G10 FX Week Ahead: Blue Valentine

It probably won't be a happy Valentine's Day for pro-cyclical currencies, as the complacency in global equities poses the risk of another leg down, though oil-related currencies may get a free pass if OPEC+ agrees on more cuts. German data may endorse EUR/USD downside, while the Reserve Bank of New Zealand and Riksbank are unlikely to surprise the markets

DXY: Testing the patience of the White House

• The dollar is outperforming once again as the coronavirus and its impact on global supply chains is seen as a greater problem for Asia, Europe and the commodity producers. With European FX under pressure alongside Asia, the DXY is now pushing back towards 100 – a level which President Trump said was too strong back in August 2019. Clearly this is a market-led move in Asian and European FX – not a managed devaluation – so these DXY levels may see the President demand more rate cuts from the Federal Reserve rather than criticize trading partners. Indeed, the story of President Trump potentially instructing the US Treasury to weaken the dollar may resurface again. 
• So far the US data story is holding up well. Employment is strong, record highs for equities are lifting consumer confidence and should in the coming week contribute to some strong US retail sales for January – released Friday. Thursday should also see CPI headline and core inflation coming in around the 2.2/2.3% YoY area, perhaps limiting the downside for US rates at the short end. That will be the case unless US equities finally succumb to the downgrading of global growth caused by the coronavirus. Also, markets will keep an eye on Powell's testimony and what he has to say about the outlook and how the economy and monetary policy may fare given the worries about the coronavirus.

EUR: Schwarze Null – we’re talking German growth, not budgets

• So far there are very little signs of optimism in the Eurozone manufacturing sector – especially Germany. In fact, German industrial production fell a staggering 6.8% YoY in December, warning of another weak Eurozone reading (December industrial production is released on Wednesday). The data also points to downside risks to German 4Q19 GDP data released on Friday. Schwarze Null (Black Zero) may come to reference German growth and not just the balanced budget more normally associated with the phrase. This is all before the shock of the coronavirus is absorbed by the global manufacturing sector – e.g. reports about European car plants struggling with supply chain issues are beginning to emerge. Money markets are yet to price in further ECB easing – e.g. EONIA 1Y1Y is quite steady – but that could be the risk.
• We doubt the fall in EUR/USD has gone unnoticed in Washington. We think 1.0900 may be the low point for EUR/USD this week, not lower, because equities look fragile and a correction could trigger a short squeeze in the EUR and secondly the risk of Washington trying to talk down the dollar.

JPY: Too little risk priced in

• Irrepressible US equity markets are keeping USD/JPY bid and the relationship between the two is increasing. The degree to whether USD/JPY goes up or down on the coronavirus may well be a function of whether its effects are largely confined to Asian equities or extend more broadly. At this stage, we would warn about complacency in global equities – especially as the world over coming weeks will discover the true extent of the reach of Chinese supply chain disruption.
• US politics are yet to have a discernible impact on the dollar so far and we doubt that this week’s New Hampshire primary will have any either. The local Japanese calendar is light this week, but presumably the Bank of Japan will at some stage have to be knocked off their persistent view of a virtuous cycle of corporate profits, employment, consumption and inflation. That will certainly occur if global equity markets take a turn for the worse and USD/JPY knocks on the door of 105.

GBP: Trade-deal uncertainty keeps pointing down

• Markets are back to pricing in negatives for sterling that resemble the “no-deal” premium we saw weighing on the currency for a large portion of the past two years. Indeed, with the UK-EU trade negotiations starting on a very confrontational tone and the significant amount of concessions that the two parties would have to make to reach an agreement, the prospect of the UK leaving the EU in December 2020 without a free-trade agreement with the bloc does not look too distant.
• Next week, the key data releases in the UK are all condensed in one day (Tuesday), when 4Q preliminary GDP numbers will be released along with the industrial production numbers for December. We expect growth to have slowed to 0.9% YoY (consensus is centered at 0.8%), while industrial production may have mildly rebounded in the MoM gauge. All in all, we expect a broadly balanced impact of data on GBP which suggests the currency will remain vulnerable to further downside bets on the back of jittery sentiment when it comes to the UK-EU future trade relationships. On the political side, a reshuffle in the UK cabinet may trigger speculation around a more or less accommodative stance ahead of the trade negotiations, but we think the actual implications will be negligible.

AUD: From weak to weaker

• The Australian dollar is the worst performer in the G10 space since the news around the coronavirus came out and has just touched its weakest level vs USD since 2009. Not even the surprisingly upbeat tone by the RBA has been able to turn the tide for the AUD, which is still suffering from its high exposure to China, commodities and global risks in general.
• Next week will be quiet in terms of data releases, so the coronavirus will be once again the primary driver of currency movements. We continue to expect AUD to underperform its pro-cyclical peers if sentiment remains choppy, but we also think – in a longer-term perspective – that it bears a bigger deal of downside risk as we expect an RBA cut in the next months and also see the bush fire emergency add idiosyncratic downside risk.

NZD: RBNZ to follow RBA’s neutrality

• The coronavirus remains inevitably the key driver for NZD next week, considering that the currency has lost almost 2% since the start of the epidemic. This is no surprise when thinking that New Zealand has strong ties to the Chinese economy and the NZD has a high-beta to market risk.
• Next week, however, the RBNZ meeting will attract quite a lot of attention. The Bank has not touched its policy rate since August 2019 and we are inclined to think they will stick to their neutrality through 2020. Markets are pricing in a 35% chance of a cut by Q2. Focusing on this meeting, there are virtually no bets in the markets for a cut and our impression is that most investors are expecting very little in terms of change in language. Almost surely, the Bank will mention the downside risks stemming from the coronavirus outbreak, but we expect it to retain a wait-and-see approach to better assess the potential impacts on the NZ economy, similarly to what the RBA did only a few days ago. In terms of FX impact, the meeting may go down as a non-event, with relatively marginal implications for the NZD, that, in turn, we expect to be solely driven by the coronavirus news next week.

CAD: Hanging from OPEC+ lips

• Payrolls in Canada came in stronger than expected, with the unemployment rate dropping and wage growth rising to 4.4% YoY. However, the market's reaction, denotes how the key story remains the coronavirus as the gains in CAD were quickly erased after the jobs data release. However, despite underperforming in line with global risk-sensitive currencies, CAD appeared from the outset less vulnerable than the Antipodeans to the Coronavirus story. At the same time, if market sentiment recovers, the loonie offers a way more attractive carry compared to AUD and NZD which still convinces us that it will keep underperforming the other two.
• Next week’s calendar offers very little in terms of domestic data and along with the coronavirus developments, markets will focus on the reaction by OPEC+ to the recent slump in prices. Currently, the OPEC+ Joint Technical Committee (JTC) is making the recommendation to the larger OPEC+ group to deepen cuts by 600Mbbls/d to 2.7MMbbls/d until the end of June. An answer by Russian officials is expected in the next days. Our commodities team think that such cuts would be enough to compensate for the surplus in the crude oil market, which should ultimately assist recovery in prices. Positive news on this side should contribute to keep CAD more protected to the choppy risk environment than its risk-sensitive peers.

CHF: Bracing for another round of pessimism

• It feels like the SNB may well be intervening around the 1.0660 area in EUR/CHF – although it is impossible to know. The SNB only releases FX intervention figures in its annual report and the fall in SNB’s FX reserves in January may have been valuation-related – e.g. the SNB is one of the most risk-seeking FX reserve mangers, with relatively high weights in equities and corporate bonds.
• Typically, local Swiss data has had little impact on the CHF recently. The coming week should see Swiss January CPI coming in at 0.2% YoY, still barely away from deflation. Given equity markets’ apparent complacency to coronavirus risk – and the possibility that the SNB scales back FX intervention – seemingly as the Bank of Israel has done – then downside risks for EUR/CHF will certainly prevail in 1Q20. 

NOK: Some protection from oil prices?

• The krone remains highly exposed to the coronavirus story and EUR/NOK has been consolidating above 10.10 this past week. We suspect there is still some potential downside for NOK unless better news starts flowing from China, possibly more versus the USD than the EUR.
• As highlighted in the CAD section, next week will be a key week ahead for the oil market, which should tell us whether more OPEC+ production cuts are on the cards to curb the slump in crude prices. This story may help offset some of the negatives stemming from the lingering risk aversion. Elsewhere, CPI numbers in Norway should remain broadly stable and unlikely to change the inflation picture for now.

SEK: Riksbank to stay put, downside risk to linger

• The Swedish Riksbank meets again next week following December’s historic rate hike. We believe this was a ‘one and done move’ and are not expecting any moves from the Riksbank for the remaining of the forecasting period, and neither is the market. This meeting shouldn’t make too many waves, but it will be interesting to see if they revise their forecasts downward, as January’s inflation is likely to disappoint the central bank due to weak energy prices. While two members voted against the hike in December – including new joiner Anna Breman – it is unlikely that they will vote to reverse the hike just yet.
• From an FX perspective, this means that the rate announcement has high chances of going down as a non-event for SEK. The krona should, therefore, continue to be driven by global sentiment, with additional downside risk possibly coming from a round of negative data in the eurozone this week, due to its high beta to European sentiment.