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Equities surged on Wall Street yesterday after Trump's tax reform package passed the first stage of the legislative process in the House of Representatives and will now proceed towards the Senate for second-stage approval. The USD, meanwhile, had a surprisingly soggy time in Asian trade overnight.
Article / 13 September 2017 at 7:41 GMT

FX Update: Strong sterling may be a step too far — #SaxoStrats

Head of FX Strategy / Saxo Bank
Denmark
  • USD reversal can't find traction just yet
  • Strong UK inflation likely an anomaly given future forecasts
  • Sterling investors should keep an eye on UK housing

Bank of England
Sterling has seen a great deal of traffic and an impressive surge of late, but traders should note that much of the UK's banner inflation comes from GBP's post-Brexit decline. Photo: Shutterstock

By John J Hardy

The USD tried to turn the corner yesterday, but hasn’t succeeded in any broad sense just yet. But we’re still on the lookout for at least a chunky EURUSD consolidation lower as it is hard to come up with additional drivers for near-term EURUSD strength now that some of the US uncertainties have been lifted and European Central Bank president Mario Draghi has effectively kept a lid on European yields. 

Elsewhere, another chart point suggesting that the USD is clawing its way into consolidation mode would be a daily close well below 0.8000 in AUDUSD, so stay tuned.  

Otherwise, the key focus for the moment is on the ongoing recovery in sterling (lots on that below) and the pronounced weakness in the yen and Swiss franc as global bond yields have jumped after notching new lows (for long US yields) for the cycle. 

EURCHF finds itself back above 1.1500 this morning, not far from highs for the cycle, and GBPCHF is attempting a rocket launch that will be poking into interesting resistance areas soon.

Before we go overboard in celebrating sterling’s rally and anticipation of a more hawkish statement from the Bank of England after yesterday’s strong CPI data (at +2.7% year-over-year for the core), it is worth our time to revisit the August 3 BoE statement  which spells out the assumption that CPI will remain painfully high and possibly peak in October before retreating, with all of the inflation impulse due to a weaker sterling. 

Specifically the following passage is worth noting:

"The MPC expects inflation to rise further in coming months and to peak around 3% in October, as the past depreciation of sterling continues to pass through to consumer prices. Conditional on the current market yield curve, inflation is projected to remain above the MPC’s target throughout the forecast period. This overshoot reflects entirely the effects of the referendum-related falls in sterling."

UK core inflation versus trade-weighted sterling

The graphic below shows the trade-weighted GBP (white) versus core inflation (blue-inverted) - it's rather easy to spot the correlation of the two. Given that sterling has stabilised and even rallied some 3% in trade-weighted terms, and is actually slightly higher on year-on year terms, the basing effects (assuming sterling doesn’t plunge anew) should quickly see inflation abating. 

If we look at the past impressive inflation spike, we have to recall that oil prices had surged back above $100/barrel in 2011 after trading to $30/b in 2009 – that effect is absent this time around.

uk cpi
Source: Bloomberg

So the BoE could tilt the language a bit, but sterling ambitions may peter out rather quickly even if there is marginal additional strength on an (for me) unanticipated change of tune from the BoE. 

Note as well that the RICS House Price Balance, the best of the UK housing surveys, is anticipated to drop to 0% for the first time since 2013 as much of the BoE’s post-GFC QE went into house price inflation. 

An outright decline in house prices would deal a severe blow to the UK economy and we should be on the lookout in coming months for this additional source of vulnerability, one of the key symptoms of Brexit uncertainty.  

Chart: EURCHF

EURCHF is banging on resistance levels above 1.1500 again as government bonds yields have perked up smartly and risk appetite has returned with a vengeance. A continuation of these developments could see renewed enthusiasm for selling CHF, particularly if the Swiss National Bank provides no new twist on its policy stance on Thursday.

eurchf

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Source: Saxo Bank 

The G-10 rundown

USD – a stabilisation in places as market focuses more on JPY and CHF for carry trading, but we can’t speak of a broad recovery just yet, even if the temporary clearing of the debt ceiling situation should allow the Fed to move forward with quantitative tightening plans at next week’s meeting.

EUR – the euro strength deserves to be broadly capped here as European rates have been successfully capped by Draghi’s ECB meeting. The most impressive downside has been in EURGBP, but we have our eye on EURUSD downside potential as well if yesterday’s test of the 1.1926 Fibo level is revisited.

JPY – the yen is a popular carry trade at the moment with some caution necessary as next week’s Bank of Japan outing approaches. At some point, the BoJ will need to roll out technical adjustments to it purchase programme as it gets to the point where there are no more JGBs to buy if the government doesn’t announce a fiscal expansion.

GBP - thorough discussion above as we suggest additional sterling strength could be limited as it is too soon to expect the BoE to pivot after a comprehensive statement addressing inflation in the August statement. Still, sterling short rates have jumped to attention, supporting the rally. Next level for EURGBP if 0.9000 doesn’t prove sticky is 0.8850 and for GBPUSD, 1.3500 is a tremendous long-term level.

CHF – the franc likely to remain a weak link if yields continue to rise and the SNB announces no change to its stance at tomorrow’s meeting.

AUD – AUD rally not looking convincing here – but in a tactical limbo in AUDUSD unless we close below 0.8000 (bearish) or above 0.8075-0.8100 (bullish trend confirmation).

CAD – USDCAD hasn’t managed much of a consolidation even as some of the momentum of the slide has been sapped. Shallow consolidations often suggest a strong resumption – but USD outlook broadly in flux here, so we’ll see what develops. All home price data is important (like today’s Teranet Home Price Index release) as BoC clearly has the housing bubble in its crosshairs.

NZD – going to be plenty of dangerous back-and forth- in NZD until we get to other side of the September 23 election. AUDNZD bulls would like 1.1000 to hold, but there is room for a 1.0850 test without entirely turning the chart structure.

SEK – reversal bar yesterday in EURSEK points lower with 200-day SMA as resistance, though a glance at Swedish rates stuck at well below 0 and off recent highs has us lacking in enthusiasm.

NOK – not much of a bounce in Norway’s rates after Region Survey yesterday saw a lower estimate for output. EURNOK is looking back at 9.40-plus resistance – the last area ahead of the 9.60-plus highs for this year.

Upcoming Economic Calendar Highlights (all times GMT)

  • 0830 – UK Aug. Aug. Jobless Claims 
  • 0830 – UK Jul. Average Weekly Earnings / Unemployment Rate 
  • 0900 – Euro Zone Jul. Industrial Production 
  • 1230 – Canada Aug. Home Price Index 
  • 1230 – US Aug. PPI 
  • 2301 – UK Aug. RICS House Price Balance 
  • 2315 – Australia RBA’s Debelle to Speak 


— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

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