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Category: Forex Strategies

Credit Suisse FX Strategist: Moment of truth?

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Credit Suisse FX Strategist

Credit Suisse FX Strategist research: Moment of truth?

Exactly what the Chinese government’s objective for the CNY exchange rate is remains uncertain, in our view. However, the pace and consistency of the CNY’s depreciation vs. its basket and on a real exchange rate basis lead us to think depreciation, not stability, is the objective.

CNY depreciation has been easy so far thanks to USD weakness. However, if US data drive a further broad USD recovery, China will have to choose between stability vs. the CNY basket or stability vs. the USD. We think China would focus on the basket and move USDCNY higher.

This leads us to think about two trading scenarios following US payrolls data today:

■ Strong payrolls, stronger USD scenario: We think long USDHKD 1y, long USDKRW, and short the SGD vs. its basket would be attractive plays on a USD rally that pushes USDCNY higher.

■ Weak payrolls, weaker USD scenario: Short the CNY vs. its basket would be attractive in this scenario, in our view.

We don’t like saying we don’t know, but the fact is that we are still uncertain what the Chinese government’s objective for its currency really is.  However, if the USD rally continues, China will be forced to reveal its hand.

The People’s Bank of China’s (PBoC) recent management of the CNY leads us to believe its objective is depreciation of the CNY on a basket basis, particularly in real exchange rate terms.  The CNY has fallen more vs. its basket than we have expected, leaving USDCNY higher than our three month forecast of 6.43. We think this tends to reinforce our outlook for USDCNY to rise to 6.65 in 12m given our forecasts for the USD to recover against most currencies in the second half of this year.

In the near term, if US payrolls data lead this broad USD rally to emerge sooner than we expect, stress around the CNY will probably rise over the next month or so. In contrast, if US data resume USD weakness, it would allow for a more benign scenario of continued drift in USDCNY and CNY depreciation vs. its basket.

Looking across the various measures of the CNY exchange rate, our bias is to think that China is depreciating its currency, not keeping it stable. Figure 1 shows that the CNY clearly has been trending lower vs. the CFETS basket. The CNY has fallen 4.3% YTD vs. the CFETS basket, an annualized rate of depreciation of 12%. It has fallen through the 98 and 97 levels that many in the market expected to be the floor for the index if the policy objective is trend stability for the nominal trade-weighted rate.

Additionally, the extent of this nominal depreciation leads us to estimate that the CNY has fallen to its lowest level since last December on a real exchange rate basis even after accounting for the recent modest rise in Chinese CPI inflation (Figure 2).

Credit-Suisse-FX-Strategist-06-May-2016-figure1-2

However, three factors create uncertainty:

1. For all of the talk of a new FX regime, USDCNY is essentially flat year-to-date.

2. Volatility of the USDCNY fix has tended to be lower than volatility of the CFETS basket until very recently (Figures 3 and 4). However, if the government were managing on a basket basis with an objective being stability in the trend in the basket, vol of the basket should be lower than vol of spot. To be sure, in Singapore, 3m spot vol is about 7.8% whereas SGD basket vol is only 3.2%. Admittedly, CNY spot vol has risen, so maybe things are changing. Perhaps the recent rise in fix vol and fall in basket vol indicates that the government has transitioned to targeting the basket, not the fix.  But the vol differences are still low enough and new enough to lead us to be uncertain.

Credit-Suisse-FX-Strategist-06-May-2016-figure3-4

3. China’s government seems keen to avoid large capital outflows driven by concern about CNY depreciation. We think this requires a stable or stronger CNY vs. the USD, not stability in the CNY vs. its basket.  Figure 5 shows that our estimate of corporate hoarding of foreign exchange, i.e. the difference between actual net FX settlement as reported by SAFE and the reported trade balance, tends to rise sharply when USDCNY rises, but moderate or reverse when USDCNY is stable or lower. We estimate these flows accounted for about 40% of outflows last year.

Credit-Suisse-FX-Strategist-06-May-2016-figure5

Summing up, we see two main scenarios following payrolls.

USD rally: If the US data drive a USD rally China will have to choose between spot stability at a cost of CNY reversal stronger vs. its basket or sustaining the CNY’s depreciation vs. its basket at a cost of a rise in USDCNY. The risk here is of a resumption of a USD appreciation trend back to its 2015 highs, not just a small or temporary bounce.

Perhaps the PBoC has been depreciating the CNY vs. its basket during the recent period of broad USD weakness specifically to create room for the CNY to reappreciate vs. the basket in the event of a USD recovery. This would allow it to keep USDCNY stable, at least in the early stages of any broad USD rally.

However, we tend to doubt this explanation.  One reason is that it would invalidate the whole concept of managing the CNY vs. a basket that the government has been advocating. Another is that if the USD TWI exceeded its past highs, China would have to accept CNY appreciation to new highs.

In contrast, we think the most likely scenario would be that the PBoC would push USDCNY higher in order to try to prevent the CNY from appreciating vs. its basket. In this scenario, we estimate roughly that if the DXY were to return to its November 2015 high, USDCNY would need to rise to about 6.86 to prevent appreciation on a basket basis. That’s for CNY stability vs. its basket. If the objective is further depreciation vs. the basket or on an REER basis, USDCNY would have to rise more sharply.

USD weaker: Goldilocks continues. A stable or weaker USD-G10 would likely lead China to keep USDCNY stable or slightly lower in order to continue trend depreciation vs. its basket.

How to trade this?

USD rally scenario:

A USD rally scenario would be most disruptive for markets, in our view. Yet market pricing of risk has CNY risk moderating slightly. Implied volatility has crept lower while implied to delivered ratios have been roughly stable and the 6m/1y vol curve has steepened. Vol adjusted risk reversals have also been stable as vol levels have fallen.

We think the best ways to position for CNY stress generated by a stronger USD are in proxies for the CNY, not the CNY or CNH itself. Specifically, we prefer:

■ Long USDHKD 1y forward points. We expect the peg to hold, but if USDCNY rises significantly we believe the HKD forward points are likely to rise back to 400 – 500 as they did in January and February vs. the current roughly 83.

■ Long USDKRW. The KRW retains Asia’s highest beta both to risk appetite falls and stress in China. Additionally, seasonal factors tend to be particularly negative for KRW in May.

■ Short SGD vs. its basket.  We expect slowing growth and moderating inflation in Singapore should push the SGD 1.5 – 2.0% lower against its basket over the next couple of quarters even without CNY stress. A resumption of an uptrend in USDCNY would likely accelerate this move in the SGD, in our view.

USD weakness scenario:

In contrast, we believe the best way to trade the implications for the CNY of a resumption of broad USD weakness is by going short the CNY vs. its basket. We would expect the PBoC to continue pursuing CNY depreciation vs. the basket at roughly the recent pace if it can achieve this with a stable or slightly lower USDCNY. Crucially, the more that the CNY depreciates vs. its basket the more it will risk creating competitive stress for other EM currencies, in our view. Remember that China’s exports have retained or gained market share in all of its major markets bar Japan over the past year even with the CNY REER at a historical high.

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Nomura Research: What’s Correlating in FX

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Nomura Research

We have constructed a monitor that tracks 1,961 correlations across markets (see full monitor on second page). To strike the right balance between stability and relevance, we focus on three-month correlations of changes in market prices. It should help to gauge the relationships driving asset prices. More importantly, identifying significant changes in these correlations can provide an early indication of “regime changes.” Focusing on G10 FX in this report, we find the following:

■ The largest correlations are dominated by equities. For example, USD/JPY has a 72% correlation with the Nikkei and EUR/CAD has a -77% correlation with the FTSE 100 (i.e., EUR falls against CAD when UK equities rally). In general, the dollar appears to be positively correlated with risk, and so the euro is the funding currency that is negatively correlated with risk. This shows in euro crosses correlating with risk (see Figure 1).

■ Outside of risk, rate differentials are correlated to some currency pairs: EUR/GBP, EUR/NZD and EUR/CAD stand out. Again, it seems the euro is the base currency through which fundamentals are expressing themselves (see Figure 1).

■ As for changes in correlations, the biggest increases to more negative or more positive appear to involve oil. It seems that a whole swathe of currency pairs from EUR/NOK to EUR/USD to USD/CHF have become correlated to oil prices (see Figure 2).

Nomura Top G10 FX correlations

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Credit Suisse research – A top for Japan confirmed

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Credit Suisse Research

 

USDJPY finally confirms a medium-term top

As we have already highlighted on a couple of occasions this year (A major top for  Japan,  20th January),  we  have  been  bears  of  Japan,  looking  for  conclusive reversals of the bull trends in USDJPY and the Nikkei/TOPIX.  The brief spike post  the  BOJ  has  been  aggressively  reversed,  and  for  USDJPY,  the  longlooked for top below 116.15 has in our view finally been confirmed. We  thus  stay  bearish  and  look  for  further  weakness  to  113.99/85  next,  ahead of  support  from  a  rare  price  gap  from  October/November  2014  at  112.56/33. This  should  be  allowed  to  hold  at  first,  ahead  of  the  sell-off  extending  to 110.09/00  –  the  September  2014  high  and  psychological  support.  Bigger picture,  we  target  106.65/60  –  not  only  the  measured  target  from  the  top,  but also the 38.2% retracement of the entire 2011/2015 bull market. Resistance  shows  at  115.85/86  initially,  then  116.15/30,  with  117.54  needing to cap to keep the immediate risk bearish.

For  GBPJPY,  the  recovery  in  late  January  was  capped  by  a  cluster  of  resistances  at 174.87/176.18  –  the  38.2%  retracement  of  the  2015/2016  collapse,  April  2015  low  and falling  13-week  average  –  and  the  subsequent  rejection  from  here  maintains  a  large  top. Key  support  is  seen  from  the  January  2016  and  2014  lows  at  163.99/88,  below  which should  act  as  the  catalyst  for  a  resumption  of  the  downtrend  to  160.02/00,  ahead  of  the 50% retracement of the 2011/2015 bull market at 156.37.

For  EURJPY,  the  stronger  EUR  is  keeping  the  cross,  for  now  at  least,  well  supported above pivotal price and “neckline” support at 126.18/09.  Although a large topping threat is present,  only  below  126.09  would  see  this  confirmed,  turning  the  outlook  bearish  for 124.97 initially, then 121.95.

When  looking  at  the  JPY  in  Trade  Weighted  terms,  a  base  was  completed  at  the beginning  of  the  year.  The  BOJ  spike  was  contained  well  above  the  uptrend  from  June 2015,  and  the  subsequent  strong  rally  maintains  the  base.  We  thus  stay  bullish  and  look for  further  broad-based  JPY  strength.  Given  the  still  strong  relationship  between  the currency and equity markets, this is expected to keep equities under pressure.

For  the  Nikkei,  the  post  BOJ  bounce  has  also  been  quickly  reversed,  leaving  the  market retesting  its  recent  low  and  38.2%  retracement  of  2011/15  rally  at  16055/15.  Below  here, which  we  look  for,  should  confirm  a  medium-term  top  is  in  place,  for  a  decline  to  the  50% retracement  and  price  support  at  14545/30,  then  13885,  the  low  of  2014.  The  measured target from the top though is seen set lower at 12920.

The TOPIX though is already below its 38.2% retracement of the 2012/2015 bull market at 1317, and with a medium-term top already in place, we stay bullish and look for weakness to extend to our 1197/77 next target – the 50% retracement and late 2014 low.

Go  short  USDJPY  at  116.30/117.30,  place  the  stop  above  118.30.  Take  profit  at 106.75.

Go  short  Nikkei  at  17000/17200,  stop  above  17950.  Also  add  below  16000.  Take profit at 13200.

 

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UBS FX Strategy: Spot Desk – More USD Buying

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UBS forex research

 

 

Spot Desk – More USD Buying

Zurich Spot Desk

 

EURUSD: Market participants that took advantage of the short squeeze earlier in the week were happy to take some profit ahead of the 1.1200 level that was toppish for almost two months; the pair has dropped 500 pips from the Monday high. Expect buying interest below 1.1200, while sellers will be lined up ahead of 1.1360/70. Flows are split between those piling into fresh USD longs and short term profit-takers. Support at 1.1230, 1.1200, and 1.1150; resistance at 1.1270, 1.1305, and 1.1365.

USDCHF: The US dollar has been trading strong after good US data, and many in the market had to jump on the bandwagon after getting squeezed out of position earlier in the week. We think the rally in risk is still fragile and volatility will surely persist for a while. The pair has tested the resistance at 0.9660/80, so if you are looking for a level to sell at, that might be it. Support at 0.9580 and 0.9541. Despite the strong rally yesterday, EURCHF remains in range. Support at 1.0750; resistance at 1.0880/1.0900.

Cable continued its downtrend yesterday, but stopped abruptly at the 200-day moving average. The pair was offered all day with the US dollar being bought across the board. EURUSD came off its high and we saw GBPUSD trade through the 100-day moving average at 1.5472 and then below 1.5400. It feels like US dollar buying could continue at lower levels. GBPUSD support at 1.5371, 1.5330, and 1.5191; resistance at 1.5454, 1.5508, and 1.5594.

EURGBP: We are biased towards selling rallies to the 200-day moving average at 0.7360. Support at 0.7279, 0.7260, and 0.7200; resistance at 0.7359, 0.7400, and 0.7421.

AUDUSD has been grinding higher on the sharp bounce in risk-on sentiment and the correction for oil. The poor capex figures yesterday and higher US yields probably explains why the pair’s move higher has been reluctant. Watch USD/EM to see if there is a further correction. If so, AUDUSD could trade back up to 0.74/0.75. We are skeptical that this rally in risk is sustainable, but recommend staying flexible because there has only been a small AUDUSD so far, relative to the moves for USDJPY and EURUSD.

NZDUSD has been trading in-sync with AUDUSD. There should be decent support at 0.6400, with the risk of a move up to 0.66/0.67.

USDCAD is trading around the same level as yesterday, but oil has gained a lot of ground, so as long as the general picture doesn’t change we are happy to be short up to 1.3220/30, with a stop above 1.3250, targeting a move towards 1.3140/50.

EURSEK and EURNOK came under pressure yesterday, with the latter leading the way on the correction for oil. Sell rallies in EURSEK towards 9.60, with a stop above 970; it is currently trading just above the support at 9.49/9.50. Sell EURNOK rallies between 9.40 and 9.50, with a stop above 9.60. The key pivot in the downside is 9.20. Swedish retail numbers are due this morning at 9:30am CET, with Norwegian unemployment data at 10:00am CET.

Barclays Daily FX Technical Strategy – Greek developments drive major EUR FX pairs lower

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CitiFX Strategy London Update – G10 FX

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Chart of the day: USD bid as US bonds sell-off

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Societe Generale FX Daily – Noflation points way to weaker Cable

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Chart of the day: Higher eurozone yields help lift EUR

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SG FX Daily: Bond meltdown infects FX

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Societe Generale Cross Asset Research

Chart of the day: USD bid returns as US yields break higher

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Chart of the day: Signs of a US Dollar bid

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