13 July 2018
JPY: Why the yen’s at a crossroads

We see two potentially large and opposing drivers of USD/JPY over the next six months. Further Fed tightening and US Treasury curve flattening look positive. A substantial escalation in the trade war looks negative; volatility looks to be too low

Bearish flattening of the US Treasury curve helping USD/JPY

Despite all the concerns of an escalating trade war, the world’s favourite safe haven currency – the Japanese Yen (JPY) – is drifting towards its lowest levels of the year against the US dollar (USD). The rise in USD/JPY over 111 probably owes to firm US yields at a time when US equities are remaining bid. Here the US$1.5trn in US tax cuts have likely delivered insulation for US equity markets.

Assuming US equities do not crash this summer, the current bias is for US yields to push higher this summer

Typically a flattening in the US Treasury curve has proved bullish for USD/JPY. Here, the typically held view is that the relative rise in short-end US rates relative to the long end makes dollar hedging costs disproportionately expensive. Japanese investors, therefore, reduce their rolling three-month dollar hedges, leading to dollar demand. For reference, it currently costs Japanese investors 2.6% annualised to hedge their USD exposure back into the JPY using three month forward contracts. That nearly wipes out all of the yield pick-ups of investing in US Treasuries. Assuming US equities do not crash this summer, the current bias is for US yields to push higher this summer as US price pressures stay firm and the balance of risks favour USD/JPY towards 114/115 at this stage.

Metals: You’ve got to roll with it

Metals have been hit hard by escalating trade wars and the perceived risks to global growth and demand. Amid the macro gloom, it’s hard to see what can provide a firm near-term floor but we do think some over-zealous shorting will be squeezed by sharp backwardations approaching

Impending tightness between July-August

Aluminium and zinc are fast approaching sharp rolls between the July-August prompts on the LME that will be costly for any near-term short positions to roll. Traders should be on the look-out for how this impending tightness could drive outright prices higher by causing shorts to exit. From thereon, however, to entice a return of long allocations will depend on the global trade-war sentiment. ING economists think that at least the direct impacts on growth/metal demand are limited and that a deal is probably going to be sought after the US mid-terms, but it’s increasingly becoming the indirect effects to business sentiment that are most risky.

In LME metals, spreads between the futures dates have the proven ability to direct prices and especially as key expiries approach. It is important to remember that in a backwardation rolling a short position forward position is costly (buying the nearby is higher than selling the further out).  Many commentators focus on the Cash-3 month (Cash-3M) LME spread. This is the price difference between historically the most defined closing prices but it actually tells us little about the real cost for traders to roll long/short positions in the market. In actual fact, most positions (over 2/3rds of open interest) sit on the LME’s regular monthly contracts (3rd Wednesdays) and so most positions are rolled between those dates.

With the July month contract soon to expire (18th July with the last full day of trading on Monday 16th), those still short the contract will be facing costs to roll the short position forward. If they choose to instead just square out their position (buy nearby without also selling further out) that is likely to bring some much needed positive momentum to these markets. The 288 kt equivalent shorts of July Zinc, 428kt of July copper are actually fairly in line at this stage ahead of the expiry, but the 1.6Mt of Aluminium July shorts, that are going down to the wire before rolling, are looking very high making it the most tense of rolls with the most short-squeezing potential.

Four crucial questions for Eurozone leaders to answer

European leaders made little progress in answering profound questions about the Eurozone's future at their June summit. But ensuring economic sustainability should be a priority, says ING's Chief Economist, Mark Cliffe

The future of Europe

Although some progress has been made over the years, we're potentially only one recession away from the fragmentation of the Eurozone. Building up Europe's resilience to future economic setbacks should be at the top of the agenda for Europe's leaders. Prompted by a recent ING-sponsored Future Europe conference, where politicians and policy-makers tackled some of the pressing issues, here are four questions that Eurozone leaders should be giving answers to.

China: Changing the nature of retaliation on trade

It may not be until September that we'll be able to assess the extent of China's qualitative retaliation to the overnight announcement by the US of an additional 10% tariff on $200 billion worth of goods

Qualitative retaliation, but how?

Chines imports from the US reached only $168 billion in 2017. So, after tariffs on $34 billion worth of goods, with an additional $16 billion in the pipeline, the overnight announcement (11 July) of a 10% tariff on a further $200 billion of goods means that China will likely retaliate "qualitatively", as previously indicated by the Chinese authorities.

Here are some measures we believe are possible (definitely not an exhaustive list). The uncertainty surrounding such qualitative retaliation could be a cause of concern for markets.

  1. We believe that the most likely "qualitative" retaliation is a version of the "Lotte Department store model" (a Korean store forced to shut down by the Chinese government after missiles were installed on land the company sold to the South Korean government). As they are opening up their market to the rest of the world, China should tread cautiously in making life difficult for US companies operating in China. But, they could, if they feel they need to, make US business operations on the mainland more cumbersome, making it clear that this is only a retaliation to US tariffs and specific to US companies. It is likely that European and domestic brands would emerge as winners.
  2. China can also limit tourists visiting the US, bringing business worth $115 billion in 2017 according to Xinhuanet. China will probably not limit students going to the US for study because these students are a source of future talent for the country.
  3.  The final weapon is not the currency, but US treasuries. Even reshuffling the foreign exchange reserve portfolio slightly by selling some US treasuries and investing more in other sovereign bonds could push up US borrowing rates.
Swiss Quarterly: On the right track

Even though Switzerland’s real GDP growth lost some momentum, the outlook is positive for the year ahead. Nonetheless, we’ve slightly revised our GDP forecast downwards to 2.2% and expect it to stabilise to around 2% in 2019 

Internal demand supports growth in 1Q18

In 1Q18, real Swiss GDP increased by 0.56% quarter on quarter, which is slightly less than the second half of 2017 (0.73% for 3Q17 and 0.62% in 4Q17), but still above its average. Moreover, compared to the first quarter of 2017, GDP grew by 2.4% which is the strongest performance in three years. 

This performance is mainly due to the service sector with trade and business-related sector recovering (+0.8% and +0.5% QoQ), while financial services (+1.0% QoQ), transport and communications (+1.3%) and healthcare (+1.2%) continued to gather pace. On the contrary, the manufacturing industry experienced a low growth situation (+0.2% QoQ) and the construction sector a stagnation.

Contrary to previous periods where growth was supported by exports, the good performance of the first quarter was due to strong internal demand. Household consumption was strong (+0.4% QoQ), investment recovered strongly (+2% QoQ, the highest quarterly growth in three years) and all of this translated into above average imports growth (+2.2% QoQ).

UK government in turmoil, what now for Brexit?

Having agreed a plan with her government, Theresa May has been rocked by the resignation of Brexit Secretary David Davis and now her Foreign Secretary, Boris Johnson. We take a look at what this means and what might happen next in the Brexit process

PM May's new plan

After all the build-up, last Friday UK Prime Minister Theresa May managed to persuade ministers to rally around a new plan for Brexit. Crucially, the agreement means that the UK will abide by a "common rulebook for all goods" - in other words, the single market for goods/agriculture. The government will also press for a "facilitated customs arrangement". Here the UK could apply different tariffs to the EU, in theory enabling it to pursue trade deals outside of the EU. Where tariff rates differ, the UK would collect fees on the EU's behalf. 

But there's still a big question of whether the EU will accept this. Here are our thoughts on what could happen next:

Reading time around 8 minutes

In case you missed it: The trade war is on

Metals have been hit hard, the world’s favourite safe haven currency – the yen drifts towards its lowest levels of the year, and China potentially considers 'qualitative' retaliation as the trade war escalates. Here's everything else we've been thinking about

In this bundle