Weekly Investment View: What Could Spark a USD Bull Trend?

This Week

Bilal discusses five key events that could boost USD; Dominique previews retail sales and consumer confidence data; Mirza discusses two new EM trades (long EURPLN and short CNH vs an EM basket); Henry expects an upside surprise in UK core inflation (driven by goods), which could provide an opportunity to fade knee-jerk hawkishness in BoE pricing; Ben argues a change in forward guidance from Riksbank board members will dictate SEK; Viresh outlines his cautiously bullish stance on crude as Red Sea tensions escalate; John expects equities to remain narrowly rangebound as regional banks report this week.

Bilal Hafeez – Global Macro

We are currently bullish on the dollar. With risk sentiment (rather than cyclical divergences) driving the greenback, we recently argued EUR/USD could fall to 1.07. However, we lacked the conviction required to enter a position. Ahead, we think dollar strength could materialize via either risk sentiment worsening or the relative cycle returning as a driver. As Antonio Del Favero explains in our upcoming G10 FX Weekly publication, we are watching five key events that could boost USD.

1. The quarterly refunding announcement (QRA) (end-January). The upcoming QRA could see coupon issuance return, term premia spike, and dollar strength.
2. Core PCE prints (26 January). We think core PCE (the Fed’s target) will likely print below 0.2% MoM. We think the market has already priced this, so the ‘lowflation’ theme may have run its course. This could support the dollar.
3. Oil prices and Middle East risks. A major escalation in the Red Sea could send oil higher, US yields higher, equity lower, and EUR/USD lower.
4. Economic data divergence. The US-EZ manufacturing PMI differential has been strongly correlated with EUR/USD in the past, but recently the two have decoupled (Chart 1). A clearer split in economic data could increase rates cycle divergence. Consequently, the relative cycle could return as a USD driver. If underlying US economic strength holds (as we expect), this could help the dollar.
5. Fed and ECB speakers. The market has priced substantial Fed easing (about 160bp of cuts in 2024), so comments from voters will likely impact EUR/USD. We think ECB speakers will resist near-term cuts, but we could hear dovish comments after the next inflation print.

Dominique Dwor-Frecaut – US Macro

The week’s most important data are retail sales and consumer confidence. This is because the US economy is 70% consumption, so consumer spending largely drives GDP growth. The consensus forecast on the retail sales control group (used to compute consumption in the national accounts) is for 0.2%. Given headline CPI at 0.3%, this implies a contraction in real retail sales. It is not impossible… The data is, after all, noisy. However, it is unlikely given the strong growth in labour income and strong household balance sheets.

Historically, consumer confidence has been linked to consumption of durables. However, the relationship has weakened due to political views biasing consumer sentiment and due to the very large one-off government handouts imparting volatility to durables consumption. Since mid-2022, however, the relationship between durables and consumption has recovered. The consensus forecast is basically a sideway move that is consistent with continued strong durables consumption (Chart 2).

Mirza Baig – Emerging Markets

We remain wary of near-term prospects for emerging markets. The breathtaking rally since November has created challenging valuations in FX, and substantial easing is discounted into local curves. A correction is underway now and, when levels are more attractive, we will shift our stance.

For now, we continue to operate a nuanced portfolio, staying USD neutral and focusing on relative value. In Asia, we are long SGD/THB and short PHP/IDR. In CEE, we are long EURCZK. In LATAM, we are received front-end in Brazil and have steepeners in Mexico.

We added two new trades this week. We turned long EURPLN, where we think the overwhelming bullish view on Poland is set to sour. We also initiated a short CNH vs EM basket position. We expect PBoC will continue to manage the FX rate, and USDCNH will trade in line with its beta to the USD. However, CNH will underperform other EM currencies. We think the CFETS index could fall from the current level of 98.15 to 95, roughly its pre-covid level.

Henry Occleston – Eurozone & UK Macro

November UK labour market data came out as expected, with a tick up in median private wages from October, but a decline in the YoY growth rate to 6.0%. The BoE will consequently need to revise down its wage growth estimates substantially at the February MPR.

Wednesday sees UK inflation data for December. CPI fell significantly in November, but some of this move appears to have been down to the timing of sampling (a week later than in 2022), which likely oversampled Black Friday sales.

As such, I expect some temporary uptick in MoM core goods (clothing and furniture in particular). The size of this effect is key; my base case would put both headline and core inflation stable at 3.9% and 5.1% respectively (overshoots vs consensus), but there could be upside risk to these. An offset in headline could come from slower airline price rises.

Our longstanding expectation is the BoE will cut in May. The market is now close to pricing this possibility (23bp by then). A surprise uptick in goods prices could provide a nice opportunity to fade any knee-jerk hawkishness. The most important detail will be the underlying trend in wage-intensive services inflation (Chart 3).

We will also get a lot of ECB speakers and the minutes from the December ECB meeting (Thursday). We have been looking for good opportunities to fade ECB March and April cuts since the middle of last December. The market has moved in the direction of our thesis, which has made entry points less attractive. Even so, 30bp of cuts priced into April seems too much, and we see value fading that.

Ben Ford – $-Bloc & Scandies

This week started with core CPI at +5.3% YoY. That was above consensus but below the Riksbank’s forecasts (+5.6% YoY). And while markets found reason for this to help SEK strengthen, the background for Swedish inflation remains the same; core inflation momentum has returned to pre-Covid ranges (Chart 4). That means misses are more likely than beats. However, going forward, we think it will be a change in forward guidance from board members that dictates SEK. We will hear from two board members this week.

Breman’s appearance will likely have more commentary and should directly give hints on her stance of policy following the CPI release, though she has already said on Friday that there is no reason to hike again (a dovish turn from the November minutes).

Governor Thedéen will be at a lecture, so we may see no comments come out. But, if they do appear, it will be important to note what changes he makes. First, he should align with Breman and Jansson and state happiness with SEK strength – previously, he was uncertain. Second, any comment on no need to hike again should be taken seriously. This is opening the door to the question: how long until we cut?

Viresh Kanabar – Commodities

Geopolitical news continues to drive the ebbs and flows within the oil markets. The most significant recent announcement is that tankers – both oil and gas – are beginning to avoid the Red Sea. This occurred after the US and allies retaliated against the Houthis for attacks over the last few weeks.

Since the start of the year, the number of tankers travelling through the Suez Canal has fallen by almost 30% (to 8 January 2024) versus this time last year.

The impact of this re-routing is twofold:

• Fewer tankers in the Red Sea reduces the chance of an attack leading to an oil spill in the Bab al-Mandeb Strait.
• However, it also means longer transit times and increased demand for bunker fuel as tankers look to go via the Cape of Good Hope instead.

Importantly, there has been no stoppage of oil flows. This is key for the oil price.

With all the noise, traders continue to use the options market to put on bullish bets as 25-delta 2-month call vols continue to rise relative to puts (Chart 5). Being outright short right now is dangerous. Any mistake could lead to a right-tail event, where shorts are wiped out. Producers may look to put on further shorts to hedge against declines during extended transit times, but we have yet to see this in the data.

The other news driving the oil market is the protests in Libya, resulting in a full closure of the El Shahara production facility and the Zawiya refinery. El Shahara produces 270k b/d (out of a capacity of 300k b/d). That is 33% of Libya’s crude production. Meanwhile, the Zawia refinery produces 120k b/d of products. This further tightens supplies at a time when 700k b/d of OPEC+ production cuts come online. From a balance point of view, this latter news is more important.

There is currently a 72-hour negotiation happening between protestors and the government, which may get extended. Libya is already suffering from a fuel shortage, leading to higher prices. The stoppage of the Zawiya refinery will likely only make things worse. The Chair of the Protestor movement recently said that ‘There was a consensus during the negotiations on our demands, except one point – the dismissal of NOC Chairman Farahat Bengdara.

Bottom line: we remain cautiously bullish on crude over coming months.

John Tierney – US Equities

Only about a dozen companies have reported so far, but already we are seeing a pattern – the underlying economy is resilient, but cost pressures are making it tough to make money.

Delta Airlines reported booming demand – but is having difficulty raising prices to cover higher fuel and labour costs.

Major banks say the consumer is in good shape and look for lower inflation and rate cuts – but also more pressure on net interest margins and regulatory costs. A bevy of regional banks report in the coming week. We look for colour on regional economies and more evidence that the banking crisis of last spring is truly over.

In the nonfinancial sector, Fastenal will report on industrial demand for critical parts, and transport giant JB Hunt may indicate whether the freight recession has bottomed yet.

We expect lot of useful colour about the economy next week, but we doubt there will be market-moving information that will push equities out of a narrow range.

(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.)