic policy room. The PBoC also employs its counter-cyclical factor to curb volatility in the Yuan. But if policymakers were to de-activate the counter-cyclical factor, that would mark a meaningful escalation in the trade war”. 

This is an extract from the Daily Currency Update, dated August 7, 2019. Please approach a Citigold Relationship Manager if you would like more information.