Weekly Investment View: Time to Turn More Constructive on EMFX?

This Week

Bilal examines the relative growth theme in play between Europe and the US; Dominique argues consumption growth must slow for the Fed to cut; Mirza outlines his more constructive stance on EM currencies; Henry previews the EZ preliminary CPI release, seeing upside risk to core; Ben expects a hawkish pause at the RBNZ meeting; Viresh argues Brent will remain rangebound at $80-85/bbl; John argues equities could break out of their range on a PCE surprise.

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Bilal Hafeez – Global Macro

I recently spoke with former UK Defence Secretary Sir Michael Fallon. He asked about the impact of the Russia-Ukraine war on Europe. I told him Germany has been hit because it disrupted one leg of the German economic model (using cheap Russian energy to export to China). I later analysed the data and realised Germany has not grown since the Russia-Ukraine war! Essentially, Germany has stagnated for almost two years. Meanwhile, the US has zoomed ahead, and even Japan has grown (Chart 1).

What does this mean for markets? For one, it suggests there is a relative growth theme in effect (US vs Europe) – we could play this via FX or equities. It also suggests that Central Europe, especially Czechia and Hungary, has a major growth headwind.

Dominique Dwor-Frecaut – US Macro

The most important economic data of the week is core PCE. However, we already know it will be around 40bp and, most importantly, that markets have already discounted it.

The second most important data is personal income and spending. This is because consumption accounts for about 70% of the US economy, and US growth is too hot for the Fed. In 2023, consumption grew on average 2.2% and contributed 1.5% to GDP growth of 2.5%. However, real consumption growth accelerated through 2023: in Q4, it grew 2.8% and contributed 1.9% to growth of 3.3% (excluding the volatile inventories change and next exports, GDP growth was 2.7%).

For the Fed to feel comfortable cutting, GDP growth must slow to nearer the FOMC estimate of trend (1.8%). This requires consumption growth to slow (Chart 2). We will get a sense of whether this is happening on Thursday.

Mirza Baig – Emerging Markets

We have maintained a neutral stance on EM currencies so far this year amid the ongoing correction in DM rates. However, we are now shifting back to a more constructive view. We will be releasing our favored trades to express this view in coming days, but the highlight is that we like buying BRL and IDR on stable carry to vol and moderate positioning, and KRW on cyclical tailwinds.

What drives our thinking here?

First, the pullback in US rates has been substantial. The 2Y SOFR swap has bounced 60bps from the lows, and market pricing for 2024 has largely converged with the DOTs. Antonio thinks the sell off may extend, particularly in the long end. But I point out that risks are less asymmetric now, particularly as the jury is still out on the pace of disinflation.

Second, despite the back-up in US yields, overall FX vol has remained low. This could be because yields are rising for ‘good’ reasons – a lower probability of recession – which could support global trade flows, as the recent pickup in global manufacturing PMIs attests to.

Henry Occleston – Eurozone & UK Macro

The main data release this week is the EZ February preliminary CPI. The market expects a decline in core CPI from +3.3% to +2.9%. I see upside risk to this, with my bottom-up model suggesting +3.1%. For the headline number, the 2.5% expected by the market seems reasonable, although household energy effects are uncertain. This would be a strongly hawkish outturn and would increase my conviction that the ECB will wait until at least June to cut.

The ECB’s estimates are for 3.1% in Q1. They have overestimated energy prices in Q1 and will most likely need to downgrade near-term headline inflation estimates in March. However, their path for core inflation looks reasonable at least out to summer. March tends to see big price rises, so (again) there is risk of volatility around that, as with January. ­­

We still like paying April-dated ESTR on the fundamental likelihood that the ECB will not cut until at least June. The trade has performed well (we raised the stop loss last week). However, note that ECB (and BoE) pricing is being almost entirely driven by Fed pricing for now (Chart 4).

This correlation will only change when the discussion of the timing of cuts becomes more serious, or the cuts start. We see room for less dovishness in ECB pricing and more in BoE (and so like paying 2Y EUR vs receiving 2Y GBP).

Ben Ford – $-Bloc & Scandies

While we expect a hawkish pause, markets are pricing a quarter chance of an RBNZ February hike. Meanwhile, ANZ and TD are pushing for a hike – the only two of 24 on Bloomberg making such a call. The call for a hike has evidence: core inflation was stronger than expected, as was the labour market. However, both prints come with nuances, as does policymaker language since their releases.

• CPI: Markets concentrated on non-tradables Q4 CPI printing higher than the RBNZ had forecasted. However, a large portion of this beat was driven by one-offs. Meanwhile, the groups that had been holding up non-tradables inflation made promising disinflationary progress.
• Labour market: Employment grew by more than expected, wage increases were larger than forecasted, and unemployment only inched higher. Yet employment has been axed from the RBNZ mandate, while the labour market is no longer beyond maximum sustainable employment, according to the RBNZ’s framework.
• Language: Language from Chief Economist Conway and Governor Orr failed to walk us into a February hike when they had every opportunity. This reflects that the RBNZ debate internally and conveys a symmetric message – in this case, a hawkish stance without committing to hiking, and comfort waiting to tighten again. This aligns with previous communication.

Viresh Kanabar – Commodities

Oil continues to hover at $80-$85/bbl, in line with our view. The Dated Brent CFD curve has shown weakness in recent weeks, with w1-w3 backwardation falling to 54c from $1.2/bbl just 10 days ago. This matches the financial market as m2m3 ICE Brent spread futures have also fallen 4c to 58c. We watch three things.

1) China continues to drain its crude inventories. The latest data from Kpler shows that Chinese inventories have fallen to 920mn barrels from almost 1bn in June.

By draining inventories, China is adding supply to the market, as it reduces their import needs.

2) Oil vols continue to fall, partly driven by lower realised vol. 2m vols are down to 26.9, the lowest since late last year. Meanwhile, riskies have fallen in favour of puts – and now are at the lowest levels since December (25d 2m).

3) The gasoil shortage in Europe and the US continues. Gasoil inventories have fallen faster than seasonal patterns in the US, driven by low refinery runs. Meanwhile, Europe has struggled to source distillates as East-West arbs have been closed.

The ICE Gasoil crack is currently sitting at around $29/bbl, and we think they will be supported in this range. Should it fall to around $25/bbl, we think it will be a good area to be long.

Market implication: We remain comfortable with our rangebound call for Brent at $80-$85/bbl.

John Tierney – US Equities

Markets get another opportunity to access the outlook for rate cuts when PCE prints on Thursday. Whether equities break out of recent trading ranges will depend on whether the PCE delivers conviction that rate cuts could be coming sooner rather than later.

Nvidia managed to surprise on the upside yet again – clear evidence that the investing community has yet to get its collective head around the AI phenomenon.

Consumers remain strongly inclined to spend on experiences rather than stuff, but some companies in the travel space sold off on expectations that had become overly inflated.

About 125 companies report this week, including a variety of retailers and several tech companies that have hawked their AI-related growth potential.

(The commentary contained in the above article does not constitute an offer, a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)