By Kira Iukhtenko, Deputy Head of Analytical Department at FBS
As the year 2016 unwinds, it’s becoming clear that the financial world is still standing on a burning platform. Currency wars are gaining momentum despite the officially stated intentions to end them up. Bank of Australia joined the party in early May, unexpectedly cutting its cash rate to 1.75%. With the increased political and social risks on top, we could see much more volatility on the global markets in the coming months. So, what should investors expect from the current balance of power?
US Dollar: The Fed Ran Out of Credit
Financial markets sighed with relief after the Fed’s rate hike in December: the move was interpreted as the end of the uncertainty era. The regulator has first pledged to raise rates four times this year, but the overvalued US Dollar and global market swings in January changed the outlook. Panic reaction to the December rate move reminded of all the global risks associated with a premature policy normalization. That’s why the Fed decided to take its time.
The next FOMC meeting will take place on June 14-15. What should we expect from the regulator this time round? Some analysts interpreted the April statement as a hawkish one: it no longer includes the idea that “global economic and financial developments continue to pose risks”. However, the Fed “keeps monitoring the external threats” and “watching the economic data”. What does it mean? As for the external risks, the UK “Brexit” referendum on June 23 seems to be the biggest one these days. The Fed is very unlikely to unsettle the markets with tightening just a week before. What’s more, China still remains a pain in the neck: the latest April round of sluggish data hurt the risk appetite badly. As for the US economic data, the Fed will get the chance to appraise Q2 GDP growth only after the June meeting. The dataflow we’re seeing these days is not persuasive enough to justify a rate rise. Stakes for the Fed are too high to risk.
Broadly speaking, we find the next hike unlikely ahead of the November 8 presidential election in the United States. That’s why the odds for a June, July or September hike are remote. Barring an economic miracle happening between May and June, the next tightening step won’t be made until the Fed’s December 21 session. According to the CME FedWatch tool, probability of a hike in December is now slightly above 60 per cent – much better than the June’s 13 per cent.
How will the Fed’s inaction impact the FX market? There is potential for more US Dollar retracement in the coming months. Even if the Fed speaks hawkish in June, markets are unlikely to believe it. The central bank has gradually run out of credit.
From the technical view, the greenback index has been trading in a consolidative mode since early 2015. Absence of Fed’s moves in June could trigger a deeper pullback towards the next support at 90 points. As a result, the EUR/USD currency pair would hit 1.2000 by the end of summer. However, in a longer term our team maintains a bullish view on the US Dollar: we expect the USD upside to renew in Q4 2016.
British Pound: Bulls Regaining Control
The UK Brexit referendum (June 23) used to be a leitmotif of the bearish GBP trade in H2 2015, but things seem to be changing. We may see how the dreams of independency are getting crushed by economic reality. OECD forecasts that leaving the EU could become too expensive for the UK economy – it could shrink by as much as 7.5% by the year 2030. With a bit more than a month left, economists now believe Great Britain will choose the “Bremain” (British remain – an opposite to British exit).
The most recent survey, which was conducted by YouGov, showed that 42 per cent of respondents supported Leave, as opposed to 41 per cent who supported Remain. Politicians are now aggressively fighting for those 13 per cent who don’t know and 4 per cent who are not planning to vote.
The UK and European governments do their best to prevent Brexit, citing dozens of economic, political, social reasons to stay. Even the US president Barack Obama has recently called Britons to vote for staying in, warning the UK-US trade agreement would be delayed for much longer in a case of Brexit. Despite the fact it won’t be Obama who decides on that trade deal, Britons find the US colleagues’ intervention quite persuasive.
Turning to the currency market, eased Brexit fears pushed the British pound to an 11-week high in early May. If global leaders continue agitating for the Bremain camp and this affects the surveys, the bullish trend in GBP will continue in the coming weeks. The cable has now faced resistance at 1.4570 – this is the trend line, connecting the Q2 2015 peaks. However, an inverse “head-and-shoulders” formation with the bottom at 1.3830 has already been confirmed by a neckline break and paves the ground for more rallies towards 1.5200 in the coming weeks.
Japanese Yen: Where Is the Limit?
Despite all the Bank of Japan’s attempts to weaken the national currency (pulling rates into the negative territory in January), yen is trading in an ascending channel since the beginning of the year. The BOJ is widely expected to ease further in the coming months, but the markets do not trust the central banks anymore. While monetary stimulus is now seen as a “new normal”, yen jumps after every no-change meeting as a spoiled kid.
What to expect from USD/JPY next? According to our forecast, the pair entered a corrective phase and is bound to decline to 100 yen in the coming months. Such a bearish view coincides with our USD expectations. Technically, this idea is confirmed by a “head-and-shoulders” pattern with a neckline at 116.50 formed in 2015. Be careful, though: as the yen comes close to the 100 waterline, the BOJ is almost certain to intervene. Analysts at Credit Agricole believe that the level of 105 yen per dollar may even be low enough.
Oil Market: New Balance
Speculation about a potential oil freeze and market rebalancing had been pushing prices higher since February: Brent crude recovered from the low of 27 dollars per barrel to 48 dollars in May. What’s next? In our view, oil price is going to enter a medium-term sideways channel in а 40-55 dollars range.
We don’t expect the production freeze to happen in the foreseeable future. The exporting countries are still trying to increase the market share – even if it hurts their local economies. Consequently, the June OPEC meeting in Vienna will likely be another non-event with many rumors surrounding it.
Despite all that, the market is now clearly setting up a new balance. Production in the US contracted by another 100,000 barrels last week; 59 shale oil companies have already gone bankrupt. According to the IEA executive director, Fatih Birol, production outside OPEC will fall dramatically this year. He expects a 700,000 barrels a day contraction that will rebalance the market by 2017 at the latest. As reported by EIA, lower oil prices had led to investment reduction of 40 per cent in 2014-2015, especially in the United States, Russia, Canada and Latin America.
Still, our moderately upbeat oil forecast could be negated by another shakeout from China. Growing expectations for a Fed’s hike could wake the sleeping Chinese dragon once again – just once of those things we’ve seen in August 2015 and January 2016.