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    IronFX Daily Commentary | 20/07/15

    Confidence returns, with a twist The fears of Greece imploding and bringing the global financial system down with it – if they ever existed – have faded quickly. The VIX index, the so-called “Wall Street fear gauge,” has gone from a three-month high on 9 July to a three-month low on Friday. Eurozone peripheral bond spreads finished the week stable at significantly lower levels than they opened on Monday (Spain for example narrowed 10 bps over the week to 115, while Portugal tightened 9 bps to 185).

    • Confidence in the US economy increased too as US inflation accelerated modestly in June and housing starts & building permits for the month both surpassed expectations. Fed fund rate expectations rose modestly while bond yields were little changed. Stocks rose for the sixth day out of seven and the NASDAQ index hit a new record high.

    • Yet the confidence did not return to commodities, which continued to sink: WTI is down 0.5% from Friday morning’s opening and copper is down 2%. Gold, another measure of risk version, is down 3.2%. This is odd because usually when investors expect economic expansion, they foresee increased demand for commodities.

    • So what does it mean when confidence seems to be coming back, yet investors don’t expect increase in demand for commodities? Two things are possible: one, a supply shock that means any increase in demand will be more than offset by an increase in supply, and secondly, a change in the nature of the demand. I think both are at play here. Certainly the price of oil and iron ore, for example, are being depressed by new supply coming on stream. At the same time, the increase in economic activity seems to be shifting from the EM countries, which are relatively commodity-intensive, to the developed nations, which use less commodities for each unit of GDP. Growth in the US and Eurozone taking over from growth in China as an engine of the global economy would be one such example.

    From fear to carry It was noticeable that the US high-grade bond market had its fifth busiest week ever last week, and most new issued tightened once trading began. The fall in the VIX and the demand for bonds indicate a shift from fear to carry. Will this spill over to the FX market? Although the TRY was the worst-performing EM currency we track on Friday, nonetheless it was the best-performing one over the week as a whole, followed by ZAR. Indeed, looking at the performance over the last week, it does seem that among EM currencies, those with the highest short-term interest rates were the best-performing ones. That should favour RUB, TRY, ZAR and MXN, although I suspect that RUB and MXN are more affected by oil prices than by carry. TRY not only has the benefit of some of the highest interest rates among currencies, but is also a commodity importer, not exporter, so its balance of payments should benefit from the fall in commodity prices.

    • Among the G10 currencies however the level of interest rates had no discernible connection with the performance of the currency. Indeed NZD, with the highest short-term rates among the G10, was also the worst-performing currency. That shows one has to look at everything surrounding a currency, not just one factor.

    Speculators add to EUR shorts, cut JPY shorts Friday’s Commitment of Traders report showed that investors added to their EUR shorts and cut JPY shorts. Is EUR going to replace JPY as the funding currency of choice? EUR shorts are still at only the 30% rank over the last five years, indicating that positioning is short but not yet at an extreme level, unlike NZD and MXN, for example, which are the shortest they’ve been in the last five years (0% level). But the absolute number of NZD contracts, -19,654, is still relatively small so I believe investors can add to their position. MXN may be due for a rebound however, although that depends to a large degree on oil prices. Speaking of which, speculators are still very long oil – there could be further long liquidation that would pressure the price. The other notable point is that investors added to their short GBP positions last week – oops! Sterling was the only G10 currency to gain vs USD last week. I could envision a big repositioning in GBP that would push the currency higher.

    Today’s highlights: The calendar is relatively light with no major indicators on the agenda. During the European day, Eurozone’s current account for May is due to be released.

    • As for the rest of the week, the highlights will be the RBNZ meeting on Thursday and three central banks (Japan, Australia and UK) releasing the minutes of their recent meetings.

    • on Tuesday, during the Asian day, Bank of Japan releases the minutes of its June 18-19 meeting. As usual, these are not the minutes from the most recent meeting but rather from the previous one. Since at their latest meeting the Bank maintained the likelihood that it would achieve its 2% inflation target on schedule, despite having lowered slightly its FY2016 forecast, the minutes of the previous meeting shouldn’t be of much interest.

    • In Australia, the RBA releases the minutes of its July meeting. At that meeting, the Bank kept its Cash Rate (CR) unchanged at 2% as expected and again, showed no clear bias with regards to the direction of the next move in rates. They could confirm that monetary policy should stay accommodative and that the data in the future will tell them whether their stance is appropriate. Therefore, the market reaction at this event could be minimal.

    • On Wednesday, the Bank of England releases the minutes of its July meeting. Following the hawkish comments by the BoE Governor Mark Carney that the first rate hike is getting closer, it will be interesting to see if any of the MPC members who previously voted for a rate hike are likely to resume their hawkish stance any time soon. I would expect GBP to regain its momentum as investors continue to re-price their rate hike expectations by the BoE.

    • As for indicators, from Australia, Q2 CPI is forecast to accelerate. The market seems to focus on the trimmed mean CPI rate, which is expected to remain unchanged at 2.3% yoy. Even though the positive data are likely to strengthen AUD somewhat, I would expect the low energy and commodity prices to drag down the currency.

    • On Thursday, the highlight of the day will be the RBNZ policy meeting. At their last meeting, the Bank not only cut rates by 25 bps, as the market largely expected, but also announced an easing bias. Given the recent weakness in the milk auction results, the poor CPI data for Q2 and the exposure to the soft Chinese and Australian economies, New Zealand’s biggest trading partners, the Bank could act again to support the economy. One of the important facts about New Zealand is that it remains one of the few G10 countries that can still lower interest rates – at 3.25%, the cash rate is still far above the next highest country Australia, which stands at 2.0%. I believe that as rate cut expectations build up, NZD could come under renewed selling pressure.

    • Finally Friday is a PMI day. During the European trading session, we get the preliminary manufacturing and service-sector PMI data for July from several European countries and the Eurozone as a whole. The expectations are for the figures to show a moderate improvement. With the Greek crisis now off investors’ radar, economic data are likely to start being important. A rise the PMI could strengthen EUR a bit.

    • In the US, the Markit PMI is expected to increase somewhat, another sign that the US economy is on a stable path.


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