Who wants to impeach a +60 ISM president?
The US has never outperformed the rest of the world in this way before outside of recession times. The political picture is though turning against the USD, as a democrat house majority could raise impeachment and debt-ceiling stand-off chances.
Table 1: Our current list of convictions
Wow. ISM is heading to the moon. Non-farm payrolls and average hourly earnings surprising positively, while Euro-area core inflation recently disappointed a tad, as did German industrial production and factory orders. In brief, the past week hasn’t done anything to dent the story of US outperformance. While global PMI has gradually slumped to its weakest level since November 2016, ISM manufacturing jumped to its highest level since May 2004, in the biggest surprise since April 2007… Outside of recessions, the ISM gauge has never outperformed in this way before.
Chart 1: Outside of recessions, the US has never outperformed in this this way before
In our four-variable dollar-o-meter framework, it is only the political factor which has started to become a problem for President Trump (and hence for the dollar). Recently, the anonymous NYT op-ed and Woodward’s new book has helped boost the perceived likelihood of impeachment (which would be USD-negative in our view).
Impeaching a president who is more popular than France’s Macron, and as popular as Carter, Clinton and Obama were at similar points in their respective presidencies (Gallup), would risk a political crisis. If Trump’s base can be turned against him, then the situation will change rapidly.
Trump supporters may however become even more convinced (by anonymous op-eds) that shadowy Deep State forces are working to overthrow a legally elected president, and this might rather fire up his base ahead of mid-terms rather than the opposite. Trump’s former chief strategist Bannon (whether influential or not) is likely to do his best to push this narrative, for instance in his new movie.
Anyhow, if the Democrats do take control of the House of Representatives, as is currently indicated by betting markets, then it might prompt questions not only pertaining to impeachment, but also relating to the scope for further fiscal reforms, and to the US debt ceiling early next year.
Chart 2: US midterms may cause a temporary surge in US liquidity due to debt-ceiling implications
As the debt ceiling (may) come into force again on March 1, the US Treasury will not be allowed to have as much cash stored with the Fed – and as it draws down on its cash account, private banks will experience an influx of bank reserves. If mid-terms bring deadlock to Congress, then it would boost the likelihood of another debt ceiling debacle, which might in turn temporarily boost US excess liquidity by some USD350bn – wildly overshadowing the liquidity effects from the Fed’s shrinking balance sheet for a while. And if there are more dollars in the system, the dollar tends to weaken, and vice-versa.
Chart 3: Dwindling US liquidity still good news for the dollar – but US election a risk
Right now, the Fed is “unprinting” dollars at a quicker and quicker pace (currently by -480bn yoy). This has so far help lead the DXY lower, as US liquidity leads the DXY index by two months. We think US growth outperformance, US inflation outperformance and the Fed’s continued unprinting of dollars are consistent with a dollar-positive stance though politics is clearly a risk as it could prompt a sudden surge in US excess liquidity early next year. We keep our EUR/USD short bias.
SEK – good thing the Riksbank is not working with air traffic control
It’s a good thing the Riksbank is not working with air traffic control, since it’s all over the place in its communication – and you don’t want that with passenger jets involved. The September meeting was no exception to this rule. On the one hand, the Riksbank kept its currency rhetoric unchanged while postponing the first rate hike somewhat. There was no likelihood for an October hike and a -50bp quarterly average for the repo rate was signalled for the fourth quarter, it also said “the risks of excessively low inflation merit particular attention” – (dovish) status quo, in other words…
One the other hand, the Riksbank explicitly mentioned it intends to hike by 25bp either in December or February (not a first hike by 10bp, as had been discussed elsewhere), Governor Ingves also sounded confident in the press conference. If we put on our tin-foil hats, we might conclude the reason he looks so happy is because the Riksbank is now on cruise-control into a rate hike in December (or February).
Chart 4: Riksbank could need to hike its near-term inflation forecast in December
We understand that market participants are tired of listening to the Riksbank at this juncture (the Governor who cried wolf?), as are we – there’s always something to warrant a dovish stance. But, for what it’s worth, if we compare our core inflation forecast with the Riksbank’s, the Riksbank may need to lift its near-term inflation forecast in December. Why should they then postpone the rate hike even further? In light of this, we think the market ought to price in a 1-in-3 likelihood of a 25bp hike in December or some-such. Listening to Ingves it appears as we need setbacks – maybe big ones – to prevent a December or February hike. Historically this would seem to be mildly SEK-positive.
Chart 5: EUR/SEK – Political worries more likely to subside than to intensify next week
We have been short-term negative EUR/SEK recently, and stuck to this view despite a net soft message from the Riksbank, the main reason being that EUR/SEK has been a buy-on-rumour ahead of the Riksbank’s decision as well as ahead of the election, and that is usually followed by a sell-on-fact. For instance, remember how everybody traded Trump as a negative ahead of the US presidential election in 2016? At the time we argued “Trump hedges could be unwound fairly soon after the results are in”. We suspect “SD hedges” could be unwound soon after the Swedish results are in… If they are, we will consider closing our EUR/SEK short ahead of the (below-Riksbank) core inflation reading on Friday.
NOK – excess liquidity no longer as problematic
EUR/NOK has indeed been wrong-footing a lot of market participants over the past few months – you can almost smell the frustration. The sudden rise in EUR/NOK over the past week was likely a result of stop-losses in the NOK/SEK cross, as some SEK shorts were unwound. We think the time to bet on new EUR/NOK downside is approaching.
Norwegian excess liquidity is becoming less of a headwind for the NOK, and if anything we would guess that EURUSD xCcy basis may widen as year-end effects come into focus. This may add pressure higher to Nibor 3m rates. We feel comfortable with being short EUR/NOK from levels just below 9.80 and add it to our tactical convictions. We mentioned last week that a short NOK/SEK position with a target of 1.0750 could make sense. As our target is already reached, we no longer see a decent risk/reward in betting on more downside in NOK/SEK.
Chart 6: Tighter USD liquidity -> higher NIBOR
CAD: The NAFTA premium
Since the inauguration of Donald Trump, deviations from the commodity development in USD/CAD has largely been driven by the NAFTA negotiations and while the US and Mexican stand-off seems as it has been resolved, a deal between Canada and US still seems a little way off, among other things due to disputes around milk.
The pick-up in NAFTA related stories (a proxy for NAFTA uncertainty) has once again increased the “risk premium” in USD/CAD , that is now trading 12-13 bfs too high compared to commodity prices.
Chart 7: USD/CAD deviations from commodities explained by NAFTA talks
We wrote back in January that “net long copper positioning is at record highs, and even a small correction in the long copper positioning would spell trouble for AUD versus the USD in coming months. Therefore, if you want a late-cycle commodity FX bet, we think it’s better to be long CAD than the AUD, as oil will outperform copper” (FX weekly: The Euphoria Rises).
And while it took some time for our short AUD/CAD to “catch down” to the lower copper to oil ratio, the bet is now performing as we anticipated that it would. As net positioning in copper is still long (and China woes not over), we think that a short AUD/CAD position is a decent way to reflect a i) bearish view on the short-term Chinese momentum, ii) the potential for a NAFTA restrike CAD rally.
We stick to both short AUD/CAD and short AUD/USD as a consequence.
Chart 8: Copper to oil ratio leads the way lower for AUD/CAD
GBP: Thank you, Barnier
Another week, another couple of big moves in the GBP based on Brexit-flashes. First Germany was allegedly on the verge of accepting a deal (which was denied after a while) and then secondly Michel Barnier headlined saying that a tailor-made fourth solution (on top of the Norwegian, the Canadian and the Turkish solution) could be in play, which admittedly sounded like a substantial softening of the EU approach. Get used to those swift and sudden moves in GBP. They will likely only get worse the closer we get to the ultimate deadline.
But outside of the Brexit-noise there are fundamental domestic reasons to be a little less worried on the GBPs behalf compared to just a few months ago. Our retail sales model has rebounded substantially and is now showing the best momentum, since the GBP fuelled post Brexit jump in the sales figures.
We say “thank you, Barnier” and keep our short EUR/GBP intact based on (at least) four reasons i) the disinflationary impulse from the GBP is about fair priced now, ii) domestic forward looking indicators are starting to look a little more healthy in UK, iii) BoE has a low tolerance for a weaker GBP, iiii) excess liquidity in GBP is shrinking (albeit slowly)