The upbeat risk tone throughout yesterday’s European trading session did have a somewhat “too good to be true” feel about it and, later in the US session, it appears markets underwent a reality check, with risk assets (led by US equities) sliding and havens picking up.
In terms of the price action today, rather than sentiment being driven by any particular risk on/risk off feel, things have been much choppier. US and European equity bourses have been going sideways either side of yesterday’s lows, while crude oil markets have managed to pick up a bit. Bonds have been choppy, though US and German 10 year futures trade near highs of the day.
In FX markets, the tone has been equally unconvincing; USD has been slammed in recent trade to fresh weekly lows, with EUR, CHF and AUD benefitting the most. JPY, CAD, NZD and GBP are all flat or lower vs USD. (More detail below).
Before we go on to discuss the price action today, lets first discuss the biggest move of the week so far; yesterday evening’s risk off.
What caused yesterday’s shift in risk appetite?
We had some updates on US/China trade tensions and on the Covid-19 outbreak in the US which are being attributed as being the cause – more likely, these updates just served as a reminder to traders and investors not to get overly bullish just yet as we still face BIG risks to the economic outlook.
US/China - The US departed from its policy of not taking sides in the South China Sea and denounced China's claims to the South China Sea as unlawful. US Secretary of State Pompeo said that Beijing's claims to offshore resources across most of the South China Sea and its "bullying" campaign are completely unlawful. The US warned that Chinese territorial claims in the South China Sea "pose the single greatest threat to the freedom of the seas in modern history". (This will anger China greatly and sets the stage for rising military tensions between the two sides).
Covid-19 – Yesterday, US Covid-19 cases rose 60.5k and death toll rose 312 (Prev. +906) – not too bad on this front, deaths not as bad as feared. BUT California Governor Newsom ordered indoor activities to close state-wide, including bars, restaurants, museums, zoos and movie theatres, while he added that the worst-hit counties must also close churches and salons. News of further lockdowns in the US’ largest state definitely helped spook market towards the end of yesterday’s US session.
Now let’s talk about the individual G10 performers and what fundamental forces have been driving them today…
The worst G10 performer today. Multiple factors have contributed to a sense of pessimism over the state and outlook for the UK economy;
1) Bad UK GDP data this morning – The UK economy re-entered expansion for the first time in two months in May, rising from April’s -20.4% M/M rate of contraction to a 1.7% M/M rate of expansion. This, however, was much more modest than expectations for a M/M growth rate of 5.5%. Y/Y, the UK economy was still 24% smaller than it was in May 2019 (vs expectations for it to have shrunk 20.8%) – showing just how far the UK economy has to go in order to fully recover from the impact of the Covid-19 lockdowns. We should see a somewhat faster rate of recovery in June/July, however; lockdown restrictions were eased much more in these months, facilitating a further pick up in economic activity.
2) Downbeat economic forecasts from the Office for Budget Responsibility (OBR) – The UK OBR released updated forecasts on the UK’s post-Covid-19 economic recovery in which it outlined three different potential scenarios; under the central scenario, GDP will end 2020 12.4% lower than in 2019, under the downside scenario, GDP would be 14.4% less and in the upside scenario, GDP would be 10.6% less. This is to be the largest annual decline in GDP in over 300 years, said OBR. Moreover, under the central scenario, the OBR expects unemployment to peak around 11.4% (it averaged 3.9% in the 3 months going into April). In other words, on the unemployment side of things, the worst is yet to come.
Both of these factors, combined with the continual “sell GBP rallies” narrative as a result from the lack of progress in negotiations with the EU, has weighed heavily on GBP today, with GBPUSD falling at one point below the 1.2500 mark despite today’s much softer USD.
Aside from NOK and SEK (the latter benefitting from firmer than expected CPI data this morning), EUR is the best performer in the G10 today, despite an apparent lack of any positive fundamental. Indeed, the news we have had on the fundamental front has mostly been not so good;
- Eurozone industrial production coming in somewhat weaker than anticipated at +12.4% M/M in May and still lower by 20.9% Y/Y on the year (vs exp. -20.0%).
- Moreover, German ZEW data for July was also a touch softer than anticipated, with Economic sentiment coming in at 59.3 (vs exp. 60.0) and current conditions coming in at -80.9 (vs exp. -65). Somewhat disappointingly, ZEW said the outlook for the German economy largely remains unchanged compared to the prior month (most would have hoped for a pick up).
- Dutch PM Rutte said he is not hopeful an agreement of the EU Recovery Fund will be reached at the EU Summit on July 17th/18th.
This latter point is important, because it almost looks as though today’s rally in EUR in part is being driven by expectations that there will be a deal at this weekend’s meeting of EU27 Leaders. In that case, there could be some downside risk for EUR over the weekend when news of how this meeting went gets out – failure to make any substantial progress and we could see EURUSD slip from its current around 1.1400 levels to maybe back below 1.1300.
USD had a bad day, giving back all of its risk off related gains that it made yesterday evening and during the overnight session and some. Perhaps the move lower in DXY reflects EUR optimism (remember, DXY is a trade-weighted basket of USD vs its major counterparts, and EURUSD makes up around 50% of this basket).
Perhaps its reflects ongoing concerns regarding US economic fundamentals (Covid-19 outbreak does not show any signs of slowing just yet), or growing expectations for more easing from the FOMC.
USD was most certainly not being driven down today by “risk on” – otherwise you would have seen stocks and other risk assets all making decent gains. Either way, DXY fell to new lows since early/mid-June of 96.21, despite US CPI data coming in a little firmer than expected for June;
Core CPI rose at an annual rate of 1.2% vs expectations for 1.1% - note, this is still well below the Fed’s 2% forecast, and CPI is not even the Fed’s preferred measure of inflation; that is Core PCE.
The rest of the G10
A mixed performance for the dollar bloc this morning; AUD is one of the G10 outperformers today alongside EU, SEK and NOK, while CAD and NZD are both trading subdued.
AUD is likely an outperformer 1) because we saw a big improvement in Australian NAB Business Confidence in June (rose to 1 from -20) and in Australian NAB Business Conditions (rose to -7 from -24) and 2) because we had stronger than expected Chinese data overnight (although this ought to also be helping NZD);
Chinese Trade Balance in dollars (Jun) 46.42B vs. Exp. 58.6B (Prev. 62.93B)
Chinese Exports (Jun) Y/Y 0.5% vs. Exp. -1.5% (Prev. -3.3%)
Chinese Imports (Jun) Y/Y 2.7% vs. Exp. -10.0% (Prev. -16.7%)
Either way, AUDUSD has bounced from overnight lows around 0.6930 and now trades around 0.6970, while NZDUSD struggled to recover back above overnight levels in the 0.6530s. Meanwhile, USDCAD is below earlier highs of above 1.3640, but has not been able to break above 1.3600, amid increasing caution ahead of tomorrow’s BoC meeting.
Meanwhile, havens CHF and JPY are performing mixed; the former firmer in line with other European currencies (aside from GBP), while the latter is flat vs USD. Gold has been choppy and is heading back towards the $1810 mark again having slipped to around $1792 in earlier trade; USD weakness is facilitating this latest batch of upside.
- Tonight we have Fed members Brainard and Bullard speaking, who will likely note increasing levels of Fed caution due to the worsening Covid-19 outbreak in the US.
- Overnight, we have the latest BoJ Rate Decision; no policy changes are expected but the bank is expected to reiterate that it is ready to do more if needed.
- In the morning tomorrow, we have UK CPI data plus BoE voting member Tenreyro.
- In the afternoon tomorrow, we have Canadian CPI data followed by the BoC’s latest rate decision.
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