EUR: Hoping for some stability

The risk environment remains constructive, buoyed by the Federal Reserve's empathy to market conditions (as evidenced in January's FOMC minutes) and hopes for progress on trade. On the latter issue: (1) Trump meets with China’s chief trade negotiator, Liu He, in Washington later today; and (2) EU trade chief Cecilia Malmstrom today seeks permission from the EU 28 to start talks on a limited trade deal with the US, which would see EU tariffs cut on industrial goods (including cars). This could allay fears of US auto tariffs. What’s required to complete this bullish story is some better activity data – particularly out of Europe. That’s why today’s German IFO will be important for the risk story. There’s little US data today and instead we’ll hear from a variety of Fed speakers – all probably providing the same, supportive message of patience. We see the dollar holding gains against the low yielders (especially the Japanese yen), but perhaps softening versus high yield.

Weighing on European FX has been the collapse in eurozone activity and confidence over recent quarters. That loss of confidence is embodied in the German IFO expectations component, dropping from 101 in September to 94.2 in January – the lowest level since 2012 and when President Mario Draghi was forced to save the euro. We really need to see some stability here and consensus sees 94.3 for this expectations component. If there is an upside surprise (which our team favours) it’s because the IFO index was revamped last year to include a 50% weight for services – and eurozone services PMI surprised on the upside yesterday. EUR/USD to edge to 1.1375/1400 unless there are any nasty surprises from the IFO survey. After the close we’ll also see ratings updates from Fitch. A downgrade of Italy to BBB- is possible (but already in the price of BTPs) and an upgrade to Hungary is possible too, keeping the positive forint story alive. We’ll also see Riksbank minutes, which may add to the negative Swedish krona mood. We have 3m EUR/SEK target at 10.75.

The failure of Prime Minister Theresa May to secure any concessions from the EU should come as no surprise. Instead, the market will re-focus on whether parliament can take negotiations out of the government’s hands in a vote next Wednesday. So far, the FX options market remains concerned, with no sign of the demand for GBP puts abating.

Regular readers will know that we’ve been fans of MXN carry so far this year. One of the threats to this position is that the credible Banxico, now with more political appointees, turns too dovish, too early. The Mexican peso sold off yesterday when the English version of Banxico’s meeting minutes promised to take action ‘in whatever direction was required’. However, within five hours Banxico republished the English-language minutes, removing the above reference and replacing it with a commitment to take the necessary actions such that inflation converges (down) to its target (3%). We’re encouraged Banxico felt the need to make this change and behind India (where RBI credibility is threatened), Mexico has the highest real policy rate in the emerging markets space (near 4%) – which looks here to stay this year. Expect the Mexican peso to stay supported and favour MXN/JPY advancing to 5.90.