FX Daily: Staying nimble on possible nuance changes

EUR and AUD might have found support; CNY might depreciate.
Philip Wee06 Dec 2021
    Photo credit: Unsplash Photo

    DXY is holding near 96 with a downside bias. According to CFTC data, speculators are caught between Omicron-led growth worries and Fed Chair Jerome Powell’s inflation pivot and have reduced both long and short positions on the USD. Bulls expect the Federal Reserve to step up asset purchases at the FOMC meeting on 15 December. This Friday, consensus expects another surge in US inflation to 6.7% YoY in November from 6.2% in October. Despite the miss in last Friday’s nonfarm payrolls, the Atlanta Fed GDPNow model sees US growth strong at an annualized 9.7% QoQ sa in 4Q21, up from the 8.6% projected on 24 November. However, bulls are struggling against a flight to safety from equities into bonds on the spread of the Omicron. Last Friday, the VIX volatility index increased above 30 for the first time since February while the US treasury yield curve (10Y vs 2Y spread) flattened below 80 bps for the first time since December 2020. 

    Although US President Joe Biden has signed a bill to keep the US government funded through 18 February 2022, Congress still needs to raise the US debt ceiling to avert a potential government debt default. Treasury Secretary Janet Yellen told the Senate Banking Committee that the ceiling will be hit on 15 December (same day as FOMC). After factoring the USD118bn transfer to the Highway Trust Fund, the nonpartisan Bipartisan Policy Center estimated a possible default between 21 December and 28 January.

    EUR found a possible support around 1.13 last week. Following Powell’s inflation pivot, the European Central Bank has become less stubborn about inflation being transitory. Although she continued to resist calls for rate hikes in 2022, ECB President Christine Lagarde conceded action will be needed if inflation stays elevated. ECB board member Isabel Schnabel believed that inflation might have peaked in November. Hence, the first CPI estimate for December scheduled for release on 7 January will be important. Meanwhile, the ECB is under political pressure to come up with a plan to normalize monetary policy at the governing council meeting on 16 December. Germany new coalition government will be taking over from Chancellor Angela Merkel this week. The incoming finance minister takes a hard line that the ECB focuses on fighting inflation and not funding the highly indebted countries. He has urged countries across the Eurozone to reduce debt.

    We are giving the AUD the benefit of the doubt at its psychological 0.70 support. No one expects any policy changes at the Reserve Bank of Australia meeting on 7 December. Omicron has potential to thwart plans to reopen the Australian economy. Lockdowns in Victoria and New South Wales led to the spike in the unemployment rate to 5.2% in October from 4.6% in September. Last Friday, the Australian government bond yield curve flattened below 100 bps to 91 bps for the first time since January. Even so, Treasurer Josh Frydenberg plans to upgrade the 2022 growth forecast at the mid-year budget review in the coming weeks. Hence, the RBA could surprise and join the Fed in reducing complacency over elevated inflation.

    We are keeping close tabs on signs for CNY depreciation. On 19 November, the central bank (PBOC) warned financial institution to refrain from one-way bets on the CNY which hit a six-year high against of a basket of currencies. Three days later, the PBOC quarterly report dropped its pledge not to engage in large scale stimulus. Last Friday, Premier Li Keqiang said that China will lower banks’ reserve requirement ratios “in a timely way” and prompted bond yields to fall this morning. We maintain our forecast for USD/CNY to end 2021 at 6.40.

    Philip Wee

    Senior FX Strategist - G3 & Asia
    [email protected]

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