[MKT] FX Strategy - US data undermining the USD
In a holiday shortened week, the market focus is still likely to be mainly on the aftermath of the Fed hike and whether the subsequent US data suggests the Fed was justified in raising rates for the first time in 10 years. Up to now, the latest US manufacturing numbers have not been particularly encouraging, with industrial production, the Markit manufacturing PMI and the Philly Fed index all on the weak side of expectations, and US long term yields have actually edged lower since the FOMC. However, they have fallen less substantially than yields in the Eurozone, so the T-note/bund spread has moved slightly in the USD's favour, though not so much as to suggest scope for a significant move below 1.08 in EUR/USD. This level was under pressure on Friday, but the failure to break and more weak US data in the form of the lower than expected Chicago Fed national activity index on Monday helped push EUR/USD back through 1.09.
There is a lot of US data over a short period this week, but typically at this time of year the data is secondary to transactional demand and book tidying exercises, so we doubt that we will see new trends begin. We still favour a mildly positive USD tone medium term, but some better US numbers look necessary if we are to see any USD advance this week. At the very least some improvement in the equity market, which has slipped back after the post-Fed rally, looks necessary to restore risk appetite in the FX market. We still regard equities as generally good value relative to bonds and cash at current levels, and the Fed hike doesn't change this. There is probably more value to be had outside the US, but we would still favour an equity rally into the end of the year and 2016, and that should favour the more risk positive currencies.
The weakness in equity markets has seemed to weigh on GBP for much of the last few weeks, helped also by declining confidence in an early UK rate hike due to slowing wage growth, and growing concerns about the potential impact of an EU referendum next year. GBP could well be a target currency for the USD bulls in the coming weeks, as the threat of the EU referendum looks likely to discourage the GBP bulls even if there is a more positive risk tone, and any loss of risk appetite seems likely to have a more negative impact on GBP than the USD. GBP/USD consequently looks vulnerable, and even though we are approaching the bottom of the weekly channel in GBP/USD, we would see bounces towards 1.50 as a selling opportunity. EUR/GBP broke above 0.73 on Monday and looks set for further gains with initial potential towards the channel top near 0.7370, but longer term we see scope for a move back up above 0.75 unless the UK data improve sufficiently to re-ignite the prospect of an early rate hike.
Our favoured currency remains the SEK, with more evidence of the strength of the economy emerging on Monday with the economic tendency survey (the best indicator of GDP) rising sharply once again to another new post 2011 high, suggesting the Q3 growth rate of near 4% y/y may even accelerate in Q4. The National Institute economic forecast also raised GDP growth for 2016 to near 4%. The SEK gained modestly, but may have much bigger gains to make medium term, though for now Riksbank resistance to SEK strength limits the upside, especially against a strong EUR. Tuesday's retail sales data may determine the short term direction, but even if the data disappoints we would be SEK buyers on any dip. .