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Fundamental Analysis 19.02.2018 - Market Outlook

Market Recap

USD rose on Friday 16th February 2018 as investors closed out short USD positions ahead of the long US weekend. News on Friday 16th February 2018 that the US Commerce Department recommended tariffs or quotas on steel and aluminum imports boosted the dollar, according to press reports, but should be a negative for USD. That’s because it’s likely to set off a round of retaliatory measures elsewhere that’s bound to hurt the US economy. The last time something like this happened – when former US President George Bush imposed tariffs on imported steel – USD generally fell.

CAD was weak on Friday 16th February 2018 as Canada is a major supplier of steel and aluminum to the US. However, note that oil prices rose yet again, which could support CAD. Over the medium terms, as the trade issue works against the US, CAD could recover. However, one concern is that nervousness over the issue might delay the Bank of Canada from hiking rates. The market currently sees a 59% chance of a rate hike in April 2018 and an 87% chance – near certainty – or a rate hike by July 2018. If the trade issue worsens, the Bank could delay its move and these near-term probabilities could recede somewhat. That could pressure CAD.

Meanwhile, European Central Bank (ECB) Council member Benoit Coeure said on Friday 16th February 2018 that the ECB was likely to change its policy pronouncements sometime soon. “Our communication on monetary policy will change,” he said. “Certainly the expectation is that this will be discussed in early 2018.” That probably referred to a statement by ECB President Mario Draghi at the last press conference on 25 January 2018, when he said “in March we'll have projections and then we'll assess really how things stand at that point in time.” The ECB meets on 8th March 2018

Today’s market

There are not any key speakers or economic indicators of note today. Moreover, China (and much of the rest of Asia) is out on holiday, as are the US and Canada. Thus the Forex action will largely be confined to Japan and Europe. 

Last week was quite an interesting week for the Forex market. The dollar fell even though US Treasury yields rose more than yields in most other countries. Normally, that would tend to support the dollar, but it didn’t help.  

The move was especially noticeable when we look at USD/JPY. The yen is the most sensitive currency to higher US Treasury yields, because the Bank of Japan is pegging the Japanese 10-year yield. That means when US Treasury yields rise, the spread between US and Japanese yields widens one-for-one. Other countries’ government bonds are often influenced by US Treasury yields and sometimes move in the same direction, which reduces the impact of any move in US Treasuries on the currency. But not the yen.

Even though US yields are rising relative to Japanese yields, what we’ve seen is Japanese investors selling foreign bonds. That shows a lack of confidence in the US markets.

What might be causing that? It could be the return of the “twin deficits.” This phrase refers to the US government budget deficit and the current account deficit. This graph shows the two of them as a percentage of US GDP, and then the sum of the two, which is the twin deficit.

Here we have the twin deficit vs the Federal Reserve’s index of the value of the dollar against the US’ trading partners. You can see two things from this graph. First, the value of the dollar did tend to broadly track the twin deficits over this time period. Secondly, note the forecast period for the twin deficits line, the red line. That’s calculated using the  Organisation for Economic Co-operation and Development (OECD)’s forecasts for the US budget deficit and the market’s forecast for the US current account deficit. As you can see, it’s expected to worsen. And it is possible that the forecast for the budget didn’t include the impact of the latest budget bill in Washington, which will cause the deficit to grow even further.

Budget discipline could be considered a concern by some. The trade deficit is widening despite the efforts of the administration to rectify it – the trade deficit ex-petroleum recently hit a record high. 

That’s making people think that the US dollar’s long upcycle, which began in 2008, did come to an end in 2016. There was some debate whether this was just a countercyclical down move within the longer upwards trend. You can see in this graph how even when the dollar is in a long-term trend one way or the other, there are often long periods  when the currency moves in the opposite direction. I think there had been some debate about whether this was just one of those counter-cyclical periods, but more and more people are thinking it’s the start of a down wave. 

The Fundamental Analysis is provided by Marshall Gittler an external service provider of an independent analytical company. Any views and opinions expressed are explicitly those of the writer. Any information contained in the article, is believed to be reliable, and has not been verified by STO and is not guaranteed to be accurate. References to specific products, are for illustrative purposes only and are not a form of solicitation, recommendation or investment advice. Past performance is not a guarantee of future performance.

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