EUR USD - FUNDAMENTAL DRIVERSEUR
FUNDAMENTAL BIAS: WEAK BEARISH
1. The Monetary Policy outlook for the ECB
The ECB provided an overall balanced policy decision at their September meeting. They chose to slow the pace of asset purchases, explaining that the current levels of financing conditions allow them to buy assets under the PEPP at a ‘moderately’ slower pace compared to the pace of purchases seen in Q2 and Q3. However, as expected, the bank made it very clear that the move was not tapering it was merely a recalibration of purchases (when you plan to perform less QE that’s technically tapering but who’s counting). The bank raised their inflation projections for 2021, 2022 and 2023, and even though the 2021 projections were arguably not as high as markets were hoping for, the more important medterm projections still showed inflation moving to well below the bank’s 2% target to affirm the transitory view of recent price pressures. All in all, the decision was broadly balanced and as a result failed to inspire any meaningful reaction in European assets. For now, market’s attention turns back to the incoming data to pave the way for clarity on the PEPP and API (and a possible transition).
2. The country’s economic developments
Earlier issues with vaccinations and lockdowns at the start of 2021 weighed on EU growth prospects, with growth differentials against the US and UK still quite wide, despite some of the recent strong economic data. Fiscal support in the US and UK have given their economies a firm advantage over the EU. However, recent activity data suggests the hit to the economy from recent lockdowns weren’t as bad as feared and some data has surprised higher. That alone though is not enough to change the current bias. Another factor we are keeping track of is the discussions among European states to allow the purchase of green bonds not to count against the budget deficits of EU countries. If such a decision were to be approved, it could change the fiscal picture and would expect to be a positive for the EUR and European equities.
3. Funding Characteristics
An interesting driver that we’ve been watching for the EUR for the past couple of months is the often-interesting funding characteristic exhibited by the EUR during periods of risk off sentiment. As a low yielder (just like the JPY and CHF), the EUR has been an interesting choice among carry trades, especially during 2019 the EUR was a favourite funding currency against the high yielding EM currencies, and part of the massive one-way upside in the EUR during the initial risk-off scare in March 2020 was attributed to large carry trades being unwound. Earlier this week we saw the EUR exhibiting lots of resilience despite USD strength, and as more and more central banks start to move towards higher rates, the use of the EUR as a funding currency should keep it pressured in the med-term vs higher yielders but could spark risk off upside if some of those trades unwind. It doesn’t mean the EUR is suddenly a safe haven, but as rates climb globally it can become more sensitive to risk.
4. CFTC Analysis
Latest CFTC data showed a positioning change of -23206 with a net non-commercial position of -22334. With large speculators back in net- short territory, as well as leveraged funds increasing shorts to a whopping -71474 net-short, the EUR is looking very stretched from a positioning point of view. The net-change in large speculators is reading above 2-stardard deviations based on a 1-year, 6-month and 3-month basis.
USD
FUNDAMENTAL BIAS: WEAK BULLISH
1. The Monetary Policy outlook for the FED
More hawkish than expected sums up the Sep meeting. The FOMC gave the go ahead for a November tapering announcement as long as the economy develops as expected with their criteria for substantial further progress close to being met. The biggest hawkish tilt was the announcement about a faster pace of tapering, with Chair Powell saying there is broad agreement that tapering can be concluded by mid2022. Inflation projections were hawkish, with the Fed projecting Core PCE above their 2% until 2024. On labour, Chair Powell said he thought the substantial further progress threshold for employment was ‘all but met’ and explained that it won’t take a very strong September jobs print for them to start tapering as just a ‘decent’ print will do. The 2022 Dots stayed very close to the June median, but the rate path was much steeper than markets were anticipating with seven hikes expected over the forecast horizon (from just two previously). It is important here to note though that even though the path was steeper, if one compares that to a projected Core PCE >2% for 2022 to 2024, the rate path does not exactly scream fear when it comes to inflation . All in all, it was a hawkish meeting. Interestingly, it took markets about three days to realize this as the expected price action only really took hold of markets a few days later. A faster tapering was a key factor we were watching for an incrementally bullish tilt in the outlook, so market’s initial reactions were surprising. However, with the recent breakout in both US yields and the USD, this has given us more confidence in moving our fundamental outlook for the Dollar from Neutral to Weak Bullish .
2. Real Yields
With a Q4 taper start and mid-2022 taper conclusion on the card, we think further downside in real yields will be a struggle and the probability are skewed higher given the outlook for growth, inflation and policy, and higher real yields should be supportive for the USD in the med-term .
3. The global risk outlook
One supporting factor for the USD from June was the onset of downside surprises in global growth. However, recent Covid-19 case data from ourworldindata. org has shown a sharp deceleration in new cases globally. Using past occurrences as a template, the reduction in cases is likely to lead to less restrictive measures, which is likely to lead to a strong bounce in economic activity. Thus, even though we have shifted our bias to weak bullish in the med-term , the fall in cases and increased likelihood of a bounce in economic activity could mean downside for the USD from a short to intermediate time horizon (remember a re-acceleration in growth and potentially inflation = reflation)
4. Economic Data
This week we’ll finally have the September NFP print, but all the previous excitement about this event has been mitigated with the Fed’s previous meeting. The Fed’s comments that they don’t need to see a huge or stellar jobs print but that a decent print will do, has largely taken the sting out of the Sep NFP print. The current concern about inflation means that the Average Hourly Earnings release could be of more interest in market participants to see whether the current labour supply shortage sparks further acceleration in wages.
5. CFTC Analysis
Latest CFTC data showed a positioning change of +5565 with a net non-commercial position of +32026. Positioning isn’t anywhere near stress levels for the USD, but with both large speculators and leveraged funds sitting in net-long territory, it does mean that the Dollar could be more sensitive from mean reversion while still elevated after the recent push higher into new YTD highs. Thus, possible reflationary data will be a key focus point for the USD in the weeks ahead.
