Global markets are reeling this morning after the US president trumped his previously announced tariffs on $50bn worth of Chinese imports with the threat of another $200bn worth should the Chinese retaliate with penalties of their own on his initial tariffs. The heightened fear of a full-blown trade war has slammed into equities and EM currencies with the usual safe-haven assets – gold, bonds and the Swiss franc – gaining.
Article / 19 April 2017 at 7:35 GMT

FX Update: Sterling squeezes, reflation trades deflate

Head of FX Strategy / Saxo Bank
  • Theresa May's snap election call sends GBPUSD to five-month high
  • Sterling's rise possibly exacerbated by thin trading ahead of French election
  • Trump support base weakens again after special election in Georgia
  • AUD continues to feel the heat as reflation trade doubts gather
n Theresa May emerges from the shadows to call a snap election for June 8. Photo: Shutterstock

By John J Hardy

The pound boiled over Tuesday as an unexpected, bold political move from UK prime minister Theresa May to call an election for June 8 caught the heavily short-positioned speculative sterling market off guard and triggered a wave of short covering.

At least, that is our interpretation of the move – the timing of the announcement before we know the result of the French election and likely somewhat thin liquidity as few want to take on new large positions this week likely exaggerated the scale of the move.

It makes some sense to see sterling firming on the news as the election will likely grant May a strong mandate domestically to move forward with a more united front and surer step on Brexit, but this doesn’t alter the equally important EU side of the negotiating table. And with the first round of the French presidential election up this weekend, it’s hard to see the wave of short covering finding significant additional legs, though traders should respect that thin liquidity could prove us wrong. 

The US special election in Georgia to replace a congressional seat (due to the former holder joining the Trump administration) resulted in a very strong showing for the Democrat Jon Ossoff, but as of this writing it appears he will fail to get the 50% majority needed to secure the seat and will be forced into a runoff against a Republican opponent in June. Still, it’s not a strong showing for Trump as this has long been a congressional district held by a Republican.

Trump is running short on time to regain popular political goodwill and with that, support from his own party, where many see him as a usurper.

The euro squeezed higher against dollar, though not due to any apparent developments that fit a neat narrative – was it simply holding onto GBPUSD’s coattails as the latter was squeezed on the UK election news? Today should tell us the answer, but of course, the big event is on Sunday.

Traders are hoping that clarity emerges already with the first round result, i.e., that at least one of the two candidates will be a centrist (Macron or Fillon) and that Le Pen sees a weak result. The most euro-positive outcome would be Macron and Fillon taking the top spot or the possibly slightly less positive Macron taking the top spot with a strong margin to a second place Le Pen. We extend the uncertainty with a very weak showing from the centrist candidates on poor turnout and the weakest euro scenario would be the low odds of Le Pen and the far left’s Melenchon taking the top two spots.

Trading is likely to remain nervous until we get to the other side of Sunday’s results in France, but we do also see an undercurrent of weakening reflation trades, as plunging iron ore prices have taken down AUD several notches, with CAD also pushing lower despite still relatively elevated oil prices. Kiwi is a holdout due to the weight of AUDNZD selling, but there seems to be a general giving up on the reflation trade at the moment.

GBPUSD rally

GBPUSD’s rally was likely aggravated by thin trading conditions as we await the French election result and as any new news often leads to large-scale squaring of positions, especially in a lopsided speculative market. Additionally, the move above both 1.2700 and 1.2800 likely triggered resting stop orders all in one go.

It would be a surprise to see immediate follow on momentum here in sterling, though we can’t deny the technical significance of this rally if it continues to hold above 1.2700 and if EURGBP pushes lower still early next week after the results of the first round of the French presidential election are in.

Will the GBPUSD rally be sustained?
 Source: SaxoTraderGO

The G-10 rundown

USD – not much independent movement in the USD, where the focus was on sterling yesterday. The greenback looks soft against the European majors, flat versus the JPY and higher versus the commodity currencies. Not sure where the market hopes to find the next catalyst, but it feels like we have run an awfully long time with the “giving up on Trump” and no-flation themes.

EUR – entirely unsure of the quality of the rally Tuesday – won’t know anything until Sunday’s election results in France. Daily closes beyond 1.0600 and 1.0800 are key for extension outside of the recent range.

JPY – JPY strength is beginning to look overdone unless the bond rally continues full steam ahead or we get a bout of ugly risk off.

GBP – EURGBP is getting into a very interesting zone as we look at whether this move lower holds early next week. In GBPUSD, the key is to maintain at least 1.2700, with a hold of 1.2800 even more impressive for a possible eventual follow-up move into 1.3000 or higher.

CHF – waiting for French election results to indicate whether EURCHF has a pulse. USDCHF key 200-day moving average near 0.9950.

AUD – the Aussie is the weakling among major currencies as its key supports – the reflation trade/China/industrial commodity price supports for AUD have all fallen away – not sure how long it can manage to maintain the range in AUDUSD if these negative developments intensify.

CAD – commodity currencies weak and oil prices have dipped a bit. USDCAD established important support in recent days in the 1.3250-1.3300 zone. Upside focus is encouraged by the latest rally – a move clear of 1.3450 adds to interest in an eventual 1.3600+ break, though we may need a broader USD strengthening for that eventuality.

NZD – NZDUSD is dead in the water – nominally still like it lower, but AUDNZD has grabbed all of the attention as AUD is more sensitive to the weakening reflation theme.

SEK – we liked the rejection of the attempt into the 9.60-65 resistance zone in EURSEK, but need to see a follow up move lower to keep the bearish case fresh. SEK undervalued, but doesn’t like bad news and the weaker small currencies elsewhere perhaps also weighing a bit here.

NOK – commodity currencies are not popular for now as EURNOK looks to carve out a range with a 9.10 low and may look back to the top of the range.

— Edited by Martin O'Rourke

John J Hardy is Saxo Bank's head of forex strategy


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