August FX outlook – USD weakness hard to oppose, but stabilization may be seen
USD weakness accelerated in July as the continued lack of action (and some signs of disintegration) from the Trump administration combined with continuing evidence of recovery elsewhere. Tightening of monetary policy in Canada and indications of a potential tapering of monetary accommodation in the Eurozone come the autumn added to pressure on the USD, as did evidence of weak inflationary pressures in the US and consequent declining confidence in further Fed tightening this year. Scheduled events are quite sparse in August, but history teaches that this does not necessarily mean the markets will be quiet. At this stage it remains hard to oppose USD weakness in the absence of news, with the Trump administration’s disarray maintaining a negative USD tone. But the USD looks technically oversold – at least in the short term – and yield spreads, although they have moved against the USD in recent weeks, do not generally justify the sharpness of the USD decline in the last month (except against the CAD). So while USD weakness may extend modestly in August, and perhaps more aggressively in the longer run, weakness seems likely to be less dramatic than in July. But the lack of significant scheduled events in August makes a major turnaround in recent USD weakness unlikely, even if modest corrections are seen.
Three-year USD Index:
Outlook for August
1) Bank of England monetary policy meeting and inflation report – August 3
The June meeting produced a surprise with 3 of the 8 members voting for a hike in rates. However, with 5 members still probably calling for no change in rates, and one of the 3 who voted for a hike – Kristin Forbes – now having left the committee, few expect the committee to find a majority vote for a hike in rates this time around. However, there is some uncertainty created by the arrival of a new committee member – Silvia Tenreyro. She has yet to comment publicly on monetary policy, but is generally expected to vote with the majority for no change in rates. So a 6-2 vote for no change is expected, and there may be more interest in the Inflation Report and the accompanying press conference, where governor Carney may provide some color on the prospects for monetary policy. However, there is a chance that chief economist Andy Haldane shifts to voting for a rate hike, judging by his latest speech. The UK data so far this year has been underwhelming, but the growth and inflation data since Q2 has been in line with the Bank of England’s expectations, so no significant change seems likely in the report.
2) Geopolitics and equities
While the relatively light calendar of events in August doesn’t suggest any major equity market reversal is likely, there have often been significant equity market moves in the summer, and geopolitics could be a trigger rather than economics. The most likely source seems to be the situation in North Korea, with the North Korean ballistic missile tests drawing a response from the US, and the Trump administration perhaps willing to take on some foreign issues given the lack of progress on their domestic agenda. Of course, there is no way of assigning a probability to such events, but there is a history of rising equity market volatility in summer and early autumn, and there is uneasiness in some quarters about the current valuation levels in the US market. Of course, for a market reaction there only needs to be some increasing concern about geopolitical issues rather than any concrete events, and a lack of economic news may increase the focus on such concerns. Increased wariness is advisable in the coming month or so around these issues, especially since market positioning is currently heavily biased away from the safe haven currencies and towards the more risk positive markets.
EUR/USD made a major break higher in July through the 2016 high of 1.1617 and the 2015 high of 1.1715. This suggests the long term downtrend seen since the 2008 financial crisis may be complete. EUR/USD has benefited both from USD weakness on disappointment at the lack of economic action from (and general lack of confidence in) the Trump administration and from continued positive news out of the Eurozone. The market now expects an announcement of tapering of the ECB’s asset purchase program in the autumn. However, EUR/USD has traded some way ahead of the usual relationship with 10 year T-note/bund yield spreads, and while it is certainly hard to oppose USD weakness at this stage, there are further significant technical resistances not far above here, with the 1.1875 low from 2010 and the 1.2040 low from 2012. There is also quite an extreme speculative long EUR position evident in the CFTC data on futures positioning. None of this means the recent EUR/USD uptrend will halt or reverse, and for now the downside looks well protected in the absence of major news. But it does suggest the headwinds may be more severe from here so progress is likely to slow and risks now look more balanced for the next month in the 1.15-1.20 range.
GBP/USD has managed to continue a modest advance through July even though UK data has not been particularly encouraging, political uncertainty remains with PM May still lacking authority and there remains no real progress on Brexit issues. Nevertheless, the weakness of the USD and the strength of the EUR for the reasons outlined above have favored a modest uptrend in GBP/USD through July even though GBP has lost ground against the EUR. The main event for GBP in August is the Bank of England monetary policy meeting and Quarterly Inflation Report presentation on August 3. The June meeting saw a surprise 3 votes out of 8 for a rate hike, and at the time this helped provide some support for the pound. But with one of the hawks – Kristin Forbes – having departed, few see much risk from the August meeting, though the recent speech from chief economist Haldane suggests he could switch to voting for a hike. On balance, though, we doubt this will happen this month, so GBP/USD looks likely to be more sensitive near term to political news both domestically, from Brexit talks with the EU and from any US and geopolitical developments. With GBP futures positioning now fairly modest and yield spreads with the US suggesting GBP/USD has overreached the economic news, the scope for gains beyond 1.30 looks quite limited. Although GBP/USD remains likely to be dragged reluctantly higher by any further EUR/USD gains, the risks may now be for a sharper decline if the recent EUR/USD rally corrects.
The CAD was the strongest of the major currencies in July, benefiting from the Bank of Canada rate hike as well as general USD weakness and a modest oil price recovery. USD/CAD broke through the 2016 lows at 1.2462 hitting a low of 1.2415, and with strong monthly GDP data at the end of July there may yet be more potential for CAD gains if the oil price continues to rise and yield spreads continue to narrow in support of the CAD against the USD. However, speculative positioning in the futures has now turned net long CAD and is now close to the recent highs seen in March, and below 1.25 the CAD can no longer be considered cheap from a long term valuation perspective. While these are not reasons to expect a reversal of CAD strength, they suggest some slowing in the uptrend or stabilization at these higher levels. The next big target for the CAD bulls is the 1.1921 low from 2015. This still looks a long way off, but USD/CAD fell more than 5 figures in July, so a test cannot be ruled out. However, USD/CAD does now look quite oversold in the short term so a correction – possibly a sharp one – may well be seen before long. Given the recent big move we may well see quite a large range in the current month – perhaps as wide as 1.20-1.27.
USD/MXN continued the steady downtrend it has seen for the whole of the year in July, breaking convincingly below 18.00 for the first time since early 2016, and now has the 17.05 2016 low in its sights. The MXN has benefited from the general USD weakness in recent months and in particular the lack of any effective policy initiatives from the Trump administration. It should also benefit from the generally positive risk appetite and the recovering oil price. The biggest risk, given that Trump’s protectionist initiatives seem to have run out of steam for the moment, is that the current positive risk appetite fades or reverses due to loss of confidence in global growth, especially if this is triggered by geopolitical concerns. But as long as equities are well supported and the global growth recovery continues, the MXN looks to represent attractive yield and good value.