Quintessence FX https://www.quintessencefx.com Providing Forex traders with the tools and the environment necessary to maximize their performance with an institutional approach. Thu, 30 Nov 2017 11:26:48 +0000 en-US hourly 1 https://wordpress.org/?v=4.9.1 124099082 Goldman Sachs Top Trade Recommendations for 2018 https://www.quintessencefx.com/goldman-sachs-top-trade-recommendations-2018/#utm_source=rss&utm_medium=rss&utm_campaign=goldman-sachs-top-trade-recommendations-2018 https://www.quintessencefx.com/goldman-sachs-top-trade-recommendations-2018/#respond Fri, 17 Nov 2017 16:09:58 +0000 https://www.quintessencefx.com/?p=36211 The post Goldman Sachs Top Trade Recommendations for 2018<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/f56768868c6490008f5cb6fb69008c5f?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Goldman Sachs Top Trade Recommendations for 2018

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We present the first seven of our recommended Top Trades for 2018. These trades represent some of the highest conviction market expressions of the economic outlook we laid out in the latest Global Economics Analyst and the related investment themes we discussed in our Global Markets Analyst.

Top Trade #1:

Position for more Fed hikes and a rebuild of term premium by shorting 10-year US Treasuries.

Top Trade #2:

Go long EUR/JPY for continued rotation around a flat Dollar.

Top Trade #3:

Go long the EM growth cycle via the MSCI EM stock market index.

Top Trade #4:

Go long inflation risk premium in the Euro area via EUR 5-year 5-year forward inflation.

Top Trade #5:

Position for ‘early vs. late’ cycle in EM vs the US by going long the EMBI Global Index against short the US High Yield iBoxx Index.

Top Trade #6:

Own diversifed Asian growth, and the hedge interest rate risk via FX relative value (Long INR, IDR, KRW vs. short SGD and JPY).

Top Trade #7:

Go long the global growth and non-oil commodity beta throughl ong BRL, CLP, PEN vs. short USD.

 

Top Trade Recommendations for 2018 :

  • Strong and synchronous global expansion:

We forecast global n GDP growth of around 4% in both 2017 and 2018, suggesting that next year’s global economy will likely surprise on the upside of consensus expectations.

  • Relatively low recession risk:

Given the low inflation and well-anchored inflation expectations across DM economies, we think central banks have little reason to risk ‘murdering’ this expansion with the kind of aggressive rate hikes that would have historically been warranted to fight the risk of inflation becoming entrenched.

  • But relatively high drawdown risk:

Even if growth remains strong in the coming year, markets are still susceptible to temporary drawdowns, especially given the high
level of valuations. We think the two most prominent risks to markets in 2018 are (1) pressures on US corporate margins from rising wages and 2) a swing in market psychology around the withdrawal of QE, which could lead to a faster re-pricing of interest rate markets than we assume.

  • More room to grow in EM.

While most developed economies are currently growing well above potential, most emerging market economies still have room for growth to accelerate in 2018.

 

Our Top Trade recommendations reflect our Top Ten Market Themes for the year ahead. To capture the gradual normalization of the bond term premium and position for a more hawkish path of the Fed funds rate than the market currently expects, we recommend going short 10-year US Treasuries. Given our expectations of a ‘soggy Dollar’ in 2018, we think investors should position for a rotation into Euro area assets and continued Yield Curve Control from the BoJ by going long EUR/JPY. We expect EM growth to accelerate further in the coming year and suggest going long the EM growth cycle via the MSCI EM stock market index. At the same time, the EM credit cycle appears ‘younger and friendlier’ than the ageing US credit cycle, so we recommend going long the EMBI Global against US High-Yield credit. The combination of solid global growth and supportive domestic factors should help the Indonesian Rupiah, the Indian Rupee and Korean Won rally in 2018, while we expect the low-yielding Singaporean Dollar and Japanese Yen to underperform. Since the strong global demand environment should also help the commodity complex perform well but commodities as an investment carry poorly, we recommend going long BRL, CLP and PEN to gain diversified exposure to the commodities story.

We will mark the starting levels for these Top Trade recommendations as of the New York close on November 16.

 

Top Trade #1:

Position for more Fed hikes and a rebuild of ‘term premium’ by shorting 10-year US Treasuries

Go short 10-year US Treasuries with a target of 3.0% and a stop at 2.0%.

We forecast that the yield on 10-year US Treasury Notes will head towards 3% next year, levels last seen before the decline in oil prices in 2014. By contrast, the market discounts that 10-year yields will be at 2.5% at the end of 2018, a meagre 20bp above spot levels. Our view builds on two main assumptions. First, QE and negative rate policies conducted by central banks in Europe and Japan have amplified the fall in the term premium on bonds globally and have contributed to flatten the US yield curve this
year – a central ingredient in our macro rates strategy for 2017. As a result of this, we think that US monetary conditions are too accommodative for the Fed’s comfort in light of the little spare capacity left in the jobs market. This will likely lead the FOMC to deliver policy rate hikes in excess of those discounted by the market (Exhibit 1). On our US Economists’ baseline projections, Dec 2018 Eurodollar futures, trading at an implied yield of 2.0%, will settle at 2.5%.

Second, we expect a normalization in the US bond term premium from the current exceptionally low levels over the coming quarters (Exhibit 2). This will reflect the compounding of two forces. One is an increase in inflation uncertainty as the economic cycle continues to mature. The other reflects the interplay of the lower amount of Treasury bonds that the Fed will roll over (quantitative tightening, QT) and higher Treasury issuance. We expect these dynamics to come to the fore particularly in the second half of the year.

Top Trade #2: Go long EUR/JPY for continued rotation around a flat Dollar

Go long EUR/JPY with a target of 140 and a stop at 130.

Although most economies are sharing in the upturn in global activity, there remains scope for divergence in capital flows and therefore FX performance. Among the major developed markets, we think this is particularly true for the Euro and Yen. We expect both currencies to head back to one twenty—1.20 for EUR and 120 for JPY—over the coming months. We therefore recommend that investors go long the cross, with a target of 140 and stop of 130 (Exhibit 3).

We interpreted the run-up in the Euro in 2017 as a kind of ‘short-covering’ rally. Euro area growth picked up, national politics trended in a favourable direction, and the ECB began to turn its attention away from monetary easing and towards the eventual normalisation in policy by tapering bond purchases. Against this backdrop, many investors seem to have decided that Euro shorts were no longer appropriate—especially given estimates of long-run ‘fair value’ for EUR/USD of around 1.30. Direct measures of investor positioning bear this out. For instance, net speculative Euro length in futures swung from a short of $9bn at the start of the year to a long of $12bn as of last week.
These portfolio shifts seem to have more room to run: bond funds remain long USD in aggregate, and FX reserve managers have not started to cover their substantial EUR underweight. Continued inflows into Euro area assets should support the EUR currency, even as interest rates remain low.

The opposite holds true for the Japanese Yen. Because of the Bank of Japan’s Yield Curve Control (YCC) policy, USD/JPY has remained highly correlated with yields on long-maturity US Treasuries (Exhibit 4). As a result of the recent general election—in which the LDP won another supermajority—a continuation of YCC appears very likely for the time being. Although the policy is beginning to bear fruit—in terms of improving price and wage trends—we suspect that Governor Kuroda (or his possible replacement) will judge these favourable signs as well short of what is needed to consider reversing course. Therefore, with global yields pushing higher on the back of solid growth, we think USD/JPY can again approach its cyclical highs.

Top Trade #3: Go long the EM growth cycle via the MSCI EM stock market index

Go long EM equities through the MSCI EM Index with a target at 1300 (+15%) and a stop at 1040 (-8%).

 

As we outline in our Top Themes for 2018, we expect strong and synchronous global growth to continue into 2018. We prefer to own growth exposure in emerging economies, which we think have more room to grow. When EM growth is above-trend and rising, equities typically outperform on a volatility-adjusted basis.

From an earnings perspective, we see much more scope for EM corporates to surprise to the upside, driving equity performance in 2018 (Exhibit 6). MSCI EM EPS have rebounded quite quickly from a six-year stagnation and, in local currency terms, EM earnings per share (EPS) has repaired the ‘damage’ of the 2010-2016 period. We expect MSCI EM EPS to rise another 10% in 2018, which should drive the bulk of the upside in this trade (“EM equity and the “macro consensus” trade heading into 2018“, Global Markets Analyst, Nov. 19, 2017).

From a valuation perspective, EM equities are not cheap relative to their own history (they are currently trading in the 86th percentile of the historical P/E range), but they are cheap relative to US equities (38th percentile of historical relative P/E range), which should hopefully offer some cushion in a global risk-off event. We find that the relative valuation of EM to DM equity is largely influenced by the growth differential between the two regions; and we forecast this differential to widen another 60bp next year, which in turn should drive EM valuations to expand relative to DM by around 3%.

To be sure, a long-only EM equity trade carries significant ‘pullback risk’, especially given the current entry point. Accordingly, we have set a stop on the recommended trade at -8%, which provides enough buffer to accommodate for a shock similar to the EM equity sell-off around the US election. Although EM equities have had a good run in 2017, we do not view the asset class as over-owned. Indeed, the cumulative foreign flow into major EM equity markets is still tracking below historical averages.

Top Trade #4: Go long the inflation risk premium in the Euro area via EUR 5-year 5-year
forward inflation swaps

Go long EUR 5-year 5-year forward inflation with a target of 2.0% and a stop at 1.5%.

We recommend going long Euro area 5-year inflation 5-years forward (henceforth 5y-5y) through EUR inflation swaps, for an target of 2.0% – levels last seen in mid-2014 ahead of the fall in crude oil prices. The rationale for the trade is threefold. First, the risk premium on Euro area forward inflation is currently depressed, offering an attractive entry point. A low inflation risk premium can be inferred from the flat term structure of inflation swap yields. The difference between 5-year inflation, which is priced roughly in line with the expectations of our European Economists (Exhibit 7), and 5y-5y forward is near the lowest levels observed since the 2011 crisis. Second, the inflation options market assigns high odds to Euro area headline inflation staying at or below 1% over the next 5 years. Against this backdrop, the ECB has reiterated its determination to keep monetary policy accommodative in order to encourage a rebuild of inflationary pressures. With the expansion in activity and job creation likely to continue, we expect the inflation risk premium to increase.

The third reason to be long forward-dated inflation relates to shifts in central bank policies already in train. We have argued that by pushing down nominal yields below their macro ‘fair value’, large-scale net purchases of long-dated bonds by the major central banks may have also distorted the pricing of future inflation (Exhibit 8) (“Low Term Premium: Why Should We Care?“ Global Markets Daily, Nov. 8, 2017; and a recent speech by BIS chief economist Hyun Song Shin ‘Do Central Banks Speak Too Much’). As the Fed rolls over only a portion of the Treasuries that mature on its balance sheet in coming quarters and the ECB brings its net purchases of Euro area government bonds to an end, the term premium on long-dated nominal bonds should edge back up. This will, in our view, also promote a steeper slope of the EUR inflation curve.

 

Top Trade #5: Position for ‘early vs. late’ cycle in EM vs. the US by going long the EMBI Global Index against short the US High Yield iBoxx Index

Go long EM USD credit through the EMBI Global against US High-Yield credit through the iBoxx USD Liquid High Yield Index, with a 1.5x1 notional ratio, indexed at inception to 100, with a total return target at 106 and a stop at 96.

The EM credit cycle is ‘younger and friendlier’ relative to an ageing US corporate credit cycle. With the improvement in macro fundamentals across EM, namely better current account balances, dis-inflation and FX reserve accumulation, we do not see a near-term risk of Dollar funding concerns. While EM credit spreads are not cheap per se, we see relative value against the US High-Yield market. In addition to the growing exposure of the latter to secularly challenged sectors, with the US cycle maturing and profit margins potentially eroding, we see more fundamental concerns in US High-Yield than in the EMBI (of which 70% of the constituents are sovereign bonds and the remainder in ‘quasi-sovereigns’).

Unlike most EM trades, long EM credit vs. US High-Yield has yet to fully recover from the sell-off following the US election. Since the ‘taper tantrum’, EM has generally outperformed with the exception of a few sharp risk-off events that had specific negative-EM implications (such as the sharp decline in oil prices and Russian recession in late 2014/early 2015, and the 2016 US presidential election). However, other risk-off periods, such as the Euro crisis in early 2011, saw EM credit outperform US high-yield.

The relative performance of EM vs. US High-Yield consistently tracks the EM-DM growth differential (Exhibit 10). We expect the general trend of EM outperformance to continue in a pro-risk environment and see the entry point as attractive, albeit admittedly slightly less so following the recent High-Yield sell-off. Finally, this trade is positive carry and should perform well if global spreads move sideways to tighter. We have set the stop at -4%, which coincides roughly with the bottom reached after the US election.

Top Trade #6: Own diversified Asian growth, and the hedge the interest rate risk via FX relative value (long INR, IDR, KRW vs. short SGD and JPY)

Go long an equal-weighted basket of INR, IDR, KRW against an equal-weighted basket of SGD and JPY, indexed at inception to 100, with a total-return target at 110 and stop at 95.

INR, IDR and KRW provide diversified exposure to the strong global growth we forecast in 2018 and specific idiosyncratic factors that should support their currencies in the year ahead. The combination of commodity exporting (IDR) and commodity importing (INR and KRW) currencies on the long leg of the recommended trade offers some protection against swings in commodity prices. By funding out of SGD and JPY, not only do we take advantage of their low yields, but JPY underperformance should also provide a hedge should the move higher in US yields lead to wobbles in the currencies where we recommend being long. The overall trade carries positively to the tune of about 4% over the year.

Country-specific factors in India, Indonesia and South Korea should boost their currencies, on top of the strong global growth environment we expect next year. Specifically:

India’s bank re-capitalization plan should impart a powerful positive impulse to investment in the coming year and should break the vicious cycle of higher non-performing loans, weaker bank balance sheets and slower credit growth. As the drags from GST implementation and de-monetization also fade, we expect growth to move from 6.2% in 2017 to 7.6% in calendar 2018. In addition to the three hikes we expect the Reserve Bank of India to deliver by Q2-2019, the high carry, FDI and equity inflows should also be supportive for the INR. We have moved our 12-month forecast for $/INR stronger to 62.

We continue to see Indonesia as a good carry market. As the drag on domestic consumption from the tax amnesty fades in 2018, we expect economic growth to move up to 5.8% in 2018 (from 5.2% in 2017), while the current account, inflation, and fiscal deficit should remain stable. We think Bank Indonesia is done easing and should move to hike rates by 50bp in H2-2018. We also expect Indonesia to be included in the Global
Aggregate bond index, which could prompt one-off inflows worth US$5bn in Q1-2018 (vs. US$10bn bond inflows YTD in 2017). We have moved our 12-month forecast for $/IDR stronger to 13000. Finally, Indonesia, like India, has accumulated reserves over the past year that now stand at record high levels and should help mitigate volatility.

We expect the KRW to outperform other low-yielding Asian peers in 2018. The strong memory chip cycle should extend at least through H1-2018, while the government’s income-led growth policy provides a fiscal boost. Together with the boost from improving exports, this should allow the Bank of Korea to withdraw monetary accommodation in the face of rising financial stability concerns, with three policy rate hikes to 2.0% penciled in by the end of 2018. The thawing of China/South Korea relations and rebound in Chinese tourists should also help the travel balance. Overall, we expect the current account to remain stable at around 5% of GDP in 2018. Further deregulation in outbound capital flows could temper KRW strength over the medium term, but might not pass the National Assembly in the near future given fragmentation in the legislative body. Our 12-month forecast for $/KRW is now stronger at 1060.

On the funding side, not only do SGD and JPY offer a low yield, we expect them to underperform in the year ahead. While we expect the Monetary Authority of Singapore to steepen its appreciation bias in October, we do not expect any significant SGD appreciation versus Asian peers given that the SGD is already trading on the strong side of the policy band. Meanwhile, we forecast USD/JPY at 120 in 12 months. With the BoJ controlling the yield curve as US rates move higher, JPY should continue to weaken, especially if US rates move higher than the forwards discount, as we expect. 16

 

 

Top Trade #7: Go long the global growth and non-oil commodity ‘beta’ through BRL, CLP, PEN vs. short USD

Go long a volatility-weighted basket of BRL, CLP and PEN (weights of 0.25, 0.25 and 0.5) against USD, indexed at inception to 100, with a total return target of 108 and a stop at 96.

The ongoing strength of global growth should continue to support a rally in most industrial metal prices. Our seventh Top Trade recommendation aims to capture this dynamic by going long the ‘growth and metals beta’. All three currencies on the long side have reliably responded to upswings in global trade and external demand over the past two decades. Moreover, each has performed particularly well in the pre-crisis decade, a period that also featured strong global growth and buoyant industrial metals prices. CLP offers direct exposure to a particularly encouraging story in copper, while BRL and PEN provide more varied metals exposures. The recommended trade has a positive carry of roughly 2.5% a year, and our 12-month forecasts are stronger than the forwards in all cases: we forecast USD/BRL at 3.10 in 12 months, USD/CLP at 605 in 12 months and USD/PEN at 3.15 in 12 months.

Beyond these global factors, our recommended Top Trade allows for diversified exposure to an encouraging Latin American growth recovery. Not only should growth in Brazil pick up as it recovers from a deep recession (and a recent BRL sell-off, creating an attractive entry-point), but BRL screens as strongly undervalued on our GSFEER currency model due to a combination of contained inflation and current account rebalancing, making BRL an attractive high carry currency. Meanwhile, PEN – the low-vol ‘tortoise’ of Andean FX – offers exposure to one of the most attractive valuation stories in the EM low- to mid-yielder space. Last but not least, CLP – the ‘hare’ of Andean FX – has moved quickly in 2017, so sends a somewhat less attractive valuation signal, but provides direct exposure to our most encouraging metals view, copper, and what opinion polls suggest is likely to be a market-friendly outcome in the upcoming Chilean election.

Finally, although it is designed for our global base case of strong growth, our Top Trade #7 can perform well in other external environments, potentially including a global growth disappointment. In particular, while BRL is a high-yielding and ‘equity-like’ currency, CLP and PEN are each lower-yielding and more ‘debt-like’: they have historically shown relatively resilient performance vs. the USD during periods of both declining growth and falling core rates.

 

 

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Nomura – EUR versus the Antipodeans https://www.quintessencefx.com/nomura-eur-versus-antipodeans/#utm_source=rss&utm_medium=rss&utm_campaign=nomura-eur-versus-antipodeans https://www.quintessencefx.com/nomura-eur-versus-antipodeans/#respond Wed, 28 Jun 2017 03:20:34 +0000 http://quintessencefx.com?p=34536 The post Nomura – EUR versus the Antipodeans<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/3e3ee6bda62c8eefd1472469501ebc69?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Nomura – EUR versus the Antipodeans

 

EUR/AUD and EUR/NZD have been on a bit of a rollercoaster over recent weeks. The
more positive tone from President Draghi should refocus the market on the looming shift
by the ECB. This, and the flow backdrop, should underpin EUR. By contrast, we continue
to see fundamental AUD headwinds. We expect EUR/AUD to remain supported on dips
and to retest recent highs as the Eurozone economy strengthens. Given our more
cautious NZD stance, EUR/NZD also looks to have more upside potential.

 

EUR/AUD and EUR/NZD rebounding

After touching its highest level in close to a year in early June (1.5299), which was in-line
but slightly earlier than our end-Q2 projection, EUR/AUD fell back. Many were asking if this
retracement could continue, but the more constructive comments from ECB President Draghi,
particularly that deflationary forces are being replaced with reflationary ones, have buoyed
EUR/AUD (Figure 1). The shift in President Draghi’s tone should refocus the market on
the ECB’s looming policy normalisation path, which we expect to be announced at the
September meeting. This process remains a medium-term positive for EUR and EURcrosses,
such as EUR/AUD, particularly if the Eurozone continues to perform strongly,
as our economists forecast, and based on the AUD headwinds that remain (see
below). In a similar vein, against our more cautious near-term NZD stance, EUR/NZD
also looks to have more upside potential. In our base case, EUR/NZD rises back above
1.60 by end-Q3.

More than just the ECB, but….
Looking back, it was more than just disappointment in the ECB’s then cautious tone at its
June policy meeting that drove EUR/AUD to partially unwind of the appreciation
experienced in the wake of the French Presidential election. From the AUD-side, there
were some supportive factors, including: a) consolidation in Australia-centric commodity
prices; b) stability in Chinese growth momentum; c) buoyant market risk sentiment and
suppressed market volatility; and d) a relative shift up in RBA interest rate expectations
after the RBA brushed off the “soft” Q1 GDP report and May employment data exceeded
consensus forecasts.

 

 

In line with its elevated correlation over recent months, the re-pricing of the risk backdrop and the shift in the Eurozone-Australia swap curve spreads (averaged across 2, 5 and 10yrs) guided EUR/AUD lower (Figure 2). However, we think there is a bias for relative interest rate differentials to revert back to where they were, favouring a higher EUR/AUD.

In contrast to the outlook for the Eurozone and EUR, we continue to see various fundamental headwinds facing both Australia’s economy and AUD. Specifically, rebounds in Australian commodity prices should be stifled by the unbalanced nature of these markets, largely due to the ongoing increases in supply coming on line while, on the demand side, the gradual moderation in Chinese growth from a peak in Q1 continues.

Likewise, we hold a relatively more downbeat assessment of Australia’s economy, with high levels of debt and negative real wage growth a headwinds to consumption. At the same time, leading indicators point to fading growth support from the housing investment cycle. Also, even though there has been an improvement in the labour market, the underutilization rate remains high, indicative of ongoing excess slack and persistently low wage growth. This will keep inflationary pressures muted. Despite the RBA’s upbeat outlook, we continue to argue that cash rate risks remain tilted to the downside over the next 12 months. We expect the RBA to substantially lag the more hawkish turns by some of the other major central banks. The mix of lower commodity prices and our bias for some more policy easing, rather than tightening by the RBA, should drive AUD to underperform on the crosses.

 

Looking beyond short-term volatility
Our bigger picture view remains conducive of a higher EUR/AUD and EUR/NZD. We anticipate a re-test of the early June highs in EUR/AUD. That said, the pace of appreciation is likely to be slower than the swift move up observed in late April/May. With ECB policy normalisation approaching, EUR’s sensitivity to incoming data should increase and, although we remain upbeat on the Eurozone’s prospects, the data are unlikely to be a one-way story. Nevertheless, we remain prepared to ride out the near-term volatility and expect EUR/AUD and EUR/NZD to be supported on dips.

As outlined, we expect the greater and more durable positive impulses, with respect to relative economic momentum and central bank policy regime shifts, to come from the EUR side. In addition to these factors, the flow picture should also underpin EUR’s appreciation path. On this front, we have found that foreign equity flows into the euro area have started to recover, and hedge ratios are lower. This has shifted the correlation between equity prices and EUR to neutral or positive, which should further enable EUR to benefit from the Eurozone’s positive economic fundamentals.

 

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Barclays – UK Surprise: GBP lustre lost https://www.quintessencefx.com/barclays-uk-surprise-gbp-lustre-lost/#utm_source=rss&utm_medium=rss&utm_campaign=barclays-uk-surprise-gbp-lustre-lost https://www.quintessencefx.com/barclays-uk-surprise-gbp-lustre-lost/#respond Fri, 09 Jun 2017 06:14:14 +0000 http://quintessencefx.com?p=34517 The post Barclays – UK Surprise: GBP lustre lost<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/3e3ee6bda62c8eefd1472469501ebc69?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Barclays – UK Surprise: GBP lustre lost

 

Likely slim coalition government raises Brexit risks; we cut GBP longs vs EUR and AUD

·      UK leadership uncertainty to raise near-term GBP volatility with downside skew.

·      Medium-term GBP appreciation still likely, but tail risks of worst-case, no-deal Brexit have risen.

·      Our forecasts are under review and we close GBP long recommendations (vs EUR and AUD).

The Conservatives’ gamble on an early election with a huge poll lead appears to have imploded with negative consequences for GBP as tail risks of a disorderly Brexit have risen. Based on BBC projections, the Conservatives appear to have fallen just short of a majority in the UK parliament, though a slim coalition majority with the Democratic Unionist Party (DUP) of Northern Ireland appears feasible. The key implications of these results, if validated in the final count, are increased uncertainty over the leadership of the UK and a higher, though still likely low, risk of a worst-case, no-deal exit by the UK from the EU. While we continue to see GBP as undervalued and remain broadly positive on it in the medium term, we expect greater near-term volatility skewed to the downside as a likely leadership battle is sorted out in coming months. We, thus, place our GBP forecasts under review and close our two outstanding long GBP recommendations, EURGBP for a loss of 0.83% (entry 0.8710, exit 0.8783) and GBPAUD for a gain of 5.84% (entry 1.6000, exit 1.6935).

Further preliminary thoughts on the implications of the election:

·    PM May almost surely out, but no clarity on replacement for weeks or months: The political gamble by Theresa May likely implies her exit as Prime Minister and Tory leader, perhaps as early as today. There is no clear successor among the Conservatives, and historically, new Conservative leaders have been surprise candidates. Prime Minister May likely would stay on as a caretaker while any possible leadership contest is determined.

·    A50 clock still ticking, raising the risks of a Brexit “crash out”: There is unlikely to be any delay in the Brexit timetable as that would require unanimous consent of remaining EU members. Hence, the Tories’ likely leadership contest will eat into valuable negotiating time before the March 2019 exit. Further, any new leadership will need time to articulate and implement a negotiation strategy. Additionally, as we pointed out in The Coq, the Lion and the Elephant, 4 May 2017, confidence plays a key role in successful negotiation; any new Tory leader will have to be chastened by today’s results. Jointly, these raise the risks of an exit from the EU without a deal, a “disorderly Brexit” that represents the worst case Brexit scenario. While we continue to believe that remains a low likelihood, there is no question the risks have risen and that GBP should reflect that through a lower expected path.

·     Scottish referendum off the table: The biggest loser of the night was the Scottish National Party (SNP), which campaigned in large part on demands for a second independence referendum. The SNP is projected to have lost a staggering 21 of 56 seats previously held and its share of the total vote fell nearly 40%. On the margin, this represents a GBP positive.

·    “Soft” Brexit still unlikely: Labour was the biggest gainer of the election, not “soft” Brexit. The only two parties campaigning on a platform of a “soft” Brexit were the Liberal Democrats (LD) and the SNP, and both saw a decline in their national vote share (although the LD picked up a handful of new seats). The DUP also favours Brexit and is unlikely to challenge the Conservatives on Brexit strategy.

·     Fiscal austerity takes a back seat: Labour’s large gains, particularly relative to the Conservatives, will call into question support for fiscal policy, though as we noted in UK 2017 General Election: Risks priced conservatively, 2 June 2017, Brexit almost surely would dominate the domestic agenda, and a slim coalition government only increases the likelihood of little domestic agenda progress.

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Deutsche Special Report – UK election night preview https://www.quintessencefx.com/deutsche-special-report-uk-election-night-preview/#utm_source=rss&utm_medium=rss&utm_campaign=deutsche-special-report-uk-election-night-preview https://www.quintessencefx.com/deutsche-special-report-uk-election-night-preview/#respond Wed, 07 Jun 2017 08:24:54 +0000 http://quintessencefx.com?p=34491 The post Deutsche Special Report – UK election night preview<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/3e3ee6bda62c8eefd1472469501ebc69?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Deutsche Special Report – UK election night preview

 

Opinion polls have narrowed significantly as the election approaches, from highs
of a 20 point Conservative lead over Labour to current poll average of 7pp
at the time of writing. While current polling still remains consistent with the
Conservatives increasing their current slim majority, the tightening of polls and
their wide range has increased the likelihood of alternative election outcomes.
Looking towards Thursday’s vote, we analyse the trends and variation in the
recent polls and preview the likely timelines for election night itself as well as the
potential formation of a coalition government. We also identify the major swing
seats to keep under watch as the results unfold including both 2015 marginal
seats and those potentially vulnerable to Brexit-related swings and tactical voting.

 

 

Poll narrowing has increased the probability of alternative election scenarios
Following the sharp narrowing of the Conservative’s polling lead in recent weeks,
the Conservatives’ lead over Labour is now down to 7 points. Comparing this
to the historic margins of error seen over previous elections, current polling
remains just in excess of the largest polling miss observed since 1992 – a 6.3pp
overestimate of the Labour vote share in 2001 – and well in excess of the average
polling error over these votes. At the same time, in elections since 1992 the
pollsters have consistently underestimated the Conservative’s vote share, by
2.1pp on average. (chart below).

 

 

Given this clear trend for polls to underestimate the Conservatives for various
reasons, including issues of poor sampling together with the “shy Tory
phenomenon” – pollsters attempt to correct their survey results to account for this
dynamic. The risk therefore is that the polls could be over-correcting and therefore
giving the Tories an advantage in the polls.
As the chart below shows, the raw voting intention data behind the most recent
polls from each of the main pollsters is relatively similar, with a limited spread
across companies. There is, however, a much larger dispersion of results when
looking at the final headline poll lead that is published. Indeed, from an average
Conservative lead of 1.3% based on the raw data, the lead increases to 6.3% after
the polling agencies’ re-weighting, with a much wider spread.

 

 

In other words, the wide range in the headline Conservative lead across polls
is a result of the statistical re-weighting employed by the polling agencies in an
attempt to correct for previous Conservative polling misses rather than a result
of variation in the raw survey data.
With the Tory poll lead ranging from +1 to +12 across different polls, the key
question for election night will re-weighting will be most correct. The chart above
compares the current re-scaling of voting intention by company relative to the
miss of that polling company in the 2015 general election. Those companies reweighting
the Conservative vote share the most in fact tended to better predict
the 2015 final result.
Thus, while there is significant re-weighting of polls in favour of the Conservatives,
this should not in itself imply the Conservative lead is being over-stated. Indeed,
in 2015 the pollsters currently re-weighting the most – ComRes, IpsosMori and
ICM – tended to get closest to the final result.

 

Timing on and following election night
■ Polls open from 7am and close at 10pm on Thursday.
■ The publishing of polls is not permitted on the day until after polling
closes– at 10pm Ipsos Mori will publish the official exit poll for the BBC
and Sky News.
■ The 10pm exit poll will also give a projection of the ultimate seats won by
each party. Historically these forecasts have been very accurate (within 15
seats for the winning party) but this means that if the exit poll projections
are tight – i.e. within a 20 seat majority for the Tories – the margin of error
means we may not know by 10pm which of the potential outcomes across
small Conservative majority, Conservative minority or Labour coalition are
the most likely.
■ The vote count begins at 10pm with the first results typically declared
between 11pm and midnight.

■ The bulk of the declarations begin to flow in from about 2am. By around
4am we should have ~50% of the vote counts declared and a good idea
of the result and by 6am close to 90% of the vote count (see chart below).
■ In the case of a clear majority for the winner, the tradition is for the leader
of the winning party to wait for the leader of the losing Party to concede
before claiming victory. In 2015, David Cameron accepted victory just
before 6 am.

 

 

Process for forming a coalition government
Given the tightening of the polls, there is a risk that no party gains an overall
majority. This would lead to a hung parliament scenario with either a minority
Conservative government or a Labour-led alliance supported by the Lib Dems and
the SNP.
In terms of the process for forming a coalition – the 2010 negotiations lasted five
days, beginning with the leaders’ speeches on the Friday morning and concluding
with Cameron and Clegg’s joint press statement on the following Wednesday.
The next state opening of Parliament (the Queen’s Speech) is scheduled for the
19th June which would be an important test in the event of a Conservative
minority government. If the vote on the Queen’s speech fails to pass then either a
new government would attempt to be formed or we move towards fresh elections.

 

Seats to watch on election night
In the UK’s first-past-the-post constituency level system, marginal seats are
crucial in defining the outcome of elections. In this section we compile the
potential swing seats to watch based on different criteria, ranked by the expected
timing of their declarations on election night.

Seats to watch 1: 2015 marginal seats (<5% winning margin)
Marginal seats are typically defined based on the size of the majority of the current
MP relative to the next best party in the last election. In Figure 6 below we list the
most marginal constituencies in Great Britain in the 2015 election – listing the 52
seats in which the margin of the winning party ahead of the runner-up was less
than 5%. We list the seats by the time they are expected to declare their result
according to the Press Association. This expected timing should be seen as an
indication only , with close results increasing the chances of later declarations.

 
Seats to watch 2: seats vulnerable to Brexit preferences and tactical voting
However, with the Brexit referendum last year and leadership changes across the
major national parties since the last election in 2015, it may be that a traditional
margin-based seat list is less appropriate than in the past. Limiting our analysis
to England & Wales, which contain the majority of marginal seats, we consider
which seats currently held by the two largest parties could be vulnerable based
on attitudes to Brexit and potential scope for tactical voting.
To make a list of potentially vulnerable Conservative seats we apply two criteria:
■ the seat voted more ‘Remain’ than the UK average (or is estimated to
have ) and
■ the Conservative vote share in 2015 was less than the combined share
of Labour, Liberal Democrats and Greens leaving the seat potentially
vulnerable to ‘progressive’ tactical voting
For vulnerable Labour seats we apply the criteria of:
■ the seat being more ‘Leave’ than the UK average
■ the combined vote share of Conservatives and UKIP being greater than
that of Labour, Lib Dems and Greens
The gives two lists of 21 and 33 seats respectively presented in Figure 8 and 7.
A number of these seats, such as Conservatives’ Croydon Central and Labour’s
Halifax appear both on these lists and on the list of marginal seats. However,
this combination of criteria also suggests seats such as the Conservatives’ Bristol
North West and the Labour seat of Wrexham, the latter expected to come quite
early in the night, could be bellwethers as to whether either side is able to take
advantage of Brexit sentiment or tactical voting.
Of the two seats that have changed hands since 2015, one makes the list
– Copeland, which was lost by Labour to the Conservatives earlier this year.
However, Richmond Park – regained by Lib Dems from Tories in late 2016, does
not make it, as the 2015 Conservative majority was too large to meet our criteria.

 
Seats to watch 3: Scottish seats vulnerable to a swing from SNP to Conservatives
The dominance of SNP in Scotland was the key theme in the 2015 election,
with the 50 seats gained by the SNP thanks to its 50% vote share in Scotland
accounting for almost half of the seats that changed hands in 2015. The question
this year is can the SNP hold on to its gains. Polls for Scotland are limited, but
they suggest that Conservatives should significantly improve from the 15% they
achieved in 2015, most of their gain coming at the expense of SNP. To keep track
of the potential for the SNP to Conservative swing story playing out, we compile a list of

SNP seats in which the Conservatives finished second in 2015 (Figure 9).
This includes the marginal seat of Berwickshire, Roxburgh & Selkirk that already
made an appearance in the marginal seat table above as well as six others.

 

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Barclays – Soft May US employment unlikely to alter near-term Fed plans https://www.quintessencefx.com/barclays-soft-may-us-employment-unlikely-alter-near-term-fed-plans/#utm_source=rss&utm_medium=rss&utm_campaign=barclays-soft-may-us-employment-unlikely-alter-near-term-fed-plans https://www.quintessencefx.com/barclays-soft-may-us-employment-unlikely-alter-near-term-fed-plans/#respond Mon, 05 Jun 2017 05:18:49 +0000 http://quintessencefx.com?p=34481 The post Barclays – Soft May US employment unlikely to alter near-term Fed plans<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/3e3ee6bda62c8eefd1472469501ebc69?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Barclays – Soft May US employment unlikely to alter near-term Fed plans

 

Employment growth has slowed. May payroll employment growth slowed to 138k from a downwardly revised 174k in April, below our (175k) and consensus (182k) expectations. The deceleration was broad-based, as private sector employment slowed to 147k and government payrolls declined by 9k. Within the private sector, goods-producing sectors added only 16k on the month, while services employment growth moderated to 131k. Construction and temporary help services were the only categories of hiring that improved relative to April. Manufacturing payroll employment fell 1k on the month, but after five consecutive months of increases, a slowing here is not unexpected. Within services, professional and business services added 38k, education and health added 47k, and leisure and hospitality added 31k. Retail employment declined for a fourth consecutive month, although the pace of decline in April and May (both -6k) slowed from February and March.

Earnings remain soft, but income growth has accelerated in Q2. Earnings growth was also soft in May, with average hourly earnings up only 0.2% m/m and 2.5% y/y, versus our expectation for a 0.3% monthly increase. Average weekly hours held steady at 34.4, which was in line with our expectation. Altogether, employment, hours, and earnings in April and May pushed the payroll proxy in Q2 to 4.7% (q/q saar), versus 3.6% in Q1, which suggests our outlook for a rebound in consumption growth remains reasonable.

The household survey is “catching up” to the establishment report. The household survey also showed a weaker employment growth, with employment declining 233k on the month. That said, the household survey is volatile, and we prefer the 3mma as a gauge of hiring trends. There, household employment growth averaged 132k in the March to May period, about in line with the 121k in the establishment report. The unemployment rate declined to 4.3%, due largely to the drop in participation to 62.7% from 62.9% last month. Our long-held view is that the participation rate is in a sideways trend, where the recovery is pulling workers into the labor force at about the same rate as retirees are leaving the labor force. At 62.7%, the participation rate is only one-tenth below where it stood in October 2013. Hence, we view the May participation rate drop as merely volatility around a sideways trend. Elsewhere, there was improvement in most underemployment categories, and the U6 rate fell to 8.4% from 8.6%.

In our view, the sharp drop in the U3 unemployment rate this year is due largely to a “catch-up” effect in household employment. Since late last year, year-on-year growth in household employment has lagged establishment employment, which meant that the unemployment rate did not decline much even as payroll growth remained solid. As household employment has begun to catch up with establishment payrolls, the unemployment rate resumed its decline. In January 2017, for example, the 12-month change in nonfarm payrolls was 2.33mn, while growth in household employment was only 1.55mn. As of April, these numbers were 2.17mn and 2.13mn, respectively. After the weak May household survey report, the gap has widened again, suggesting the differential between the two surveys has not yet fully resolved and points to some further downward pressure on the unemployment rate in the months ahead.

No change in Fed plans for now. We do not view today’s employment report as altering the near-term Fed path. In our view, it has clearly signaled for another 25bp increase in the policy rate in June and is committed to starting to shrink the balance sheet. In addition, the Fed desires a slowing in employment growth so that it does not get too far offsides on its employment mandate as it awaits further inflation firming. At 138k, employment growth is still nearly twice that needed to keep the unemployment rate steady (assuming a flat participation rate). FOMC members may, therefore, welcome slower employment growth as a sign that Fed policy is working properly. That said, the combination of softer employment growth and weak inflation trends calls into question whether the FOMC would go ahead and raise the policy rate again in December. We maintain our call for a third rate increase at the December meeting, but that is conditional on our expectation that labor market conditions remain healthy and core inflation gradually firms.

Slower employment growth always begs the question of recession risks. In our view, employment growth is one of the stronger recessionary indicators, and slower employment growth is something we always take seriously. In past cycles, slower employment growth (relative to the recovery-level average) has preceded recessions by 9-12 months, and we would take it as a negative signal should employment growth continue to soften. However, slower employment growth at present could be related to the abating of post-election euphoria that could have led to a faster pace of hiring earlier this year. Or, slower employment in April and May could be related to seasonal factors that pulled hiring into January and February. In our view, the data are not yet conclusive, and we look to incoming figures on claims for a near-term signal on separations and labor market conditions.

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Nomura – Waiting for inflation – ECB preview https://www.quintessencefx.com/nomura-waiting-inflation-ecb-preview/#utm_source=rss&utm_medium=rss&utm_campaign=nomura-waiting-inflation-ecb-preview https://www.quintessencefx.com/nomura-waiting-inflation-ecb-preview/#respond Wed, 26 Apr 2017 04:08:30 +0000 http://quintessencefx.com?p=1510 The post Nomura – Waiting for inflation – ECB preview<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/3e3ee6bda62c8eefd1472469501ebc69?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Nomura – Waiting for inflation – ECB preview

 

We are in line with the consensus in expecting all the ECB’s key policy parameters to be left unchanged at this week’s ECB meeting on 27 April. The markets will focus instead on the forward guidance, but we are not expecting any shifts in this either. A surprisingly soft core inflation reading in March combined with some lingering political uncertainties should leave the ECB comfortable for now with the status quo. That being said, if Emmanuel Macron beats Marine Le Pen in the second round of the French Presidential elections on Sunday 7 May that ought to be positive for the regional growth outlook. That has certainly been the markets’ interpretation of recent events over the past day or two. And if, as we expect, the regional growth data continue to improve, we may not have to wait too long before the ECB indicates a change in its policy stance. If, moreover, President Draghi stresses this week that the risks to the regional growth outlook are more evenly balanced instead of being skewed to the downside, which we think is possible, that will provide an important signal to the market about a prospective policy normalisation. But what will it take to trigger that normalisation?

A sustained rise in core inflation would be the ECB’s answer. In our view, the pre-conditions for that sustained climb in inflation are in place. In Figures 1 and 2 and 5-7 we illustrate a range of indicators, including output gaps, capex orders, youth unemployment levels and inflation expectations that all point to a higher level of core inflation in the eurozone in the immediate months ahead. We still wait, however, for that trend to be exhibited in the core inflation data itself.

To be clear, we think core inflation will rise over the next two to three months. That should pave the way for a shift in the ECB’s forward guidance at the next meeting on 8 June. And that in turn should generate an announcement of a tapering of the QE programme at the September meeting for enactment at the start of next year. At this stage, and in line with the ECB’s communication on this matter, we do not believe that policy rates will be lifted until QE purchases have come to an end and specifically not until the latter half of 2018. But the risks to that view are tilted toward a swifter normalisation of interest rates than we are forecasting and a slower normalisation of the QE programme.

 

Fixed income strategy

Over the past couple of months EUR rates markets have switched between 1) pricing in a faster pace of ECB normalisation (to include a possible shift in the sequencing), and 2) increased political risk (and therefore a slower pace of normalisation). In the first part of this year the focus was firmly on 1) a faster pace of normalisation, as characterised by steeper front-end Eonia slopes, higher yields, wider EGB spreads, tighter swap spreads and steeper long-end curves. The price action on the front end was sharp and fast, as the market began to speculate not only on a faster pace of normalisation but on the possibility of a shift in the sequencing of ECB normalisation, with rate hikes to come first.

In late March several governing council members, including Mr Draghi, pushed back on market pricing by reaffirming the appropriateness of the ECB’s current easing stance. Additionally, the suggestion of there being a shift in the sequencing of normalisation was rejected. This resulted in markets pricing out all hiking expectations for the following 12 months and pricing lower the pace of any tapering. The price action across rates markets was then compounded by a shift onto, 2) heightened political risk, in particular the uncertainty surrounding the first round of the French elections. This compounded shift resulted not only in flatter front-end slopes, but a sharp flight-to-quality bid into Bunds taking the 10yr back to the lows of its recent trading range, wider EGB spreads, wider swap spreads and wider front-end EURUSD cross-currency basis spreads.

With French election risk priced significantly lower, following a strong win in round one by Emmanuel Macron, rates markets are once again likely to start focusing on ECB normalisation – and once the French elections are fully over, we would expect this focus to remain and indeed increase through H2.

However, we expect little signal from the ECB at this meeting. The slight fall we have seen in inflation has afforded the ECB time – and until it sees a sustained rise in inflation, we expect it to continue to re-affirm the appropriateness of its existing easing measures. Indeed, the recent bank lending survey adds further support for the existing easing measures and as yet provides little evidence of the negative policy rates having an adverse impact on the recovery; providing therefore little incentive for the ECB to reignite the normalisation sequencing debate.

For euro rates markets this means we continue to hold onto our front-end Eonia steepeners and EUR swap spread tighteners, with the latter focused on the 2yr, acknowledging small near-term risks. Both are medium-term trades, and while there may be some continued near-term pull-back given the sharp price action following round one of the French elections, the rationale for both trades still holds. We are also biased to EUR 5s30s swap spread steepeners and continue to hold 5s30s BTP steepeners as a high-carry bearish trade on Italy, which has its own election risk at the end of this month. And the trade should further benefit from a reduction, going forward, in ECB buying.

 

FX strategy

We are currently bullish on EUR. The tail risk from the French election has diminished significantly, while the macro-economic fundamentals of the euro area continue to improve more than other major economy (see “Macr-On vs Le Pen is risk-On”, 23 April 2017). At the meeting this week, we will look for: 1) a possibility of any changes in the ECB’s economic risk assessment, and 2) the ECB’s view on the likely normalisation sequence.

There is a possibility that the ECB and President Draghi might suggest that the risk to the growth outlook is now more balanced. That change would not surprise the market much as the strength of euro area economic data has been clear, but the market and our confidence in near-term ECB normalisation would strengthen.

Our main scenario on the policy normalisation sequence remains that the ECB will not hike its policy rates before ending its QE programme. Recent communication from ECB officials has suggested a high possibility of the Bank keeping its commitment on the sequence unchanged, and we would President Draghi to follow that script this week. Nonetheless, earlier rate hikes could accelerate EUR appreciation further and President Draghi’s stance will be crucial in assessing the speed and magnitude of likely EUR appreciation over the next three to six months (see “EUR: ECB normalization sequence matters”, 30 March 2017).

As we expect no changes in the forward guidance this week, we think the initial EUR reaction to the ECB announcement is likely to be muted again (Figure 4). No change in the forward guidance may be a small disappointment for the market. We also estimate April core CPI released on Friday to be +0.9% y-o-y, slightly weaker than the consensus forecast (+1.0% y-o-y). Although core CPI inflation is still expected to recover from +0.7% y-o-y in March, a weaker inflation recovery may encourage profit-taking from EUR long positions. Core CPI inflation is still likely on track to recover, so the possible dip after the ECB meeting and inflation data later this week may provide a good opportunity to buy EUR

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Goldman Sachs: Gold sell-off set to continue near term https://www.quintessencefx.com/goldman-sachs-gold-sell-off-set-continue-near-term/#utm_source=rss&utm_medium=rss&utm_campaign=goldman-sachs-gold-sell-off-set-continue-near-term https://www.quintessencefx.com/goldman-sachs-gold-sell-off-set-continue-near-term/#respond Tue, 25 Apr 2017 01:41:07 +0000 http://quintessencefx.com?p=1477 The post Goldman Sachs: Gold sell-off set to continue near term<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/3e3ee6bda62c8eefd1472469501ebc69?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Goldman Sachs: Gold sell-off set to continue near term

 

Following the first round of the French presidential election n on Sunday, gold has
sold off by $12/oz to $1276/oz, alongside the decline in the French and Germany
yield spread and fall in VIX.
-We continue to expect gold will come under pressure in the near term, and
our 3-mo target remains $1,200/oz.
-This week is likely to continue to be volatile but should provide further catalysts
to the downside in our base case scenario, as we may see a rally in real rates
following the expected unveiling of President Trump’s tax policies on Wednesday
(or shortly thereafter), and as our US economists do not expect a US government
shutdown on April 29 (in their view, a shutdown this week has around a one in
four chance; if the debate extends to next week, it has a one in three chance).
-Anticipated bearish catalysts on a 3-mo view include a repricing of US rate hikes
(higher) and a QE reduction (faster) on the back of an increased expectation of US
tax reform delivery (cuts) and further solid US and global economic growth
(should the hard data confirm the survey data).
-In terms of downside support, in this piece we find that Chinese buying was key
in absorbing the ETF selling sub-$1,200/oz earlier this year, and would expect this
to be important again should we retrace to those levels.
-The main risks to this bearish near-term outlook are, in our view, increased
military tensions in North Korea and slower-than-anticipated US (and global)
growth; however, these developments are not our base case.
-Over the medium term, we would see our anticipated pullback as a buying
opportunity as our 12-mo target remains $1,250/oz. On a 12-mo view from
current prices, we still remain broadly agnostic on gold from current levels, as our
primary commodity view is one of a stronger cyclical backdrop; and how the Fed
responds to this environment, and hence the path real interest rates follow, is still
uncertain (US real rates are the primary driver of our gold pricing model).
-Nevertheless, our work within this piece points to some constructive
medium to longer term dynamics, including a weak supply growth outlook
based on the global gold capex cycle, high valuations in competing asset
classes (our year-end S&P 500 target is 2300 based on valuation concerns),
and a strong outlook for emerging market dollar savings which should
support demand growth.

  • The full report is available to Quintessence Insider Subscribers

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Soc Gen – French Election Focus https://www.quintessencefx.com/soc-gen-french-election-focus/#utm_source=rss&utm_medium=rss&utm_campaign=soc-gen-french-election-focus https://www.quintessencefx.com/soc-gen-french-election-focus/#respond Mon, 24 Apr 2017 01:30:54 +0000 http://quintessencefx.com?p=1439 The post Soc Gen – French Election Focus<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/3e3ee6bda62c8eefd1472469501ebc69?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Soc Gen: French Election Focus

 

Tail risks fade as polls suggest Macron will be the next President: 

WHAT THE POLLS SAY: Polls ahead of the second round on 7 May show Macron in the lead with 61.6% of the vote compared to 38.4% for Le Pen, offering a comfortable margin.

As illustrated in the chart below, Macron has a significant lead over Le Pen in the opinion polls ahead of the second round of the French Presidential election on Sunday 7 May 2017. To alter this outcome would require either polls to get it very wrong (judging from the first round results, this seems less likely), a very dramatic shift in public opinion, and/or an exceptionally low turnout rate amongst the Macron supporters. Lower than normal turnout is a risk given the 8 May bank holiday but, as we show below, for Le Pen to win based on what the average of the latest five opinion polls shows, just 56% of Macron’s voters would have to turn up compared to 90% for Le Pen. This is unrealistic and would imply a total participation rate of just 68%. A further important point to note is that Fillon and Hamon have already called on their voters to vote Macron in the second round

 

A good track record for opinion polls. France’s presidential elections draw far more voters than any other election in France and the turnout rate is usually close to 80% (77% for the first round according to the preliminary numbers), especially for the second round. On average, the turnout of the second round has been 81.6%, 1.4pp higher than the first round average. This helps explain why, historically, the opinion polls have so far never failed to accurately predict the second round winner.

Turnout would have to be exceptionally low for Le Pen to win. As illustrated in both the case of the UK referendum and the US presidential election, a differentiated turnout can make a big difference. For instance, if a specific group, be it by age or social group (generally measured in France by educational attainment), has an actual participation rate on the election day that differs significantly from past behaviour then opinion polls could be wide of the mark. In the table above, we have replicated the methodology developed by Cevipof (Centre for Political Research, Sciences Po and CNRS, cf Marine Le Pen can breach her glass ceiling: The drastic effect of differentiated abstention). The table shows different assumptions on voter turnout and voter preferences for the total electorate. For example, if the electorate has a preference at 61.6% for Macron and 38.4% for Le Pen (average of the latest five opinion polls), then if Le Pen’s turnout is 90% then Macron would still win as long as his turnout was at least 56%. Such a low turnout seems unrealistic: it would for instance require a doubling of the abstention rate of the citizens that support Macron and who have had a Baccalaureat or a higher degree.

FX:
Although the FX market has reduced short EUR positions and EUR/USD risk reversals are already less skewed to the downside, further EUR gains are likely ahead of the second round.

At the time of writing, it appears the opinion pollsters did a better job of predicting the first round votes in the French election than they did in the case of Brexit or the US presidential vote. That doesn’t mean we should be overconfident of the outcome in those second round, but as the US statistician and election analyst Nate Silver observed on Twitter, whereas Hillary Clinton led Donald Trump by 2-3pp and ‘Remain’ led ‘Leave’ by 1-2pp in the run-up to those votes, Emmanuel Macron leads Marine Le Pen by a whopping 26pp in runoff polls. Given that she hasn’t polled better in the first round than polls had suggested she might, and given the well-known challengers she faces to significantly boost her support between the first and second rounds, it would not be at all surprising for the FX market to start to price in ‘President Macron’ with a fair degree of confidence. Should that happen, the market focus will likely shift back to an improving French and eurozone economy, and to the prospect of further withdrawal of monetary stimulus by the ECB. That, in turn, would put Bund yields under upward pressure, and narrow interest rate differentials between the US and Europe along the length of the yield curve, in both nominal and real terms.

CFTC data for last week show a slight rebound in the (small) speculative EUR short in the futures market, but the striking feature of the relationship between positioning and the level of the EUR is the de-coupling we have seen since the US presidential election. In both 2015 and in the spring of 2016, a cut in short positions took EUR/USD to 1.14-1.16. The starting point is lower this time, and the election is most definitely not over yet, but the scope for a move into the mid-teens if Macron does win seems clear, and this week will likely see a step in that direction.

In the longer run, there are two variables that will determine the outlook for the EUR. The first is relative interest rates, and in particular longer date yield differentials, in both real and nominal terms. The current 25bp on 10y Bund yields reflects a lot of political uncertainty and may rise sharply. It also puts the 10y real yield at -1.05%. The more this moves, the more the EUR rallies. The second variable is what the election means for monetary policy and what that means for Europe’s balance of payments. We’ve written a fair bit about this in the past, but with the most updated data (for February released last week) we see a €362bn current account surplus in the last year being easily recycled as European investors buy a net €576bn in foreign bonds (Euro buying – foreign buying of European debt), but that number is now already down from a peak of over €720bn in the year to September. If reduced political uncertainty and a strengthening economy push the ECB towards a faster reduction in its bond purchases, European investors, who have been crowded out of European bonds and, in the process, dragged the EUR lower, would be slowly crowded back into European markets. The combination of QE and bond buying was the catalyst for EUR/USD to trade in its current 1.04-1.16 range, instead of the 1.20-1.40 range of the previous years.

Political volatility premium to collapse but not to disappear. Conjecture that Mélenchon might qualify for the second round (Google Trends) triggered a short-lived spike in EUR/USD 2w vol on Sunday. But the stress vanished with the projected results excluding a second round with two anti-European candidates, but including the market-friendly Macron, largely favoured by the polls to be the election winner. The option market premium for political risk started to ease over recent weeks, with 6m-1y risk reversals of euro crosses trading softer. The premium remained very high for the options expiring the Monday following the vote of each round. Our new SG FX-Event Tracker, which can be used to visualise how the perception of a political risk event changes over time, highlighted that the market priced a similar premium for each round. The outcome of Macron vs Le Pen coming out of the first round substantially reduces the political uncertainty, and the volatility market will start the week in a risk-friendly mood. Even if the EUR turns out to be very well bid and quite volatile, implied volatility should stay fairly contained. The recent EUR/USD realised volatility includes periods of high turbulence but is not that high, so that cannot justify the fact that the vol market is durably bidding the gamma. However, the political risk premium won’t totally disappear, as there will still be uncertainty concerning the general elections. Macron may struggle to obtain a political majority with his new political formation ‘En Marche!’. A scenario seeing some political uncertainty regarding the political support of the parliament cannot be ruled out. Afterwards, the option market should essentially shift all its focus to the ECB communication regarding tapering modalities.

 

 

TECHNICAL ANALYSIS: EUR/USD: remaining above the multi-year graphical level of 1.0860/1.08 will be key

 Additional evidence that the pair has achieved a major trough at 1.0350, the down sloping channel support in place since 2015, is emerging. Indeed, the EUR/USD is breaking the crucial 1.0860/1.08 graphical barrier that represents the multi-year horizontal level (red dash line), the declining trend line from May 2016 and the 38.2% retracement of the following down move and, last but not least, the confirmation level of an Inverted Head and Shoulder pattern that formed at 1.0350.

 Remaining above 1.0860/1.08 (daily closing) is therefore instrumental in the extension of the ongoing recovery towards the upper band of the short-term up channel resistance at 1.0985 and 1.1130, the 61.8% retracement of the down move and also last September/November’s graphical levels. 1.13, the 76.4% retracement and more importantly the projected potential for the aforementioned pattern, will be a significant objective.

 Immediate supports are placed at 1.0860 and 1.08/1.0780, which are also the 23.6% and 38.2% retracement levels of the last bout of up move.

 

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Goldman Sachs FX Views The Euro & Frexit Risks https://www.quintessencefx.com/goldman-sachs-fx-views-euro-frexit-risks/#utm_source=rss&utm_medium=rss&utm_campaign=goldman-sachs-fx-views-euro-frexit-risks https://www.quintessencefx.com/goldman-sachs-fx-views-euro-frexit-risks/#respond Fri, 21 Apr 2017 06:01:00 +0000 http://quintessencefx.com?p=1428 The post Goldman Sachs FX Views The Euro & Frexit Risks<dataavatar hidden data-avatar-url=https://secure.gravatar.com/avatar/f56768868c6490008f5cb6fb69008c5f?s=96&d=mm&r=g></dataavatar> appeared first on Quintessence FX.

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Goldman Sachs FX Views The Euro & Frexit Risks

1. Since the beginning of the year, news around the French elections has driven the Euro as polls turned more favourable to Ms. Le Pen or, more recently, became less indicative of a possible victory for one of the two mainstream candidates (Mr. Macron or Mr. Fillon). The market focus is now on the risk that France could leave the Euro area if Ms. Le Pen becomes the next President of France. However, given the uncertainty around the outcomes of the first and second round votes, and
considering that a ‘Frexit’ would be a tall order even under a Le Pen presidency , it is useful to assess how much the Euro could depreciate or appreciate under different scenarios.

In particular, in this FX Views, we provide a framework to forecast possible moves in the Euro depending on changes to the probability that investors assign to: (1) Ms. Le Pen becoming the next French President; (2) a break-up of the Euro area; and (3) a ‘flight to safety’ regime triggered by the French election result. While these three events are positively correlated, they are also distinct. For example, in the event that Ms. Le Pen does not qualify for the second round of the French elections, investors are unlikely to completely price out Euro area break-up risk given the rise of Euro-sceptic parties in other members of the monetary union.

To preview our results, our analysis suggests that an increase in the probability that investors assign to a break-up of the Euro area which is close to its peak in July 2012 could push the EUR about 5% lower versus the USD and the JPY, effectively taking EUR/USD close to parity. Conversely, should Ms. Le Pen fail to make it to the second round, EUR/USD could trade around 1.13 (from the current level of 1.0770).

2. We use a simple framework to estimate the betas of a change in the EUR nominal exchange rate versus all G-10 currencies, as well as the currencies of Poland, Hungary, the Czech Republic and Romania, to changes in three different indicators of Euro area break-up risk. The indicators are: first, a variable that measures the probability of Ms. Le Pen being elected President, based on bookmaker quotes. This series is available on Bloomberg at a daily frequency since 20 January 2017 and shows a tight negative correlation with EUR/USD (see Exhibit 1).

Second, the Euro area Sentix index, a survey-based measure, available at monthly frequency since June 2012, which measures the probability that investors assign to a break-up of the Euro area. This index is currently at 19%, having peaked at 73% in July 2012, before Mr. Draghi’s “whatever it takes” speech lowered the EUR convertibility risk, taking the index to its lows (7%) in July 2014.
Third, a variable, captured at daily frequency and estimated by our European economists , which indicates whether or not markets are pricing a ‘flight to safety’ regime.
In each specification, we control for the change in interest rate differentials between the two currencies (measured by 2-year swap rate differentials). We also run robustness checks by adding controls for changes in oil prices, changes in the VIX and our proprietary economic data surprise indices.

Exhibit 1: EUR/USD and the Odds of a Le Pen Victory Have Shown a Tight Negative Correlation
Exhibit 2 EURUSD Could Depreciate by Around 2 If Ms Le Pen’s

3. Using the first indicator (i.e., the odds of Ms. Le Pen being elected President), we quantify the impact of a 10pp increase in the odds of a Le Pen presidency on the various Euro crosses (Exhibit 2). This exercise is particularly useful as it gives us a sense of the market impact should Ms. Le Pen get a higher vote share in the first round than currently indicated by polls (say greater than 30%, compared with the low 20% that polls currently suggest). Our framework implies that, among the G-10 crosses, EUR/USD would fall the most (about 2%) and EUR/NOK the least (about 0.5%), while EUR/SEK would show a slight appreciation.

Conversely, should Ms. Le Pen fail to make it to the second round (which would lead to a decline in the odds of her being elected to 0, from the current level of 23), EUR/USD could appreciate by around 5%, reaching around 1.13 (from the current level of 1.0770).
We do not find any statistically significant effect of a change in the odds of a Le Pen presidency on the EUR/CEE crosses (HUF, PLN, RON, CZK), with the estimated betas being very small.
4. While our results may seem intuitive in terms of the direction and relative magnitude of currency moves under the various possible outcomes of the first round vote, there are reasons to caveat these estimates. First, the probability variable is available only from 20 January 2017, which means the coefficients are estimated over a small sample. Second, these coefficients may under- or overestimate moves in the crosses we consider because the mapping from the odds variable to the probability of a break-up

will likely be non-linear. Hence, the EUR can move by more or less than indicated in Exhibit 2 depending on how investors reprice the risk of a break-up of the Euro area following the vote (see below for further discussion of this).

5. The probability that investors assign to a break-up of the Euro area (as captured by the Sentix index) has declined from 25% in February to 18% in March – a period over which the odds of a Le Pen presidency have declined from around 35% to 25%. If both the centrist candidates make it into the second round, which in our view would be the most market-friendly outcome, it is unlikely that the probability of Euro area break-up would fall to 0, given that populist, Euro-sceptic movements in other countries (Italy in particular) would still pose a threat to the currency union. This could effectively cap any gains in the Euro from the perspective of a lowering in Euro area break-up risk after the French election.

However, a strong endorsement of Ms. Le Pen in the first round would likely lead investors to reassess Euro break-up risk to the upside. We would expect such a revision to be very sizeable and persistent if the odds of her presidency increase beyond 50%, and if she makes a referendum to pull France out of the currency union a central point of her campaign between the first and second rounds – a dynamic that would clearly increase downside risks for the Euro.

6. To gauge how an increase in Euro area break-up risk maps onto moves in the Euro,
we estimate the betas of different EUR crosses to changes in the Sentix indicator that measures the probability that investors assign to a break-up of the Euro area over the next 12 months. On our estimates, should this probability increase from the current 19% level to 73% (the level in July 2012 before Mr. Draghi’s “whatever it takes” speech lowered the convertibility risk priced in the EUR), EUR/USD could depreciate by about 5% and trade close to 1.02, EUR/JPY could move to 111.5 and EUR/GBP to 0.82, from current levels. We think that the risk to these estimates could be to the downside, although admittedly in a very negative risk environment the response of the ECB will be key, particularly to determine the persistence of the negative shock. If markets turn more negative on the possibility of deposit flights out of the French banking system or on Italian BTPs and banks, the currency can fall more in the absence of a decisive
response from the ECB. But, if the ECB were to show a strong hand in the market, buying sovereign debt, this perception could change. Our European Economists do not expect the ECB to be constrained in taking more unconventional policy measures (if
needed) between the first and second rounds of the French elections

Conversely, a reduction in break-up risk to 10% would lead to a slight appreciation of the EUR versus the major G-10 currencies. Once again, we do not find any statistically significant effect on the EUR/CEE crosses (HUF, PLN, RON, CZK), with the estimated betas being very small. This may simply reflect the close ties of these economies to the Euro area and the fact that CEE central banks have adjusted policy in the past to prevent sharp changes in their currencies.

 

Exhibit 3 An Increase In the Sentix Index to 2012 Highs Could
Exhibit 4 An Increase In the Sentix Index Has Not Always Resulted

7. Finally, our measure of the probability of a ‘macro flight to safety’ (FTS) event in the Euro area currently stands at 0.6%. This low level implies an asymmetric bias for the EUR around the French election. On a market friendly outcome in the first round, the FTS indicator is likely to remain below 1%, and there would be no impact of flight to safety dynamics on the EUR. However, in the event of an unfavourable outcome, we estimate that the EUR would depreciate by between -0.13% and -0.24% against safe-haven currencies (USD, JPY and CHF) for each 10pp increase in the likelihood of a Euro area ‘flight to safety’.

If a victory for Ms. Le Pen were large enough to trigger a definitive ‘flight to safety’ event in France (i.e., an increase in the probability of entering an FTS from 0.6% to 100%), the EUR could depreciate by -1.2% against USD, -1.1% against CHF and -2.2%
against JPY (over and above the effects captured by changes in interest rate differentials) based on this framework. Indeed, these effects are smaller than our estimates under the previous two indicators: election probabilities and the Sentix index.
One possible explanation is that the two variables (the Sentix Index and FTS) measure different risks. Indeed, the correlation between the monthly average of the flight to safety indicator and the Sentix index is just 14% over the sample starting in June 2012 and there are several periods (including this year) when the Sentix index has increased substantially but the FTS index has not, and vice versa.

8. In summary, our analysis suggests that an increase in the probability that investors assign to a break-up of the Euro area that is close to its peak in July 2012 could push the EUR about 5% lower versus the USD and the JPY, effectively pushing EUR/USD close
to parity. The potential upside following a market friendly outcome of the French electionwould likely be much smaller given the market’s benign pricing of Euro area break-up risk currently, and given little evidence that we are in a ‘flight to safety’ regime, which
would be the case should Ms. Le Pen win the French elections. That said, how negative and persistent the market reaction will be also depends on the policy response, which, however, is unlikely to be as straightforward as in the aftermath of the Brexit vote, when the ECB supported Italian and Spanish spreads by buying more sovereign bonds. This time, the political constraints posed by France leaving the Euro area could also constrain the ECB, as some members of the Monetary Union will likely be concerned about Target 2 imbalances in a scenario in which a break-up of the Euro area becomes a realistic threat.

 

Marketing communication : This document has not been developed in accordance with legal requirements designed to promote the independence of investment research and its author(s) is/are not subject to any prohibition on dealing in the relevant financial instrument ahead of the dissemination of the marketing communication.

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