29 June 2018
G10 Week Ahead: It ain’t looking pretty

The landscape for FX markets is set to remain murky this summer with four key themes dominating - trade wars, European politics, how the Fed, the ECB - as well as Eurozone and US growth - is impacted as a result of external factors. There's no guarantee that the USD wins against all major currencies - in particular havens like the EUR and JPY

Eurozone: And it does move

In another nightlong meeting, European leaders agreed on an initial deal to shake up immigration rules. The meeting was clearly too energy-consuming to agree on any eurozone reforms

When European leaders negotiate for an entire night and present their results just before sunrise, you know that negotiations were tough but that something substantial was concluded. It was clear that these negotiations had to deliver some results. Going home empty-handed would not have been an option for Italian prime minister Giuseppe Conte and could have marked the last European Summit ever for German Chancellor Angela Merkel. Consequently, European leaders agreed on some interesting measures to tackle the flow of migrants into the European Union and to shake up existing rules.

EUR/USD: What’s next for euro-dollar?

Here are four potential EUR/USD paths as we try to cut through the global markets' gloom. Click here to download our fuller PDF report

EUR/USD has confounded consensus expectations this year, hit by both intermittent episodes of USD strength and EUR weakness. Of the many factors that will drive EUR/USD over the next 12-18 months, four stand out:

  1. Trade wars
  2. European politics
  3. The relative ECB/Fed policy outlook
  4. The relative EZ-US growth (and equity) prospects.

This is taken from our more comprehensive report, which you can download here

US inflation starting to climb

The 'Big 4' inflation measures that the Federal Reserve follows are all at or above the 2% target. With the economy set to grow by around 4% in 2Q18, the risks remain skewed towards a more aggressive pace of interest rate hikes in the United States

Today's release of the core personal consumer expenditure deflator shows the headline rate of inflation rising from 2% to 2.3% year on year while the core rate, which excludes the volatile food and energy components, rose to 2% from 1.8%. Both were above what the market was expecting (2% and 1.9% respectively) with both also showing the fastest rates of inflation for over six years.

This suggests that the next FOMC announcement (1 August) will need to see a more robust acknowledgement of the inflation pressures in the US economy. We expect all inflation measures to remain under upward pressure over the summer - particularly with oil prices on the rise again - with the more widely followed CPI measure likely to hit 3% in the next two to three months. Momentum is certainly to the upside given the strength of the economy and the tightness of a labour market that has the lowest rate of unemployment for 50 years.

Meanwhile, the Atlanta Federal Reserve Bank's Nowcast model, based on the recent data flow, currently suggests that real GDP growth could come in at around 4.5% for 2Q18. However, today's report showed real consumer spending for May was weaker than hoped at 0% versus the 0.2% month on month consensus. As such, we think 4.5% is a stretch, but something close to 4% looks possible. With inflation rising at such a rate, nominal GDP growth will be in excess of 6%, suggesting to us that the market remains too cautious on the outlook for Federal Reserve interest rate hikes.

Turning tide? The Brexit threat to UK foreign direct investment

Businesses urgently need clarity, and a change of tack, from the UK government as they decide on current and future investments in the UK

The Brexit threat

In 2016, the UK had accumulated the fourth largest stock of inward foreign direct investment (FDI) in the world, and the largest among EU countries (Chart 1). Several factors have contributed to the UK’s success in attracting investment, including the size and relative wealth of its domestic market, a flexible and skilled workforce, relatively low taxation, supportive government policies, and an entrepreneurial culture.

Why we’re revising our yuan forecast down again

We are revising our USD/CNY forecast to 7.0 by the end of 2018. But there's no panic in the market and we don't expect a repeat of August 2015

Policies could attract foreign investments, reduce outflow worries

Our previous argument for a slight yuan depreciation was based on the concern that a weaker yuan could lead to massive capital outflows, which would then push the yuan down even further, resulting in a vicious cycle. 

But new policies to open up the market for foreign investments reduce the risk of outflows. These policies could also help to offset any outflows that do occur as a result of the weaker yuan. 

New policies cover a whole range of sectors including agriculture, rare earth, automobiles, shipbuilding, aviation, railway, shipping services, surveying and financial services. The scope is not only larger than expected, it targets sectors affected by tariffs. Foreign companies facing tariff risks could move production to China to avoid tariff hurdles. 

These measures, together with potential inflows from more A-share inclusion into MSCI and China Depository Receipts (CDR) in 2H18, have led us to reassess our outlook for capital outflows. We were overly pessimistic.

Riksbank preview: Still waiting for Godot

We expect the Swedish central bank to keep the monetary policy stance unchanged at its July meeting. That may provide some short-term support for the krona and short-term rates, though we would never exclude a dovish surprise from the Riksbank

The outlook for the Riksbank remains broadly similar to the last meeting in April. We expect only limited changes to its economic forecasts, and the interest rate path to be left unchanged (indicating the first hike at the end of 2018).

The Riksbank has a well-known dovish bias and has delivered a de facto softer policy stance at each of its past three meetings. So even an unchanged stance at this meeting, reiterating its forecast that interest rates will rise by the end of the year, might provide some short-term support for the krona and short rates.

In the longer term, our view remains that weak domestic inflation pressure and the very gradual tightening of ECB policy means the Swedish central bank is unlikely to deliver its first rate hike until mid-2019. We believe the Riksbank’s policy stance will start to shift slowly in that direction as the year goes on.

Below is a more detailed analysis of the key factors driving the Riksbank’s policy.

Reading time around about 6 minutes

In case you missed it: Crunch time

The global landscape is looking murky. Further trade tensions this week prompted yet another downgrade to our Chinese yuan forecast, EU leaders are in "extend and pretend" mode and could Brexit lead to another 'Minsky Moment'? Plus, we look at four scenarios that could drive the EUR/USD in the coming year 

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