G10 FX Week Ahead: Gimme Shelter

The Coronavirus continues to scare global markets, which should continue to seek shelter under the low-yielders. In the US, the Democratic primaries will kick off and the data flow should remain supportive. Elsewhere, the RBA may deliver a surprise cut, adding pressure to the vulnerable AUD.

DXY: Data flow to stay supportive

• The dollar has been on a rollercoaster in the past few trading sessions as the Coronavirus fears prompted a rise in (USD-positive) safe-haven flows but also a revamp in (USD-negative) Fed easing expectations. We expect this week’s dataflow in the US to be broadly supportive for the greenback. Most of the attention will be on payrolls data on Friday, where our economists expect employment gains to remain solidly around the 150k area (in line with consensus), while wage growth could inch up to 3.0% (YoY). ISM surveys should also be USD-positive as we expect signs that manufacturing has bottomed while the service sector is holding up well. All in all, we expect next week’s data to start denting the expectations around Fed easing while the Coronavirus story (however unpredictable it is) may keep fuelling safe-haven demand. On balance, the dollar may continue to outperform risk-sensitive currencies but underperform vs low-yielders, making the case for a neutral weekly outlook.  
• Also, the Democratic primaries are set to kick off, with the vote in Iowa. The state only awards a total of 49 delegates, so the Caucus will be more important in timing than in size. Biden and Sanders appear tied in the polls, which however have to deal with a high number of undecided, which leaves a wide margin for surprises. Markets will likely look at the caucus in an attempt to gauge the different candidates’ momentum, but for now the implication for risk assets may be limited.

EUR: Lifted by dropping equities?

• EUR/USD showed some mild signs of life on Friday, rising to the upper half of the 1.10-1.11 range. The move was mostly triggered by the drop in equity markets, which benefited the EUR due to its funding characters. More news about the spread and dead toll of the Coronavirus will come during the weekend and the risk is that we may see another leg lower in equities as markets re-open on Monday. This may allow another small run in the EUR, with EUR/USD possibly advancing into the 1.11 region.
• The calendar in the Eurozone is not particularly inspiring next week and most focus will likely be on a few scheduled speeches by ECB officials. President Lagarde is due to attend two events on Monday and Wednesday but most attention will be on the remarks before the Committee on Economy and Monetary Affairs. At this stage, most of the focus is likely to remain on any comments around the ECB strategy review, given the lack of indication of any imminent change in the monetary policy stance.

JPY: Capital preservation mode

• JPY implied option volatilities look too low in light of the risks stemming from the Coronavirus. And given the JPY’s position as a strong hedge against equity risk plus no exposure to commodity exports, we expect the JPY to remain in demand. We would expect equities to have a difficult open to the week as Chinese stock exchanges re-open on Monday and potentially drag down global bourses.
• Macro data will likely be of secondary importance to USD/JPY this week and we suspect that solid US data provides little lasting support here. Typically Japanese authorities will not appreciate a stronger JPY, although JPY/KRW (a key cross rate for Japanese authorities) is still 5% below levels seen last summer. Were things to get really nasty with equities, we see outside risk to the 105 area in USD/JPY.

GBP: Stabilization ahead

• At the time of writing, the UK is spending its last hours as a EU member and will officially leave the Union at 11:00 pm. Markets have already moved their focus to what lies ahead for the UK, which is the bumpy road to striking a trade deal with the EU and other countries. Uncertainty around this topic appears elevated, and this may keep the upside for sterling broadly limited, curbing the currency’s momentum after the “hawkish hold” by the BoE this week.
• On the back of such uncertainty, the market should continue pricing in a probability of a cut in the second half of year (the BoE revised both the GDP and CPI outlooks lower). We expect a stabilization in GBP next week but, looking ahead, we see EUR/GBP move back above the 0.8500 level in coming months.

AUD: RBA may deliver a surprising cut

• The Australian dollar ends its worst week since last summer and heads into another crucial one. The RBA meets on Tuesday and markets have recently slashed their expectations for a cut: from almost 60% of implied probability to the current 17% in only ten days. The two key drivers of such repricing have been a reduction in the unemployment rate and an advancement in inflation. We note, however, that the increase in employment has only been driven by part-time workers, while full-time hiring was flat. Inflation has moved closer to 2% but remains far from the central bank's mid-point (2.5%) target.
• We think that the bushfire emergency as well as the concerns related to the Coronavirus (and its impacts on Chinese activity) play a key role in the Australian economic outlook and should convince the RBA to lower the Cash Rate (by 25bp) next week. Alternatively, a hold should still be charachterized by a more dovish tone hence suggesting an imminent rate cut. Given that the implied probability for a cut is very low, we expect the downside potential for AUD/USD to be significant. If the Coronavirus story keeps market on a risk-off mood, we cannot exclude a break below 0.66 next week.   

NZD: Likely to outperform AUD

• The NZD is one of the most exposed currencies to the Coronavirus, due to New Zealand’s economic ties with China and the high beta to risk sentiment. Moving ahead, with the spreading of the virus and the economic implication still hard to predict, we still think that the NZD bears less downside risks compared to its closest peer AUD.
• Next week, barring a turn for the best in the Coronavirus story, choppy risk sentiment keeps suggesting some downward pressure on NZD. A lot of potential spillover will come from the RBA meeting on Tuesday. A cut would likely push yields lower in NZ too as markets would raise their bets that the RBNZ will follow suit. This suggests downside risk for NZD/USD, but also for AUD/NZD, with the latter remaining under pressure (in our view) on the back of monetary policy divergence. 

CAD: Jobs market losing momentum

• CAD has managed to hold better than its risk-sensitive peers in the midst of the Coronavirus panic, mostly thanks to its looser economic connections with China and a modestly supportive data flow. The underperformance of oil continues, however, to pair with sluggish risk appetite in keeping the loonie under pressure.
• Next week will be focused on the labor report. The jobs market is indeed under special scrutiny after the Bank of Canada (within its dovish message) acknowledged that “job creation has slowed”. We expect payrolls change to have the “plus” sign but possibly a low figure. Unemployment may tick up and wage growth may edge lower. All in all, we suspect the labor market will lose momentum along with the whole economy. Also, keep an eye on BoC Deputy Governor Wilkins' speech, which might shed some light on the fresh dovish tone of the Central Bank. All in all, risks seem tilted towards more upside in USD/CAD next week.

CHF: watch out for USD/CHF this week

• EUR/CHF is beginning to comfortably trade below the 1.07 area as equities come more broadly under pressure. Evidence of SNB intervention is scarce, but this week will see January FX reserve data. These can be inflated by valuation changes (eg, of bonds and equities as well as the SNB’s FX reserve mix) making transparency on FX intervention difficult. This suits the SNB and frustrates the US Treasury.
• Weak growth in the Euro area, including a very poor 4Q19 GDP result in Italy, only adds to the pessimism on European activity. And actually a big fall in USD/CHF, eg, below 0.9500, will make the trade weighted CHF even stronger and encourage the SNB to resist CHF appreciation even more.

NOK: Very badly positioned

• Given its high beta nature and exposure to the oil prices, NOK has been on of the main casualties in the coronavirus induced decline in risk assets. With NOK exerting the lowest liquidity among the G10 currencies, this also doesn’t help the krone in times of stress. Given our cautious view on risk environment next week, we look for further NOK decline
• Domestic data should of a limited importance for NOK price action next week as global environment matters more. 4Q GDP (Fri) will be of interest. Re-testing the 2019 highs of EUR/NOK 10.3132 is on the cards.

SEK: Driven down by global risk

• With risk environment being unsupportive of cyclical FX, EUR/SEK clear bias remain on the upside. While not feeling the direct negative spillover coming from the falling commodity prices (unlike its commodity cyclical G10 peer such NOK), the outlook for SEK is nonetheless negative given the open nature of the economy.
• Domestic data should have a limited impact on the currency with risk environment, being the key. Jan PMI Services should thus be of secondary importance for SEK. EUR/SEK likely to test the 10.75 level, while NOK/SEK should continue falling, into the 1.03-1.04 area