Currencies In-Depth

Highlights The rising spectre of global market volatility has reignited interest in the Swiss franc. In the current geopolitical game of brinksmanship between the U.S. and China, the risk of miscalculation is high, suggesting it pays to have insurance in place. The large net short positioning in the Swiss franc and cheap valuation make it attractive from a contrarian standpoint. That said, the Swiss National Bank (SNB) is unlikely to sit and watch the CHF catapult to new highs. We expect currency intervention will be actively and aggressively used as a policy tool. Over the longer term, high domestic savings, rising productivity and a chronic current account surplus are underlying sources of support for the Swiss franc. Hold on to CHF/NZD positions recommended on April 26. We expect the unofficial floor of EUR/CHF 1.08-1.12 to hold in the near term but will respect our stop-loss at 1.11 if it is breached. Feature For most of the past decade, the Swiss franc has tended to be a dormant currency, interspersed by short bouts of intense volatility. For example, the USD/CHF is sitting today exactly where it was in early 2008, yet during this period the franc has seen wild gyrations that have lasted anywhere from just a few days to a few months. Outside of these swings, both USD/CHF and EUR/CHF have been mostly stable (Chart I-1). Chart I-1On The Verge Of A Big Move? The first bout of volatility occurred during the Great Financial Crisis, when the franc appreciated by 13% versus the euro, from July to October 2008. The second adjustment was marked by the European debt crisis, with the drop in the euro putting tremendous upward pressure on the franc. From the beginning of 2010 until September 2011 (when the SNB eventually put a currency floor in place), the euro plummeted by almost 35% versus the franc. More importantly, two-thirds of this adjustment occurred in the short few months before the SNB took action. The most recent adjustment in the franc has been the most interesting, because it was the central bank itself – not market forces – that triggered volatility in the exchange rate. In January 2015, the SNB decided to abandon the EUR/CHF 1.20 floor. The euro instantaneously cratered by about 30% versus the franc before retracing half of those losses a few days after. Since then, the EUR/CHF has been slowly creeping back towards the levels that prevailed before the floor was abandoned. The unifying theme across all three episodes is that the franc has tended to stage big moves near market riot points. Over the past week, the Swiss franc has emerged as one of the best-performing currencies amid the rising spectre of global market volatility (Chart I-2). This brings forward a few interesting questions. Will the SNB abandon the unofficial floor of EUR/CHF 1.08-1.12, or does it have an incentive to vigorously defend the currency? Should market volatility intensify from current levels, what trading opportunities are available to investors? Finally, what is the medium- and long-term outlook for the Swiss franc? Chart I-2The Franc Loves Volatility The Case For An Unofficial Cap The irony of the Swiss currency cap is that both its inception in 2011 and eventual demise in 2015 were rooted in deep external deflationary shocks, but the rationale behind the SNB’s moves in both episodes was vastly different. Back in 2011, Switzerland was rapidly stepping back into deflation, having just barely escaped it a year earlier. More importantly, this was driven by tradeable goods prices, given the franc’s rampant appreciation. At its nadir in 2011, goods prices were deflating by 3%, and rapidly dragging down inflation expectations with them. The SNB quickly realized that for a small, open economy like Switzerland, the exchange rate becomes incrementally important if deflation is entrenched (Chart I-3). Ergo, sitting and watching the trade-weighted Swiss franc continue to appreciate, especially given the euro was in a cascading downdraft, appeared to be a recipe for disaster. The stakes were especially high, given recent memory of the Great Recession. The cap worked like a charm, and the authorities could not have hoped for a better result. Inflation expectations staged a V-shaped recovery, along with headline inflation. The economy entered into a meaningful economic rebound, with the PMI swiftly rising above 50 and real GDP growth accelerating from near standstill to a 2.5% pace by 2014. This set the stage for a stock market rally that more than doubled the SMI index, nudging it back to its pre-crisis highs. The SNB quickly realized that for a small, open economy like Switzerland, the exchange rate often dictates the trend in domestic inflation. Since then, the inflation dynamics have improved even further, reinforcing the view that the SNB continues to manage the currency, even though the EUR/CHF floor was abandoned over four years ago. Inflation has risen almost uninterruptedly since it bottomed in 2015 (Chart I-4) – a feat that has not been replicated in major economies like the U.S. or euro area. During the same period, the EUR/CHF has trended higher, stabilizing during bouts of EUR/USD weakness but strengthening alongside gains in the euro. This has cheapened the trade-weighted franc, buffeting consumer prices. Chart I-3Exchange Rates Affect Tradeable Goods' Prices Chart I-4The SNB Has Done A Good ##br##Job So Far Our bias is that the whisper floor of 1.08-1.12 for EUR/CHF will continue to persist until the Swiss economy decisively exits deflation. In its latest monetary policy report, the SNB lowered its inflation target for 2019 and 2020 from 0.5% to 0.3% and 1% to 0.6% respectively. Meanwhile, three key factors suggest the inflation rate will continue to be anchored at low levels in the near term: Global trade has slowed meaningfully since the onset of 2018 and continues to drift downward. Given the complex nature of Swiss exports and their high-ranking in the value chain, they have been largely insulated from the slowdown (Chart I-5). It also helps that exporters have been able to cut prices to maintain volume sales. However, there is a natural limit as to how much exporters can cut prices to maintain demand, or how long exports can be insulated from a global slowdown, let alone a trade war. Falling exports will be a renewed powerful deflationary pulse for the domestic economy. While the franc has cheapened, our models suggest it still remains 5% overvalued versus the euro (Chart I-6). This explains in part why import prices remain under downward pressure, since it is just the mirror image of an expensive currency. In a world of still-low inflation, any adjustment in the real exchange rate can only occur very slowly. Swiss prices are rising at a 0.7% annual rate, while eurozone prices are rising at a 1.7% clip. This suggests it will take about five years just for the franc to close its overvaluation gap versus the euro. This suggests the SNB will be loath to tolerate any knee-jerk appreciation in the franc. Chart I-5Swiss Exports At Risk From A Trade War Chart I-6EUR/CHF Is Still 5% Cheap While the output gap has closed, it remains well below levels that have previously begun to generate meaningful inflationary pressures in the domestic economy. Domestic retail sales remain weak on the back of tepid wage growth. While the unemployment rate is at 2.4%, it usually takes the unemployment rate falling below 1% before it begins to generate any significant inflationary pressures. This is unlikely to happen over the next six to nine months. The Swiss labor market is extremely flexible and fluid, allowing for tremendous efficiency. Part-time employment continues to dominate job gains, meaning the need for precautionary savings will continue to restrain spending. Chart I-7Money Supply Growth Has Converged To GDP Growth Interestingly, the SNB has not had to ramp up its balance sheet significantly in recent years. Part of the reason is that the slowdown in global trade eased natural demand for francs, which meant the SNB was no longer accumulating foreign exchange reserves at a rampant pace. More importantly, the SNB has used the global slowdown to drain excess liquidity from the system and somewhat renormalize policy. Back in 2011 when the SNB put the cap in place, there was an explosion in domestic liquidity, with broad money supply rising at a 10% pace. As panicked investors were fleeing the European periphery, there were large inflows into the Swiss economy and into the haven of government bonds, driving up the franc in the process. The same pattern was repeated again in 2016 after the U.K. referendum to leave the EU. This time around, a lack of significant EU tail risks on the near-term horizon have curtailed safe-haven flows into the franc. This has allowed Swiss money supply growth to converge towards nominal GDP growth, effectively sterilizing excess liquidity (Chart I-7). The message from SNB Central Bank Chair Thomas Jordan has been very clear: Interest rates could be lowered further, along with powerful intervention in the foreign exchange market if necessary. This suggests that in the near term the preference for the SNB is for a stable exchange rate. The issue is that market forces have occasionally dictated otherwise, especially during riot points. With the S&P 500 off its highs, corporate spreads both in the U.S. and euro area inching higher, the VIX in an uptrend and government bond yields falling, we may be approaching such a point. Lessons From The 1990s And 2015 The natural questions that follow are that if the cap worked so perfectly, then why was it scrapped in the first place? And why not explicitly put it back on, given the rising specter of global asset volatility and Swiss franc strength? After all, if the risk for Switzerland is that it could abruptly step back into deflation, then the SNB can use the franc as a potent weapon to ease domestic financial conditions. Capping the franc at a cheap level to the euro, say back at 1.20, could be exactly what the doctor prescribed. The reality is that there are both political and economic constraints to such a commitment. While the decision to scrap the EUR/CHF floor was a puzzle to most investors back in 2015, a post-mortem analysis suggests the reasoning in hindsight was rather obvious. Back in 2015, the world economy was entering into a manufacturing recession as China closed off the credit spigots. This was particular acute in the Eurozone, which had just exited a double-dip recession but was facing credit growth falling at a 7% pace. Enter quantitative easing.  The deflationary backdrop back then had already led to an explosion of high-powered money as foreigners flocked into Swiss assets. Foreign exchange reserves were rapidly outpacing the monetary base and quickly closing in on nominal GDP (Chart I-8). The risk of course is that if surging money and credit growth cannot fuel consumer price inflation, it can only stimulate an asset price boom. A floor to a currency about to ride a wave of large-scale monetary stimulus was disconcerting to even the most Keynesian of Swiss central bankers. A floor to a currency about to ride a wave of large-scale monetary stimulus was disconcerting to even the most Keynesian of Swiss central bankers. Meanwhile, there had already been a rising chorus of discontent among right-wing politicians in 2014, specifically those within the Swiss People’s Party (SVP) who wanted the central bank to stop buying foreign currencies and significantly lift its gold holdings instead. As early as October of 2014, opinion polls suggested that support for the proposal was at 44%, with only 39% of Swiss citizens against.1 Memories from the 1990s asset burst in Switzerland were front and center among SVP members. The Plaza Accord had led to the proliferation of carry trades into Switzerland as the U.S. dollar fell. This was supercharged by strong migration into Switzerland ahead of the fall of the Berlin Wall. All of this lit a fire under the real estate market. The SNB was eventually forced to raise interest rates from 3.5% in 1998 to 9% in 1992, transforming a real estate bull market into a 20-year bust (Chart I-9). With the SVP currently ahead in opinion polls ahead of the October 2019 elections, this is likely to remain a constraint Chart I-8Still Lots Of High-Powered Money In Switzerland Chart I-9Macro-Prudential Measures Have Stymied A Housing Bubble Economically, the SNB has to walk a fine line between a predominantly deflationary backdrop in Switzerland but a rising debt-to-GDP ratio that pins it among the highest in the G10 (Chart I-10). Too little stimulus, and the economy runs the risk of entering a debt-deflation spiral, as inflation expectations continue to be anchored strongly to the downside. Too much stimulus, and the result will be a build up of imbalances, leading to an eventual bust. This dilemma was the “raison d’ être” of the Swiss currency cap in 2011, but let to its eventual demise in 2015. Chart I-10The Swiss Have Lots Of Debt A final thought about the cap: It is different from a peg in that the former allows the franc to depreciate versus the euro, while the latter does not. This makes the cap an asymmetric mechanism: Only when the CHF is under upward pressure will the cap act as a QE mechanism, because the SNB has to buy euros while selling Swiss francs. Should the franc weaken against the euro, the SNB does not have to intervene, hence its balance sheet stops expanding and QE ends. The key risk is that the euro drops substantially, inviting speculation back into the Swiss economy. This risk is clearly unpalatable for both Swiss politicians and the SNB, which is why two-way asymmetry was reintroduced into the system. Trading Dynamics As A Safe Haven Switzerland ticks off all the characteristics of a safe-haven currency. Its large net international investment position of 125% of GDP generates huge income inflows. Meanwhile, rising productivity over the years has led to a structural surplus in its trading balance and a rising fair value for the currency. Consequently, the franc has tended to have an upward bias over the years, supercharged during periods of risk aversion (Chart I-11). Switzerland ticks off all the characteristics of a safe-haven currency. During bull markets, countries that have negative interest rates are subject to powerful outflows from carry trades. The impact of these are difficult to measure, but it is fair to assume that periods of low hedging costs (which tend to correspond with periods of lower volatility) can be powerful catalysts. As markets get volatile and these trades get unwound, unhedged positions become victim to short-covering flows. Given the negative yield from hedging trades funded in Swiss francs (Chart I-12), it is fair to assume a pronounced flight-to-safety will cause a knee-jerk appreciation in the franc, like in past episodes. Chart I-11The "Curse" Of The##br## SNB Chart I-12Hedging Against Franc Strength Is Expensive This is especially true, since the U.S. tax reforms have already driven foreign affiliates in Switzerland to liquidate investments (mostly real estate) and repatriate those funds back into Treasurys. Foreign direct investment in Switzerland is falling at a rate of 15% of GDP, causing the basic balance to hit -4% of GDP. These FDI outflows are unlikely to remain a headwind for the franc going forward, assuming the tax benefit was a one-time deal. Instead, a favorable balance-of-payments backdrop will continue to be a key underpinning behind the strong franc (Chart I-13). Chart I-13A One-Time Adjustment In The Basic Balance The message is that during rising periods of risk aversion, like now, speculators should accumulate francs as a portfolio hedge. We continue to favour the CHF/NZD, recommended on April 26. Aggressive investors can also sell the USD/CHF. Investment Conclusions Our long-term fair value models suggest the Swiss franc is currently cheap (Chart I-14). This makes it attractive both on a short- and longer-term basis versus a basket of currencies. The exception is versus the euro, given the EUR/CHF is still undervalued by 5%. Froth in the housing market has been eliminated. Stricter policies toward immigration, along with macro-prudential measures, such as a cap on second homes and stricter lending standards, have helped (Chart I-15). Meanwhile, the surprise move by the SNB to abandon the EUR/CHF floor has rebalanced the market. Back then, Swiss real estate became more expensive for investors in the euro area who used the SNB put to speculate on properties in Zurich and Geneva. Demand for Swiss real estate has largely decreased since then, eliminating this key source of risk for the SNB (Chart I-16) Chart I-14The Swiss Franc Is Cheap By Some Measures Chart I-15The Swiss People's Party ##br##Had Its Way Our bias is that over the next few years, the Swiss franc will be more of a dormant currency, gently appreciating towards its fair value but periodically interspersed by bouts of intense volatility. Interestingly, we may be entering such a riot point. German bund yields fell below Japanese levels this week. Historically, a falling bund yield has been a bad omen for EUR/CHF.  We will respect our 1.11 stop loss on long EUR/CHF if breached (Chart I-17). Chart I-16The SNB Had Its Way Chart I-17Where Next For Bund Yields?   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see www.reuters.com. Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data from the U.S. have been positive: Headline inflation and core inflation increased to 2% and 2.1% year-on-year respectively in April. NFIB business optimism index increased to 103.5 in April. NY Empire State Manufacturing index increased to 17.8 in May. Retail sales fell by 0.2% month-on-month in April, but the Redbook retail sales clocked in a solid 5.4% growth year-on-year. Industrial production decreased by 0.5% month-on-month in April, but is still growing at 0.9% year-on-year. On the housing market front, MBA mortgage applications contracted by 0.6% in May. NAHB housing market index increased to 66 in May. Housing starts increased by 5.7% to 1.24 million month-on-month in April. Building permits increased by 0.6% to 1.3 million in April. DXY index increased by 0.4% this week. U.S. and Chinese negotiators failed to reach an agreement regarding tariffs. The increased tariffs on Chinese goods was followed by the inevitable retaliation by China this Monday. As the market gauges the net impact of the tariff from both sides, volatility will prevail. Report Links: President Trump And The Dollar - May 9, 2019 Take Out Some Insurance - May 3, 2019 Currency Complacency Amid A Global Dovish Shift - April 26, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been weaker-than-expected: Industrial production in the euro area fell by 0.6% year-on-year in March. The euro area ZEW economic sentiment fell to -1.6 in May. The German ZEW economic sentiment fell to -2.1 in May, while current situation improved to 8.2. Euro area GDP growth came in line at 1.2% year-on-year in Q1. German GDP growth increased to 0.4% quarter-on-quarter in Q1, while on a year-on-year measure, the growth rate fell from 0.9% to 0.6%. Trade balance in the euro area fell to 17.9 billion euros in March. German harmonized consumer price inflation was unchanged at 2.1% year-on-year in April. French industrial output contracted by 0.9% month-on-month in March, while non-farm payrolls increased to 0.3% quarter-on-quarter in Q1. EUR/USD fell by 0.4% this week. While signs are still pointing to a tentative recovery in the euro area, global trade war rhetoric and volatile incoming data continue to weigh on investor sentiment. Trump is poised to delay a decision to impose auto tariffs on EU and Japanese exports by up to six months, which suggests he might ramp up the trade war with China. Report Links: Take Out Some Insurance - May 3, 2019 Reading The Tea Leaves From China - April 12, 2019 Into A Transition Phase - March 8, 2019 The Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mixed: Leading economic index and coincident index fell to 96.3 and 99.6 respectively in March. Trade balance by the balance-of-payment measure increased to 700 billion yen in March. Adjusted current account balance fell to 1.27 trillion yen in March. On the housing market front, the construction orders increased by 66.1% year-on-year in March. Housing starts grew by 10% year-on-year in March. Reconstruction efforts following last year’s disasters appear well underway. Machine tool orders contracted by 33.4% year-on-year in April. Japanese producer price inflation decreased to 1.2% year-on-year in April, while still higher than expected. USD/JPY fell by 0.7% initially, then gradually recovered, returning flat this week. The ongoing trade disputes largely increased short-term volatility in the yen. We continue to recommend the yen as a portfolio hedge. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 A Trader’s Guide To The Yen - March 15, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been solid, despite softer employment data: Nominal GDP growth increased to 1.8% year-on-year in Q1. Manufacturing production increased by 2.6% year-on-year in March. Industrial production increased by 1.3% year-on-year. Total trade balance came in at a deficit of 5.4 billion pounds in March. This was an improvement from the last reading of a 6.2 billion deficit in February. ILO unemployment rate fell to 3.8% in March, while the average earnings growth fell from 3.5% to 3.2%. Moreover, claimant count increased by 24.7K in April. GBP/USD fell by 1.6% this week. The pound remains one of our favorite currencies for the time being from a valuation perspective. Moreover, U.K. data continue to surprise positively. The catalyst for pound weakness this week was Theresa May’s announcement she will set out a timetable for her resignation next month, once the fourth iteration of Brexit is submitted for a vote. Report Links: Take Out Some Insurance - May 3, 2019 Not Out Of The Woods Yet - April 5, 2019 A Trader’s Guide To The Yen - March 15, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been negative: Home loans contracted by 2.5% in March. Crucially, this was driven by both owner-occupied and investor lending. National Australia Bank’s business conditions and business confidence indices both fell in April. Business conditions fell to 3, and business confidence decreased to 0. Westpac consumer confidence fell to 0.6% in May. Consumer inflation expectations fell to 3.3% in May. On the labor market front, the wage price index was unchanged at 2.3% year-on-year in Q1. Unemployment rate increased to 5.2%, while participation rate increased to 65.8%. 28.4 thousand new jobs were created in April. However, this is due to the creation of 34.7 thousand part-time jobs, while 6.3 thousand full-time jobs were lost. AUD/USD fell by 1% this week. We remain overweight the Australian dollar as it will be one of the first pro-cyclical currencies to benefit from Chinese stimulus. But we will respect our AUD/USD 0.68 stop loss if it is breached. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 Into A Transition Phase - March 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been negative: Food price index fell by 0.1% month-on-month in April. Visitor arrivals contracted by 2.6% year-on-year in March. REINZ house sales continue to contract by 11.5% year-on-year in April. Net migration fell to 59 thousand in Q1. Migration has been an important source of demand for New Zealand. NZD/USD fell by 0.4% this week. The New Zealand dollar remains very vulnerable to external shocks, especially from the trade front. Meanwhile, terms of trade dynamics continue to favor AUD vis-à-vis NZD. The domestic environment, including reduced immigration also remains a headwind for the economy. Report Links: Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data from Canada have been promising: Building permits increased by 2.1% month-on-month in March.  On the labor market front, the unemployment rate fell to 5.7% in April, and 106.5 thousand new jobs were created. Participation rate increased to 65.9%, and average hourly earnings increased by 2.6% year-on-year in April. This was a blockbuster jobs report. Headline inflation increased to 2% year-on-year in April, while core inflation decreased to 1.5%. Manufacturing sales increased by 2.1% month-on-month in March. USD/CAD decreased by 0.1% this week. The good news from the Canadian housing sector and labor market has supported the loonie. On Wednesday, Canadian Foreign Affairs Minister Chrystia Freeland called again for the U.S. to lift steel and aluminum tariffs in order to create “true free trade” on the continent. On the U.S. side, Treasury Secretary Steven Mnuchin said that Washington was close to resolving its differences with Mexico and Canada over steel and aluminum tariffs. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 There is little data from Switzerland this week: Producer and import prices fell by 0.6% in April. USD/CHF fell by 0.1% this week. The Swiss franc remains a safe-haven currency, and growing political uncertainty will increase demand for the franc. We discuss the outlook for the franc at length in the front section of this report. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been mixed: Core inflation fell to 2.6% year-on-year in April, while still higher than the expected 2.5%.  Headline inflation was unchanged at 2.9% year-on-year in April. Real GDP growth did slow down to a 0.3% quarter-on-quarter pace in Q1. However, seasonal factors were at play. Strong agricultural output in Q4 2018 was not repeated in Q1 following last year’s summer drought. There was also low power production in the months of February and March. The trade balance increased to 17.6 billion NOK in April. USD/NOK has been volatile but returned flat this week. Two Saudi oil-pumping stations were targeted in a drone attack this Tuesday. The tensions in the Middle East increased the risk of oil supply shortages, which is bullish for oil price, thus beneficial for the Norwegian krone. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive: Swedish Public Employment Service (PES) unemployment rate fell to 3.5% in April. Headline consumer price inflation climbed to 2.1% year-on-year in April. Core consumer price inflation increased to 1.6% year-on-year in April. USD/SEK has been flat this week. As a pro-cyclical currency, the Swedish krona will soon benefit from a global growth recovery once political uncertainties and external shocks play out. We remain positive on the krona. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights The clear and present deterioration in Sino-U.S. trade negotiations suggests the dollar will remain bid in the near term. While the probability of a trade deal has fallen, the situation remains highly fluid, and the odds could shift either way rather dramatically. Ultimately, it is beneficial for both parties to come to an agreement. We highlighted last week that in an environment where volatility was low and falling, it paid to have insurance in place. The yen and Swiss franc remain attractive from this standpoint. Our thesis remains that the path of least resistance for the dollar is down, but gauging how high the dollar can catapult before ultimately reversing course is paramount for strategy. Our estimation is that the trade-weighted dollar could rise 2-3% before ultimately cresting. Expect more pronounced USD moves vis-à-vis growth-sensitive currencies. We were stopped out of our short USD/SEK position with a 1.9% loss. If global growth rebounds, this will be a high-conviction trade, but we are standing aside for risk-management purposes. Feature Markets received a dose of volatility this week. First, evidence has emerged that China is retracting on previous commitments toward a Sino-U.S. trade deal. A systematic volte face to core pledges such as legally addressing the theft of U.S. intellectual property and trade secrets, fair competition policy, and removing foreign caps on financial services, aggravated the Trump administration and prompted a new round of tariffs. As we go to press, the final details have not been revealed, but the proposal is to raise tariffs on $200 billion worth of Chinese goods from 10% to 25%, while slapping an additional 25% tariff on the remaining $325 billion of Chinese goods “shortly” after (Chart I-1). Almost simultaneously, tensions between the U.S. and Iran are flaring up following President Trump’s decision not to extend sanction waivers to Iranian oil exports beyond May. The Iranian response has been to threaten to claw back some of the commitments it made in the landmark 2015 nuclear deal, mainly a halt to its uranium enrichment program. The risk of miscalculation and escalation is high. With an aircraft carrier strike group departing from U.S. shores, Tehran could be forced into a corner and begin striking key pipelines in the Iraqi region of Basra, which is home to significant oil traffic. Meanwhile, investor exuberance towards green shoots in the global economy continues to be watered down with incoming data. Chinese export data has weakened anew, both in April and on a rolling three-month basis, following weak PMI numbers last week. Money and credit numbers were soft. Swedish manufacturing data, a strong proxy for global growth, continue to disappoint, with industrial new orders contracting by 8.1% in March – the worst pace since November 2016. And after a brisk rise since the start of the year, many China plays including commodity prices, the yuan, emerging market stocks and even A-shares are rolling over (Chart I-2). Chart I-1Back To The Firing Lines Chart 1-2Reflation Indicators Are Topping Out These developments have unsurprisingly put a bid under the dollar against pro-cyclical currencies. However, the euro is up versus the dollar this week, while the DXY marginally down. The lack of more pronounced volatility in currency markets despite a ramp-up in trade-war rhetoric is eery. Our thesis remains that the path of least resistance for the dollar is down, but gauging how high the dollar can catapult before ultimately reversing course is paramount for strategy. Tariffs And Exchange Rates Standard theory suggests that exchange rates should move to equalize prices across any two countries. This is simply because if prices rise significantly higher in country B versus Country A, it pays to buy the goods from A and resell them to B for a profit, assuming other costs are minimal. Country A’s currency rises following increased demand, while that of Country B falls, until the price differential is arbitraged away. This very simple concept originated from the School Of Salamanca in 16th century Spain, and still applies to this day in the form of Purchasing Power Parity (PPP). The question that naturally follows is by how much should the currency increase? The answer is that the exchange rate will move by exactly the same percentage point as the price increase, everything else equal. If both countries produce homogeneous goods, then it is easy to see why, since there is perfect substitution. But assuming they produce heterogeneous goods, then the loss of purchasing power in Country A will lead to less demand for Country B’s goods. This means Country B’s currency will have to adjust downwards for the markets to clear. The decrease has to match the magnitude of the price increase, since there are no other outlets to liquidate Country A’s goods. If, say, Country A moves to hike prices as well, then both currencies remain at par. This is obviously a very simplified version of the real world economy, but it highlights an important point that is central to the discussion: The currency move necessary to realign competitiveness will always be equal to, or less, in percentage point terms to the price increase. In the case where the entire production base is tradeable, it will be the former. But with a rise in the number of trading partners, a more complex export basket, import substitution, shipping costs and many other factors that influence tradeable prices, the currency adjustment should be a fraction of the price increase. Since the onset of 2018, the U.S. has slapped various tariffs on China, the most important of which was 10% on $200 billion worth of Chinese goods. Assume for the sake of argument that only China and the U.S. were trading partners. The U.S. currently imports $522 billion worth of goods from China, about 17% of its total imports. However, as a percentage of overall U.S. demand, this only represents 2.5% (Chart I-3). This suggests that at best, a 25% increase on all Chinese imports will only lift import prices by 4.3% and consumer prices by much less. On the Chinese side of the equation, exports to the U.S. account for 20% of total exports, so a tariff of 25% should only lift export prices by 5%. The conclusion is that the yuan and dollar only need to adjust by 4-5% to negate the impact of a 25% tariff. Chart 1-3Sino-U.S. Trade Is Small Relative To Domestic Demand Chart 1-4No Disorderly Rise In ##br##The Dollar   The DXY index is up 10% since the 2018 trough (Chart I-4), and the dollar was up an average of 74 basis points versus the Chinese Yuan from the day major tariffs were announced until the peak in trade-war rhetoric (Table I-1). This would be in line with economic theory. But there is a caveat: With no corresponding export subsidy for U.S. goods, the rise in the dollar makes exporters worse off. And with over 40% of S&P 500 sales coming from outside the U.S., this would have a meaningful dent on corporate profits. A paper by the Peterson Institute for International Economics showed that imposing a border adjustment tax caused the real effective exchange rate (REER) of the country to rise, hurting competitiveness.1  In quantity terms, the IMF estimated that a 20% import tariff from East Asia would lift the U.S. dollar’s REER by 5% over five years, while dropping output by 0.6% over the same timeframe.2  With the dollar not currently overvalued on a REER basis, this does not bode well for future competitiveness (Chart I-5). Finally, trade wars are usually synonymous with recessions. As such, there are acute political constraints inching both sides toward an agreement. For President Trump, a deteriorating U.S. manufacturing sector in the Midwestern battleground states is a thorn in his side. The U.S. agricultural sector has continued to bleed from falling grain prices (Chart I-6). For President Xi, rising unemployment is a key constraint. April manufacturing and credit numbers out of China show that the economy is relapsing anew. So, either China compromises and inches towards a trade deal or launches another round of stimulus. Chart I-5The Dollar Is Not Undervalued On A REER Basis Chart I-6A Drought In Cash Flows For ##br##U.S. Farmers   Bottom Line: Standard theory suggests the dollar’s bid should be capped at 2-3% on the imposition of new tariffs. Getting the global growth picture right will be more important in dictating the dollar’s trend. Of course, a full-blown trade war puts the entire thesis in jeopardy. Questions From The Road We were on the road this week, talking to clients and teaching the BCA Academy. Most clients agreed that the dollar is in a transition phase, given the presence of emerging green shoots in the global economy (Chart I-7). However, most were also concerned to what degree this view could be offside. The concerns centered around the fact that the growth differential between the U.S. and the rest of the world remains wide, yield differentials still favor the U.S., profit leadership also continues to favor the U.S. and it is unclear to what degree the world is short of U.S. dollars. U.S. profit leadership in the world continues, but one prescient indicator for the dollar is whether banks are easing lending standards for large firms relative to smaller ones.  We continue to lean towards the narrative that most of the factors driving the dollar higher are behind us. U.S. growth tends to be low-beta relative to the world, so a rebound in the global economy will be negative for the dollar. An end to the Federal Reserve’s balance sheet runoff will steer growth in the U.S. monetary base from deeply negative to zero. Meanwhile, a rising external profit environment will lead to an increase in foreign central bank reserves. The yield differential between the U.S. and the rest of the world remains wide, but this has a natural limit since global bond yields tend to converge towards each other over time. Chart I-7Global Growth Should##br## Rebound Chart I-8Positive Earnings Revisions Bodes Well For Growth   U.S. profit leadership in the world continues (Chart I-8), but one prescient indicator for the dollar is whether banks are easing lending standards for large firms relative to smaller ones. A better external environment will suggest banks will allow credit to flow to larger firms relative to smaller ones, since the latter tend to be more domestic. This is also an environment where global equities tend to outperform. The latest Fed Senior Official Loan survey showed that on the margin, lending standards are easing for large relative to small firms. This may suggest that return on capital is starting to improve outside the U.S., which will be a headwind for the dollar (Chart I-9). Chart I-9S&P 500 Foreign Earnings Need A Weak Dollar From a technical standpoint, almost all currencies are already falling versus the U.S. dollar – a trend that has been in place for several months now. This means most of the factors putting upward pressure on the dollar are well understood by the market. For example, global growth has been slowing for well over a year, based on the global PMI. Putting on fresh U.S. dollar long positions is at risk of a washout from stale investors, just as it was back in 2015, a year after growth had peaked (Chart I-10). It will be difficult for the dollar to act as both a safe-haven and carry currency, because the forces that drive both move in opposite directions.  Dollar technicals are also very unfavorable. Speculators are holding near-record long positions, sentiment is stretched, and our intermediate-term indicator is also flagging yellow. Over the past five years, confirmation from all three indicators has been followed by some period of U.S. dollar indigestion (Chart I-11). This may help explain relative stability in the broad trade-weighted dollar, despite a flare up in global risk aversion. Chart I-10Dollar Bull Case Is Well Known Chart I-11Dollar Technicals Are Unfavorable   Finally, with U.S. interest rates having risen significantly versus almost all G10 countries in recent years, the dollar has itself become the object of carry trades. This has also come with a good number of unhedged trades, as the rising exchange rate has lifted hedging costs. It will be difficult for the dollar to act as both a safe-haven and carry currency, because the forces that drive both move in opposite directions. The strength in EUR/USD this week despite the rise in global risk aversion is testament to this thesis. Bottom Line: Aside from the renewed specter of a trade war, most of the factors driving the dollar higher are behind us. House Keeping Chart I-12Buy Some Insurance Rising market volatility suggests some trades could be at risk from being stopped out. First, our long AUD/USD sits right at the epicenter of any growth slowdown in China. Maintain stops of 68 cents. Second, in an environment where volatility is low and falling, it pays to have insurance in place. We continue to favour CHF/NZD (Chart I-12). Third, we were stopped out of our short USD/SEK position for a 1.9% loss. If global growth rebounds, this will be a high-conviction trade. However, we are standing aside for risk-management purposes. Finally, the Reserve Bank Of Australia kept rates on hold this week, while the Reserve Bank Of New Zealand cut rates. This bodes well for our strategic AUD/NZD position.     Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Caroline Freund and Joseph E. Gagnon, “Effects of Consumption Taxes on Real Exchange Rates and Trade Balances,” Peterson Institute for International Economics, April 2017. 2 Maurice Obstfeld, “Tariffs Do More Harm Than Good At Home,” IMFBlog, September 8, 2016. Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. have been mostly positive: To begin with the labor market, the unemployment rate fell to a 50-year low of 3.6% in April, despite a slight fall in the participation rate to 62.8%. Change in nonfarm payrolls came in above expectations at 263K in April, while average hourly earnings was unchanged at 3.2%. Moreover, JOLTS job openings came in at 7.5 million, above expectations. On the PMI front, the Markit composite PMI fell to 53 in April. ISM non-manufacturing PMI fell below expectations to 55.5. On the housing market front, mortgage applications increased by 2.7%, an improvement from the last reading of -4.3%. This nudged the MBA Purchase Index from 259.4 to 270.2. DXY index fell by 0.2% this week. On Sunday, Trump tweeted that tariffs on $200 billion worth of Chinese imports will increase from 10% to 25%, which again toppled the market. The ongoing trade disputes increase uncertainty in the global growth outlook. Report Links: Take Out Some Insurance - May 3, 2019 Currency Complacency Amid A Global Dovish Shift - April 26, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area are improving: Headline and core inflation in the euro area rose to 1.7% and 1.2% year-on-year, respectively in April. Markit composite and services PMI came in at 51.5 and 52.8, respectively, both surprising to the upside. The French composite and services PMI increased to 50.1 and 50.5. The German composite and services PMI increased to 52.2 and 55.7. Sentix investor confidence rose to 5.3 in May, well above consensus. Retail sales increased by 1.9% year-on-year in March. EUR/USD appreciated by 0.3% this week. The European Commission (EU) released the spring 2019 Economic Growth Forecasts this week, citing that “growth continues at a more moderate pace.” While the global growth slowdown and trade policy uncertainties could weigh on the European economy, domestic dynamics are set to support the economy. According to the forecast, growth will continue to pick up in all EU member states next year. Report Links: Take Out Some Insurance - May 3, 2019 Reading The Tea Leaves From China - April 12, 2019 Into A Transition Phase - March 8, 2019 The Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been neutral: Nikkei composite PMI increased to 50.8 in April. The manufacturing PMI increased to 50.2, while the services PMI fell slightly to 51.8. Vehicle sales increased by 2.5% year-on-year in April. Consumer confidence index fell to 40.4 in April. USD/JPY fell by 0.9% this week. Volatility caused by the ongoing trade disputes has reduced risk appetite, enhancing the outperformance of the safe-haven yen. According to the BoJ minutes released this Wednesday, Japanese financial conditions remain highly accommodative, and the domestic demand is likely to bounce, despite the drag from external growth. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 A Trader’s Guide To The Yen - March 15, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been solid: Markit composite PMI increased to 50.9 in April. Services PMI also came in above expectations at 50.4 in April, an improvement from the last reading of 48.9. The British Retail Consortium (BRC) like-for-like retail sales increased by 3.7% year-on-year in April, outperforming expectations. Halifax house prices increased by 1.1% month-on-month in April and 5% year-on-year. GBP/USD fell by 0.9% this week, erasing the gains from last Friday after positive PMI data. We continue to favor the pound given its cheap valuation and healthy domestic fundamentals. However, the window for pound upside will rapidly close as we approach Brexit 2.0. Report Links: Take Out Some Insurance - May 3, 2019 Not Out Of The Woods Yet - April 5, 2019 A Trader’s Guide To The Yen - March 15, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mostly positive: CBA Australia composite and services PMI both outperformed, increasing to 50 and 50.1, respectively. Building permits contracted by 27.3% year-on-year in March. However, this looks like a volatile bottoming process on a chart. Retail sales increased by 0.3% month-on-month in March. The trade balance came in at a surplus of A$4.95 million in March. AUD/USD has been flat this week. The Reserve Bank of Australia kept interest rate on hold at 1.5% this week, which disappointed the bears. Moreover, in the monetary policy statement, the RBA estimates the economy will grow around 2.75% in 2019 and 2020, supported by increased investment and a pickup in the resources sector. Report Links: Beware Of Diminishing Marginal Returns- April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 Into A Transition Phase - March 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been mixed: ANZ commodity prices increased by 2.5% in April, higher than expected. 2-year inflation expectations remain at 2%. Dairy price index increased by 0.4% in April, above the estimated -1.1%. NZD/USD fell by 0.5% this week. On Tuesday, the RBNZ lowered its interest rate by 25 bps to 1.5%. Our long AUD/NZD position, which is currently 0.8% in the money, is likely to profit from the widened interest rate differential. In the monetary policy statement, the RBNZ stated that a lower rate is mostly consistent with the current employment and inflation outlook in New Zealand. Moreover, global uncertainties, coupled with domestic housing market softness and reduced immigration remain a headwind to the economy. Report Links: Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been positive: Ivey Purchasing Managers’ Index increased to 55.9 in April, well above estimates. Housing starts increased by 236K year-on-year in April. Imports and exports increased to C$52 billion and C$49 billion respectively in March, resulting in a small deficit of C$3 billion. New housing price index increased by 0.1% year-on-year in March. USD/CAD has been flat this week. On Monday, Governor Poloz gave a speech focusing on the Canadian housing sector. He aims to provide more flexible mortgage choices for Canadian consumers, which could help the housing market to stabilize. The possible measures include diversifying mortgage terms, developing an MBS market, and encouraging different mortgage designs. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been neutral: Headline inflation fell to 0.2% in April on a month-on-month basis, while unchanged at 0.7% on a year-on-year basis. Core inflation was unchanged at 0.5% year-on-year. Foreign currency reserves increased to 772 billion CHF in April. Unemployment rate was unchanged at 2.4% month-on-month in April. The SECO consumer climate fell to -6 in Q2. USD/CHF fell by 0.2% this week. While the trade disputes and increased global growth uncertainties could support the Swiss franc in the near term, we continue to favor the euro over the franc on a cyclical basis. Report Links: Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been mixed: Registered unemployment fell to 2.3% in April. Manufacturing output contracted by 0.8% in March. House prices rose by 2.2% year-on-year in April, below March’s 3.2% annual growth. USD/NOK increased by 0.2% this week. On Thursday, the Norges Bank kept interest rates on hold at 1%, in line with expectations. The monetary policy continues to be accommodative, which is a tailwind for the Norwegian economy. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been negative: Industrial production contracted by 1.3% year-on-year in March. Manufacturing new orders decreased by 8.1% year-on-year in March, the worst since November 2016. USD/SEK increased by 0.8% this week. Our short USD/SEK position was stopped out at 9.6, due to the weaker-than- expected Swedish data and unexpected U.S. dollar resilience. We will look to put the trade back on when we see more clear signs of a global growth bottom. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights Evidence continues to mount that the Chinese economy is in a bottoming process. This suggests the path of least resistance for the RMB is up. Meanwhile, as the U.S. and China move closer to a trade deal, any geopolitical risk premium in the RMB will slowly erode. The ultimate catalyst for CNY longs will be depreciation in the U.S. dollar, which we believe is slowly underway. The ECB is turning more dovish at a time when euro area growth is hitting a nadir. This will be bullish for the euro beyond the near term. Our limit buy on the pound was triggered at 1.30. Target 1.45 with stops at 1.25. With the Aussie dollar close to the epicenter of Chinese stimulus, data down under is increasingly stabilizing. We are closing our short AUD/NOK position for a small profit. Feature Chart I-1The Chinese Yuan Is Pro-cyclical In addition to the dovish shift by global central banks, most investors are rightly fixated on China at this juncture in the economic cycle.  For one, it has been mostly responsible for the mini cycles in the global economy since 2014. And with improvements in both Chinese credit and manufacturing data in recent months, the consensus is drawing closer to the fact that we may be entering a reflationary window. Looking at risk assets, MSCI China is up 25% from its lows, while the S&P 500 is up 20%. Commodity prices are also rising, with crude oil hitting a new calendar-year high this week. The corollary is that if the improvement in Chinese data proves sustainable, it will propel these asset markets to fresh highs. The evolution of the cycle has important implications for the yuan exchange rate, because the RMB has been trading like a pro-cyclical currency in recent years. The USD/CNY has been moving tick for tick with emerging market equities, Asian currencies, and even some commodity prices (Chart I-1). Ever since its liberalization over a decade ago, the RMB may finally be behaving like a free-floating exchange rate. Therefore, a simple evaluation of how relative prices between China and the rest of the world evolve will be valuable input for the fair value of the RMB exchange rate. Reading the tea leaves from Chinese credit data can be daunting, but we agree with the assessment of our China Investment Strategy team that while the credit impulse has clearly bottomed,1 the magnitude of the rise is unlikely to be what we saw in 2015-2016. That said, a higher credit-to-GDP ratio also requires a smaller increase in credit growth to have an outsized effect on GDP. As such, monitoring what is happening with hard data in the economy concurrently – in particular, green shoots – could add valuable evidence to the reflation theme. A Repeat Of 2016? Cycle bottoms can be protracted and volatile, but also V-shaped. So it is useful when economic data is at a nadir to pay attention to any green shoots emerging, because by the time the last piece of pertinent economic data has turned around, it may well be too late to call the cycle. Admittedly, most measures of Chinese (and global) growth remain weak. But there have been notable improvements in recent months that suggest economic velocity may be picking up: Production of electricity and steel, all inputs into the overall manufacturing value chain, are inflecting higher. Intuitively, these tend to lead overall industrial production. Overall industrial production remains weak, but the production of electricity and steel, all inputs into the overall manufacturing value chain, are inflecting higher. Intuitively, these tend to lead overall industrial production (Chart I-2). Electricity production for the month of February grew 5% after grinding to a halt in 2015-2016. Production of steel also rose by 7%. If these advance any further, they will begin to exceed Q4 GDP growth, indicating a renewed mini-cycle. Chart I-2A Revival In Industrial Activity Chart I-3Metal Prices Are Sniffing A Rebound   In recent weeks, both steel and iron ore prices have been soaring. Many commentators have attributed these increases to supply bottlenecks and/or seasonal demand. However, it is evident from both the manufacturing data and the trend in prices that demand is also playing a role (Chart I-3). Overall residential property sales remain soft, but evidence from tier-1 and even tier-2 cities is signalling that this may be behind us, given robust sales. Over the longer term, the ebb and flow of property sales has tended to be in sync across city tiers. A revival in the property market will support construction activity and investment. House prices have been rising to the tune of 10% year-on-year, and real estate stocks in China may be sniffing an eventual pick-up in property volumes (Chart I-4). Over the last 20 years or so, Chinese credit growth has been a reliable indicator for car sales with a lead of about six months. Government expenditures were already inflecting higher ahead of last month’s China National People’s Congress (NPC). Again, this suggests stimulus this time around may be more fiscal than monetary (Chart I-5). In addition to the recent VAT cut for manufacturing firms from 16% to 13%, a string of policy easing measures will begin to accrue, including a cut to social security contributions effective May 1st, and perhaps a pickup in infrastructure spending. Already, real estate infrastructure spending growth is perking up, with that in the mining sector soaring to multi-year highs. Chart I-4Real Estate Volumes Could Pick Up Chart I-5The Fiscal Spigots Are Opening Finally, Chinese retail sales including those of durable goods remain very weak. Car sales are deflating at the fastest pace in over two decades. But the latest VAT cut by the government is being passed through to consumers, with an increasing number of car manufactures cutting retail prices. Chart I-6Car Sales Typically Have V-Shaped Recoveries   Over the last 20 years or so, Chinese credit growth has been a reliable indicator for car sales with a lead of about six months (Chart I-6). The indicator right now suggests we could witness a coiled-spring rebound in Chinese car sales over the next few months. Bottom Line: Both Chinese stocks and commodity prices have been suggesting a bottoming process in the domestic economy for a while now. Incoming data is beginning to corroborate this view. This has important implications for both the Chinese yuan and other global assets. Capital Flows Improving domestic and external conditions will likely offset any renewed pressure on the Chinese yuan from capital outflows. Our China Investment Strategy team reckons that even after adjusting for cross-border RMB settlements and illicit capital outflows, there is less evidence of capital flight today than there was in 2015-2016.2  Chart I-7Offshore Markets Don't See RMB Weakness Typically, offshore markets have had a good track record of anticipating depreciation in the yuan. Back in 2014, offshore markets started pricing in a rising USD/CNY rate, and maintained that view all the way through to 2018, when the yuan eventually bottomed. Right now, no such depreciation is being priced in (Chart I-7). The reason offshore markets in Hong Kong and elsewhere can be prescient is because more often than not, they are the destination for illicit flows out of China. For example, one of the often-rumored ways Chinese money has left the country is through junkets, key operators in Macau casinos.3 These junkets bankroll their Chinese clients in Macau while collecting any debts in China allowing for illicit capital outflows. This was particularly rampant ahead of the Chinese 2015-2016 corruption clampdown, when Macau casino equities were surging while equity prices in China remained subdued. Historically, both equity markets tend to move together, since over 70% of visitors to Macau come from China (Chart I-8). Right now, both the Chinese MSCI index and Macau casino stocks are rising in tandem, suggesting gains are more related to fundamentals than hot money outflows. Chart I-8Macau Casinos: A Good Proxy For Chinese Spending A surge in illicit capital outflows could also be part of the reason for an explosion in sight deposits in Hong Kong ahead of the 2015-2016 clampdown (Chart I-9). Admittedly, most of these deposits were and still are due to cross-border RMB settlements, but it is also possible that part of these constituted hot money outflows. With these sight deposits rising at a more reasonable pace, it suggests little evidence of capital flight. Chart I-9The Chinese Government Has Clamped Down On Illicit Flows Trade Truce A trade truce between the U.S. and China will be the final catalyst for a stronger yuan. The news flow so far has been positive, with both U.S. President Donald Trump and Chinese President Xi Jinping publicly acknowledging they are closer to a deal. Even well-known China hawk Peter Navarro, head of the U.S. National Trade Council, has admitted that the two sides are in the final stages of talks. But with a still-ballooning U.S. trade deficit with China, Trump will want to take home a win (Chart I-10). Chart I-10Trump Needs To Take A Win Back To America Concessions on the Chinese side so far seem reasonable, allowing us to speculate that there is a rising probability of a deal. They have agreed to increase agriculture and energy imports from the U.S. by about $1 trillion over the next six years, announced a cut on import tariffs, revised their Patent Law to improve protection of intellectual property, and provided a clear timeline for when foreign caps will be removed in sectors such as autos and financial services. These seem like very reasonable concessions that will allow Trump to go home and declare victory. Trade wars are usually synonymous with recessions. As such, there are acute political constraints inching both sides towards an agreement. For President Trump, a deteriorating U.S. manufacturing sector in the midwestern battleground states is a thorn in his side. For President Xi, rising unemployment is a key constraint. On the currency front, the details of any agreement are still unknown, but should Chinese economic fundamentals start to genuinely improve, it will put upward pressure under rates – and ergo the yuan (Chart I-11). A gradually rising yuan exchange rate will further assuage any doubts or concerns that Trump may have. Bottom Line: Our fundamental models show the yuan as undervalued by about 3%. This means China could allow its currency to gradually appreciate towards fair value, with little impact on the domestic economy or even exports. Given some green shoots in incoming economic data, little risk of capital flight, and the rising likelihood of a trade deal between the U.S. and China, our bias is that the path of least resistance for the Chinese RMB is up (Chart I-12). Chart I-11Rising Chinese Rates Will Favor The Yuan Chart I-12The RMB Is Not Expensive     Another Dovish Shift By The ECB In another dovish twist, the European Central Bank kept monetary policy unchanged following this week’s meeting, while highlighting that it might be on hold for longer. Unsurprisingly, incoming data has been weak of late, which the ECB (like other central banks) blamed on the external environment. It did fall short of speculation that it will introduce a tiered system for its marginal deposit facility, which would have alleviated some cash flow pressures for euro area banks. Our bias is for the new Targeted Long Term Refinancing Operation (TLTRO III – in other words, cheap loans), to remain a better policy tool than a tiered central bank deposit system. In the case of a TLTRO, the ECB can effortlessly decentralize monetary policy, since liquidity gravitates towards the countries that need it the most. While a tiered system can allow a bank to offer higher rates and attract deposits, there is no guarantee that these deposits will find their way into new loans. It is also likely to benefit countries with the most excess liquidity. In the case of a TLTRO, the ECB can effortlessly decentralize monetary policy. Beyond any short-term volatility in the euro, we think the ECB’s dovish shift could be paradoxically bullish. If a central bank eases financing conditions at a time when growth is hitting a nadir, it is tough to argue that it is bearish for the currency. Meanwhile, fiscal policy is also set to be loosened. Swedish new orders-to-inventories lead euro area growth by about five months, and the recent bounce could be a harbinger of positive euro area data surprises ahead (Chart I-13). Chart I-13Euro Area Growth Will Recover Bottom Line: European rates are further below equilibrium compared to the U.S., and the ECB’s dovish shift will help lift the euro area’s growth potential. Meanwhile, investors are currently too pessimistic on euro area growth prospects. Our bias is that the euro is close to a floor. House Keeping Our buy-stop on the British pound was triggered at 1.30. We recommend placing stops at 1.25, with an initial target of 1.45. As we argued last week,4 the odds of a hard Brexit continue to fall, with U.K. Prime Minister Theresa May explicitly saying this week that the path for the U.K. going forward is either a deal with the EU or with no Brexit at all. As we go to press, EU leaders have granted the U.K. an extension until the end of October, with a review in June. Chart I-14What Next For The Pound? Back when the referendum was held in June 2016, even the pro-Brexit Tories, a minority in the party, promised continued access to the Common Market. Fast forward to today and there are simply not enough committed Brexiters in Westminster to deliver a hard exit. Given that the can has been kicked down the road, markets are likely to turn their focus on incoming economic data. On that front, economic surprises in the U.K. relative to both the U.S. and euro area are soaring (Chart I-14). Elsewhere, we are also taking profits on our short AUD/NOK position. Since 2015, the market has been significantly dovish on Australia, in part due to a more accelerated downturn in house prices and a marked slowdown in China. The reality is that the downturn in Australia has allowed some cleansing of sorts and has brought it far along the adjustment path relative to its potential. Any potential growth pickup in China will light a fire under the Aussie dollar, which is a risk to this position. Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see China Investment Strategy Special Report, titled “China: Stimulating Amid The Trade Talks,” dated February 20, 2019, available at fes.bcaresearch.com 2 Please see China Investment Strategy Special Report, titled “Monitoring Chinese Capital Outflows,” dated March 20, 2019, available at fes.bcaresearch.com 3 Farah Master, “Factbox: How Macau's casino junket system works,” Reuters, October 21, 2011. 4 Please see Foreign Exchange Strategy Weekly Report, titled “Not Out Of The Woods Yet,” dated April 5, 2019, available at bca.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. have been mostly positive: In March, 196K nonfarm jobs were created, surprising to the upside; unemployment rate stayed low at 3.8%, though average hourly earnings growth fell to 3.2% year-on-year. The factory orders in February contracted by 0.5% month-on-month. More importantly, headline consumer price inflation in March rose to 1.9% year-on-year, however this was mostly lifted by rising energy prices. Core inflation excluding food and energy dropped by 10 basis points to 2%. JOLTs job openings unexpectedly fell to 7.1 million in February, from 7.6 million. However, initial jobless claims fell to 196K. After a 3-month lull, producer prices are inflecting higher at a pace of 2.2% year-on-year for the month of March. DXY index fell by 0.44% this week. Global risk assets are on the rise this week. Meanwhile, the Fed minutes highlighted that members are in no rush to raise rates. Stalling interest rate differentials will be a headwind for the dollar.  Report Links: Not Out Of The Woods Yet - April 5, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 Into A Transition Phase - March 8, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been positive: The Sentix Investor Confidence index continues to inflect higher, coming in at -0.3 from -2.2.  German industrial production grew by 0.7% month-on-month in February. Trade balances improved across the euro area. In France, the trade deficit fell to €-4.0B in February. In Germany, the trade surplus increased to €18.7B. Italian retail sales increased by 0.9% year-on-year in February. On the inflation front, consumer price inflation in Germany and France both stayed at 1.3% year-on-year in March. EUR/USD rose by 0.57% this week. On Wednesday, the ECB has decided to leave policy unchanged as expected. Mario Draghi also highlighted more uncertainties and downside risks to the euro area amid the ongoing trade disputes. While the global trade war might add volatility to the pro-cyclical euro, easier financial conditions should eventually backstop growth. Report Links: Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 Balance Of Payments Across The G10 - February 15, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: Preliminary cash earnings fell by 0.8% year-on-year in February, the only decline since mid-2017. Household confidence continues to tick lower, coming in at 40.5 in March. The trade balance in February came in at a surplus of ¥489.2B. Capex is rolling over. Machinery orders fell by 5.5% year-on-year in February. Machine tool orders remain extremely weak, at -28.5% year-on-year for the month of March. Lastly, the foreign investment in Japanese stocks increased to ¥1,463.7B. USD/JPY fell by 0.46% this week. In its April regional outlook, the BoJ downgraded most of the prefectures in Japan, with only Hokkaido that had an upgrade in the aftermath of the earthquake. As domestic deflationary pressures intensify, this will favor the yen.  This also raises the probability the government defers the consumption tax hike. Report Links: Tug OF War, With Gold As Umpire - March 29, 2019 A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been strong: In February, manufacturing production increased by 0.6% year-on-year; industrial production also increased by 0.1% year-on-year, both surprising to the upside. Both were deflating in January. The goods trade balance in February fell to £-14.1B, however the total trade balance came in at a smaller deficit of £4.86B. Monthly GDP also came in higher at 2% year-on-year in February. House prices gains have pared the increase of previous years, but the Halifax house price index still increased by 2.6% year-on-year for the month of March.  GBP/USD rose by 0.41% this week. Theresa May got an extension for Brexit to October 31. Meanwhile, U.K. data have been stronger than consensus recently. We are long GBP/USD from 1.30, with a 0.6% profit. Report Links: Not Out Of The Woods Yet - April 5, 2019 A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have continued to improve: Investment lending for homes in February grew by 2.6%. Home loans in February increased by 2% month-on-month, surprising to the upside. Westpac consumer confidence came in at 100.7 in April, increasing by 1.9%.  AUD/USD surged by 0.64% this week. The RBA Deputy Governor Guy Debelle hinted that a wait-and-see approach for interest rates seemed like the appropriate path, signaling that policy will continue to be accommodative. Meanwhile, the Australian dollar is probably anticipating better upcoming data from China, as it is Australia’s largest trading partner. If the world’s second largest economy can turn around, the Aussie dollar is likely to grind higher. Report Links: Not Out Of The Woods Yet - April 5, 2019 Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 There was little data out of New Zealand this week: The food price index came in at 0.5% month-on-month in March, shy of the estimate of 1.3%. NZD/USD plunged after rising by 0.5% initially this week, returning flat. Incoming data in New Zealand is likely to lag its commodity currency counterparts pushing the kiwi relatively lower. Our long AUD/NZD position is now 0.7% in the money since entry last Friday. Report Links: Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been negative: On the labor market front, the participation rate in March fell slightly to 65.7%; 7,200 jobs were lost, underperforming the estimated creation of 1,000 jobs; unemployment rate was unchanged at 5.8%. On the housing market front, starts in March increased by 192.5K year-on-year, underperforming the expected 196.5K; building permits dropped by 5.7% month-on-month in February. USD/CAD rebounded quickly after falling by 0.7% earlier this week, offsetting the loss. While the dovish shift by the BoC and looser fiscal policy, together with rising oil prices are likely to be growth tailwinds, the data disappointment coming from the housing market and overall economy limit upside in the CAD. Report Links: A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 There was scant data in Switzerland this week: The foreign currency reserves came in at 756B CHF in March. Unemployment rate in March was unchanged at 2.4%, in line with expectations. USD/CHF appreciated by 0.44% this week. With the euro area economy slowly recovering, the franc is likely to underperform as risk appetite rises. We are long EUR/CHF for a 0.1% profit. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Waiting For A Real Deal - December 7, 2018 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been strong, with inflation grinding higher: Headline consumer price inflation increased to 2.9% year-on-year in March; core inflation also rose to 2.7% year-on-year, both surprising to the upside. Producer price index grew by 5.2% year-on-year in March, outperforming expectations. USD/NOK depreciated by 1.16% this week. The improving domestic economy, rising oil prices, and the tick up in inflation are all the reasons why we favor the Norwegian krone. We are playing the NOK via a few pairs, notably long NOK/SEK and short AUD/NOK, which are currently 3.11% and 0.75% in the money, respectively. Report Links: A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been mixed: Industrial production fell to 0.7% year-on-year in February, lower than the previous reading of 3%. New manufacturing orders contracted by 2.8% year-on-year in February. However, the leading manufacturing new orders to inventory ratio is rising suggesting we might be near a bottom. Consumer price inflation came in higher at 1.9% year-on-year in March. USD/SEK fell by 0.21% this week. We remain bullish on the Swedish krona due to its cheap valuation and the imminent pickup in the euro area economy. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights The correlation between oil and petrocurrencies has deeply weakened in recent years. One of the reasons has been the prominence of new, important producers, notably the U.S. Oil prices should trend towards $75/bbl by year-end. This will favor the NOK, but the CAD and AUD will be held hostage to domestic slowdowns. Sell the CAD/NOK at current levels. Meanwhile, aggressive investors could begin accumulating USD/NOK shorts, given the Fed’s complete volte-face. Both the SNB and the BoE have delivered dovish messages, joining the chorus echoed by other central banks. However, the BoE remains a sideshow until the final chapter of the Brexit imbroglio unfolds. Feature Oil price dynamics have tended to have a profound impact on the trend of petrocurrencies. In theory, rising oil prices allow for increased government spending in oil-producing countries, making room for the resident central bank to tighten monetary policy. This is usually bullish for the currency. An increase in oil prices also implies rising terms of trade, which further increases the fair value of the exchange rate. Balance-of-payments dynamics also tend to improve during oil bull markets. Altogether, these forces combine to be powerful undercurrents for petrocurrencies. In the case of Canada and Norway, petroleum represents around 20% and 60% of total exports. For Saudi Arabia, Iran or Venezuela, this number is much higher than in Norway. It is easy to see why a big fluctuation in the price of oil can have deep repercussions for their external balances. Getting the price of oil right is usually the first step in any petrocurrency forecast. The Outlook For Oil1 Our baseline calls for Brent prices to touch $75/bbl by year-end. Oil demand tends to follow the ebbs and flows of the business cycle, with demand having slowed sharply in the fourth quarter of 2018 (Chart I-1). With over 60% of global petroleum consumed fueling the transportation sector, the slowdown in global trade brought a lot of freighters, bulk ships, large crude carriers and heavy trucks to a halt. If, as we expect, the impact of easier global financial conditions begins to seep into the real economy, these trends should reverse in the second half of the year. BCA’s Commodity & Energy Strategy group estimates that this would translate into a 1.5% increase in oil demand this year. Chinese oil imports have already started accelerating, and should Indian consumption follow suit, this will put a floor under global demand growth (Chart I-2). Chart I-1Global Oil Demand Has Been Weak Chart I-2Oil Demand Green Shoots This increase in oil demand will materialize at a time when OPEC spare capacity is only at 2%. In its most recent meeting, OPEC decided not to extend the window for production cuts beyond May, waiting to see whether the U.S. eases sanctions on either Venezuela, Iran or both. At first blush, this appeared bearish for oil prices. However, the bottom line is that global spare capacity cannot handle the loss of both Venezuelan and Iranian exports. Unplanned outages wiped off about 1.5% of supply in 2018. Lost output from both countries will nudge the oil market dangerously close to a negative supply shock (Chart I-3). Bottom Line: If Venezuelan sanctions continue, we expect the U.S. will likely extend the current waivers to Iranian exports further out into the future. Meanwhile, demonstrated flexibility by OPEC makes it increasingly the fulcrum of the oil market. That said, the balance of risks for oil prices remain to the upside since a miscalculation by both sides is a possibility. The Good Old Days Historically, the above analysis would have been largely sufficient to buy most petrocurrencies, especially given the gaping wedge that has opened vis-à-vis the price of oil (Chart I-4). But the reality is that the landscape for oil production is rapidly shifting, with the U.S. shale revolution grabbing market share from both OPEC and non-OPEC members. Chart I-4Opportunity Or Regime Shift? In 2010, only about 6% of global crude output came from the U.S. Collectively, Canada, Norway and Mexico shared about 10% of the oil market. Meanwhile, OPEC’s market share sat just north of 40%, having largely been stable among constituents like Saudi Arabia, Iran and even Venezuela. Fast forward to today and the U.S. produces almost 15% of global crude, having grabbed market share from both developed and politically-fragile economies (Chart I-5). Chart I-5A New Oil Baron At the same time, the positive correlation between petrocurrencies and oil has been gradually eroded as the U.S. economy has become less and less of an oil importer. Put another way, rising oil prices benefit the U.S. industrial base much more than in the past, while the benefits for countries like Canada and Norway are slowly fading. U.S. shale output in the Big 5 basins rose by about 1.5 million barrels in 2018, close to the equivalent of total Libyan production. Meanwhile, Norwegian production has been falling for a few years.  The reality is that the landscape for oil production is rapidly shifting, with the U.S. shale revolution grabbing market share from both OPEC and non-OPEC members. In statistical terms, petrocurrencies had a near-perfect positive correlation with oil around the time U.S. production was about to take off (Chart I-6). Since then, that correlation has fallen from around 0.8 to around 0.3. At the same time, the DXY dollar index is on its way to becoming positively correlated with oil as the U.S. becomes a net energy exporter. Chart I-6Shifting Landscape For Petrocurrencies Bottom Line: Both the CAD and NOK remain positively correlated with oil. So do the Russian ruble, and the Colombian and Mexican pesos. That said, a loss of global market share has hurt the oil sensitivity of many petrocurrencies. Transportation bottlenecks for Canadian crude and falling production in Norway are also added negatives. The conclusion is that rising petrodollar reserves have historically been bullish for the currency (Chart I-7) but expect this correlation to be weaker than in the past.  Chart I-7Rising Petrodollar Reserves Will Be Bullish The Fed As A Catalyst The Federal Reserve recently completed the volte-face that it launched at its January FOMC meeting. The dots now forecast no rate hikes in 2019 and only one for 2020. Previously, three hikes were baked in over the forecast period. GDP growth has been downgraded slightly, and CPI forecasts have also been nudged down. Rising petrodollar reserves have historically been bullish for the currency but expect this correlation to be weaker than in the past. The reality is that U.S. growth momentum relative to the rest of the world started slowly rolling over at a time when external demand remained weak.2 Recent data confirm this trend persists: Industrial production peaked last year and continues to decelerate; the NAHB housing market index came in a nudge below expectations; and the U.S. economic surprise index is sitting close to its one-year low of -40. With bond yields having already made a downward adjustment by circa 100 basis points, the valve for financial conditions to get looser could easily be via the U.S. dollar (Chart I-8). We have been selectively playing USD shorts, mostly via the SEK and the euro, as per our March 8th report. Today, we add the Norwegian krone to the list. Chart I-8Bond Yields Down, Dollar Next? Sell CAD/NOK The Norges Bank hiked interest rates to 1% at yesterday’s meeting, which was widely expected, but the hawkish shift took the market by surprise. Governor Øystein Olsen signaled further rate increases later this year, at a time when global central banks are turning dovish. This lit a fire under the Norwegian krone. The 6.60 level for the CAD/NOK has proven to be a formidable resistance since 2015.   The Norwegian economy remains closely tied to oil, with the bottom in oil prices in 2016 having jumpstarted employment growth, business confidence and wage growth. With inflation slightly above the central bank’s target and our expectation for oil prices to grind higher, we agree with the central bank’s assessment that the future path of interest rates is likely higher (Chart I-9). Chart I-9The Norwegian Economy Is Faring Well Our recommendation is that NOK long positions should initially be played via selling the CAD, as an indirect way to express USD shorts (Chart I-10). The 6.60 level for the CAD/NOK has proven to be a formidable resistance since 2015, and our intermediate-term indicators suggest the next move is likely lower. Meanwhile, relative economic surprises are moving in favor of Norway, with export growth, retail sales and employment growth all outpacing Canadian data. The discount between Western Canadian Select crude oil and Brent has closed, but our contention is that the delay in Enbridge’s Line 3 replacement will likely push the discount back closer to $20/bbl. Chart I-10Sell USD Via CAD/NOK Over the longer term, both the Canadian and Norwegian housing markets are bubbly, but in the latter it has been concentrated in Oslo, with Bergen and Trondheim having had more muted increases. In Canada, the rise in house prices could rotate to smaller cities, as macro-prudential measures implemented in Toronto and Vancouver nudge investors away from those markets (Chart I-11).  Chart I-11Bubbly Housing In Norway And Canada The Canadian government has decided to provide residents with a potential line of credit in exchange for equity stakes of up to 10% in residential homes. The maximum home value that qualifies for this line of credit has been capped at C$480,000. While this does little to improve the affordability of houses in expensive cities, it almost guarantees that those in competitive markets will be bid up. This will encourage a continued buildup of household leverage. Historically, when the leverage ratio for Canada peaked vis-à-vis the U.S., it was a negative development for the Canadian dollar (Chart I-12).   Chart I-12The CAD Looks Vulnerable Bottom Line: Go short CAD/NOK for a trade, but more aggressive investors should begin accumulating short positions versus the U.S. dollar outright. Hold USD/SEK shorts established a fortnight ago, currently 3% in the money. Housekeeping We are taking profits on our short AUD/CAD position this week, with a 1.4% profit. As highlighted in our March 8th report, the Australian dollar has been severely knocked down, and is becoming more and more immune to bad news. Despite home prices falling by more than 5% year-on-year, worse than during the financial crises, the Aussie was actually up on the week. Meanwhile, Australian exports will be at the top of the list to benefit from China’s reflationary efforts.   Chester Ntonifor,  Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Commodity & Energy Strategy Weekly Report, titled “OPEC 2.0: Oil’s Price Fulcrum,” dated March 21, 2019, available at ces.bcaresearch.com 2 Please see Foreign Exchange Strategy Special Report, titled “Into A Transition Phase,” dated March 8, 2019, available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 The recent data in the U.S. have shown more signs of a slowdown: February industrial production growth missed expectations, coming in at 0.1% month-on-month. Michigan consumer sentiment in March came in higher than expected at 97.8. NAHB housing market index in March came in at 62, below consensus. January factory orders slowed to 0.1% month-on-month.  Philadelphia Fed business outlook came in at 13.7, surprising to the upside. Initial jobless claims in March were 221k, also outperforming analysts’ forecast. The DXY index slumped by 0.8% post-FOMC, and is now slowly recovering on the strong data from the Philly Fed business outlook and initial jobless claims. The Fed left interest rates unchanged on Wednesday, while further signaling that no rate hike is likely through 2019. Moreover, 2019 GDP forecast was downgraded to 2%. The dovish turn by the Fed could weigh on the dollar in the coming weeks. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 The recent data in the euro zone have been mostly positive: February consumer price index came in line at 1.5% year-on-year; core consumer price index also stayed at 1% year-on-year. The seasonally-adjusted trade balance in January improved to 17 billion euros. Q4 labor cost fell to 2.3%. ZEW economic sentiment survey came in at -2.5 in March, outperforming the consensus of -18.7. EUR/USD increased by 0.5% this week. The FOMC-led sharp rebound sent EUR/USD to a new week-high of 1.145 on Wednesday. We expect more positive data coming from the euro zone, which will further lift the euro. Report Links: Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 Balance Of Payments Across The G10 - February 15, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have continued to soften: The merchandise trade balance came in at 339 billion yen in February. Total imports contracted by 6.7% year-on-year, while total exports fell by 1.2% year-on-year. Industrial production increased by 0.3% year-on-year in January. Capacity utilization in January fell by 4.7% month-on-month, missing expectations. The leading economic index in January fell to 95.9 from a previous reading of 97.2. USD/JPY slumped by 0.9% this week. Last Friday, the Bank of Japan left its key interest rate unchanged at -0.1%, as wildly expected. The 10-year government bond yield target also stayed unchanged at around 0%. Like many global central banks, the BoJ has been blindsided by the deep external slowdown that is beginning to seep into the domestic economy. Report Links: A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mostly positive: Average earnings excluding bonuses in January grew in line by 3.4%. ILO unemployment rate in January fell to 3.9%. The retail price index in February stayed in line at 2.5% year-on-year. The February consumer price index increased to 1.9% year-on-year. Retail sales growth in February increased to 4% year-on-year, outperforming expectations.  GBP/USD fell by 1.1% this week, erasing the gains triggered by dollar weakness earlier on Wednesday. The BoE left its interest rate unchanged at 0.75%, and the sterling continues to show more volatility with a delayed Brexit. Report Links: A Trader’s Guide To The Yen - March 15, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have shown the housing market is toppling over: The housing price index in Q4 fell sharply by 5.1% year-on-year. New jobs created in February were 4,600, missing the expectations by 9,400. Moreover, 7,300 full-time employment jobs were lost, while 11,900 positions were created for part-time employment. The unemployment rate in February fell to 4.9%, while the participation rate decreased to 65.6%. AUD/USD appreciated by 0.6% this week. It pulled back a little after reaching a 0.7168 high on Wednesday following the dovish Fed decision. During a speech this week, RBA highlighted the concerns over the ability of households to service their debt. Both external and internal constraints remain headwinds for the Australian dollar. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been weak: Credit card spending growth in February slowed to 6.4% year-on-year. Q4 GDP growth came in at 2.3% year-on-year, underperforming consensus of 2.5%. The current account deficit widened to 3.7% of GDP in Q4. NZD/USD appreciated by 0.5% this week. The Q4 GDP breakdown showed that growth was mainly driven by the rise in service industries. Primary industries, however, fell by 0.8%. Agriculture was down 1.3%, mining was down 1.7%, forestry and logging fell 1.6%, and lastly, the fishing activity was down 0.9% quarter-on-quarter. The Kiwi will benefit from any dollar weakness, but is not our preferred currency. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Updating Our Intermediate Timing Models - November 2, 2018 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada continue to paint a mixed picture: January manufacturing shipments increased to 1% month-on-month. Foreign portfolio investment in Canadian securities saw an increase of C$49 billion in January, while Canadian portfolio investment in foreign securities decreased by C$8.4 billion. January wholesale sales growth increased to 0.6% month on month. USD/CAD rebounded overnight after falling sharply on a dovish Fed. CAD finally ended the week flat. On Tuesday, Bill Morneau, the Finance Minister of Canada, unveiled the new federal budget for 2019. It showed several new measures aiming to assist young and senior Canadian citizens, including first-time home buyers. While these measures might appease Canadian millennial voters, they will also result in significant deficits. The deficit projection for the year 2019-2020 widened to $19.8 billion, which could crowd out private spending. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 The trade balance in February came above expectations at 3,125 million CHF. Exports came in at 19,815 million CHF, while imports came in at 16,689 million CHF, respectively. USD/CHF depreciated by 1% this week. The Swiss National Bank left the benchmark sight deposit rate unchanged at -0.75%, as wildly expected. We struggle to see any upside potential for the franc, amid a dovish central bank, an expensive currency and muted inflation. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Waiting For A Real Deal - December 7, 2018 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway has been positive. The trade balance in February fell to 15.8 billion NOK, from a previous reading of 28.8 billion NOK. USD/NOK fell by 1.3% this week. The Norges Bank raised rates by 25 bps to 1%, in line with expectations, while signaling further rate hikes in the second half of this year. The Norges Bank once again demonstrated to be the most hawkish among G10 members. The bank reiterated that the economy is running at a solid pace and capacity utilization is above normal levels, while inflation keeps navigating above the bank’s target. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 There has been no major data release from Sweden this week. USD/SEK fell by 1.5% this week. Our short USD/SEK position is now 3% in the money since we initiated it 2 weeks ago. As we see more signs of recovery in the euro zone, we expect the exports of Sweden to pick up, which is a tailwind for the Swedish krona. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights Every diversified currency portfolio should hold the yen as insurance against rising market volatility. However, for tactical investors, the latest dovish shift by global central banks almost guarantees the Bank of Japan will err on the side of stronger stimulus (explicitly or indirectly). Our bias is that USD/JPY could trade sideways in the next three to six months, but EUR/JPY could test 132 by year-end. Carefully monitor any shift in yen behavior in the coming months, in particular its role as a counter-cyclical currency. Investors who need to hedge out sterling volatility should favor GBP calls. Hold onto the USD/SEK shorts established last week, currently 1.6% in the money. USD/NOK shorts are looking increasingly attractive, as will be discussed in next week’s report. Feature The yen has proven an extremely tough currency to forecast in the last few years. Carry-trade investors who used widening interest rate differentials between the U.S. and Japan in 2018 to forecast yen weakness got decimated in the February and March 2018 equity drawdowns. More agile investors who timed the global equity market bottom in early 2016 have been shifted to the wayside on yen shorts, as the currency has strengthened since then. For value-based investors, the yen that was 14% cheap on a fundamental basis in 2015 is 19% cheaper vis-à-vis fair value today. Seasoned investors recognize the need to pay heed to correlation shifts, as they can make or break forecasts. In the currency world, the most recent have been dollar weakness after the Federal Reserve first tightened policy in December 2016, dollar weakness in 2017 despite four Fed rate hikes and more recently, yen resilience despite the equity market rally since 2016. In this report, we revisit traditional yen relationships to identify which have been broken down, and which still stand the test of time. Trading Rules A rule of thumb still holds true for yen investors: buy the currency on any equity market turbulence (Chart I-1). In of itself, this advice is not sufficient. If one could perfectly time equity market corrections, being long the yen will be low on a long list of alpha-generating ideas. Chart I-1The Yen Is A Risk-Off Currency The power of the signal comes when macroeconomic conditions, valuations and investor sentiment all align in a unifying message. Back in late 2016, global growth was soft, the yen was very cheap and everyone was short the currency on the back of a dovish shift by the Bank of Japan (BoJ). Having recently introduced yield curve control (YCC), the market was grappling with the dovish implications for the currency, arguably the most significant change in monetary policy by any central bank over the last several years. In retrospect, this was the holy grail for any contrarian investor. Given that backdrop, the yen strengthened by circa 10% from December 2016 to mid-2017, even as equity markets remained resilient. When the equity market drawdown finally arrived in early 2018, it carried the final legs for the yen rally. This backdrop underlines the golden rule for trading the yen, primarily as a safe-haven currency. Economically, the net international investment position of Japan is almost 60% of GDP, one of the largest in the world. On a yearly basis, Japan receives almost 4% of GDP as income receipts, which more than offsets the trade deficit it has been running since the middle of last year (Chart I-2). It is therefore easy to see why any volatility in markets could lead to powerful repatriation flows back to Japan. Chart I-2Japan's Income Receipts Are Quite Large One other factor to consider is that during bull markets, countries that have negative interest rates are subject to powerful outflows from carry trades. The impact of these are difficult to measure, but it is fair to assume that periods of low hedging costs (which tend to correspond to periods of lower volatility) can be powerful catalysts. As markets get volatile and these trades get unwound, unhedged trades become victim to short-covering flows (Chart I-3). Chart I-3Hedging Costs Have Risen The global picture today has some echoes from 2016. Growth is slowing everywhere and markets have staged a powerful bounce from the December lows. This has been in anticipation of a better second half of this year. In the occasion that data disappointments persist beyond the first half, especially out of China, stocks will remain in a “dead zone,” which will be potent fuel for the yen. This is not our baseline scenario, as we expect growth to bottom in the second half of this year, but it remains an important alternative to consider at a time when Japanese growth is surprising to the downside. If the BoJ is preemptive and eases monetary policy, the yen will weaken. But the odds are highly in favor of the yen strengthening before. Bottom Line: Every diversified currency portfolio should hold the yen as insurance against rising market volatility. The BoJ’s Next Move By definition, any data dependent central bank will be behind the curve, but the incentive for the BoJ to act preemptively this time around is getting stronger. The starting point is that history suggests the consumption tax hike, scheduled for October this year, will be disastrous for the economy. Since the late 1990s, every time the consumption taxed has been hiked, the economy has slumped by an average of over 1.3% in subsequent quarters. For an economy with a potential growth rate of just 0.5%-1%, this is a highly unpalatable outcome (Chart I-4). More importantly, similar to past episodes, the consumption tax is being hiked at a time when the economy is slowing, with growth in the third quarter of last year clocking in at -2.4%. Chart I-4The Consumption Tax Hike Will Be Negative However, things are not that simple for the Japanese Prime Minister Shinzo Abe’s administration. Despite relatively robust economic conditions since the Fukushima disaster, consumption has remained tepid, even though there has been tremendous improvement in labor market conditions. By the same token, the savings ratio for workers has surged (Chart I-5). If consumers are caught in a Ricardian equivalence negative feedback loop,1 exiting deflation becomes a pipe dream for the central bank. Chart I-5Strong Labor Market, Weak Consumption The good news is that the government realizes this and has been taking steps to remedy the situation. At the margin, this is positive: The Japanese government recently passed a law that will allow the largest inflow of foreign workers into the country. There are about 1.5 million foreign workers in Japan today, who collectively constitute circa 2% of the labor force. The importance of foreign labor cannot be understated. Due to Japan’s demographic cliff, foreign workers were responsible for 30% of all new jobs filled in 2017. Assuming public aversion towards immigration remains benign, as is the case now (these are mostly lower-paying jobs in sectors with severe labor shortages), the government’s target to attract 350,000+ new workers by 2025 will go a long way in alleviating the country’s chronic labor shortage. This will also be marginally beneficial for consumption. Abe’s government hopes to offset the consumption tax hike with increased social security spending, especially on child education. For example, preschool and tertiary education will be made free of charge, financed by the tax hike. Labor reform has gone a long way to increase the participation ratio of women in the labor force (Chart I-6), but the reality is that almost 50% of single mothers in Japan still live below the poverty line, according to the BoJ. This is because many of them remain temporary workers. Temporary workers receive about half the pay of full-time workers’ and are not privy to most social security benefits. This has contributed to the surge in the worker’s savings ratio. Alleviating this source of uncertainty could help solve the consumption problem. Chart I-6Rising Female Participation In The Labor Force Transactions made via cashless payments (for example, via mobile pay) will not be subject to the 2% tax increase for nine months. Cashless payments in Japan account for less than 25% of overall transactions – among the lowest of developed economies. Increasing the share of cashless payments will help lift the velocity of money, which will be a positive development for the BoJ (Chart I-7). Chart I-7Money Velocity Is Still Falling Finally, the Phillip’s curve appears to be finally working in Japan, with wages accelerating at a 1.4% pace. Provided the government continues to indirectly put pressure on big firms to raise wages by at least 2-3% in upcoming Shunto wage negotiations, this trend should continue. An extended period of rising wages will help shift the adaptive mindset of Japanese households away from deflation (Chart I-8). Chart I-8Rising Wages Will Help At The Margin The BoJ pays attention to three main variables when looking at inflation: Core CPI prices, the GDP deflator and the output gap, in addition to other measures. The recent slowdown in the economy has tipped two of those indicators in the wrong direction (Chart I-9). This makes it difficult for the Abe administration to declare victory over deflation – something he plans to do before his term expires by September 2021. Chart I-9Inflation Variables Are Softening The perfect cocktail for the Japanese economy will be expansionary monetary and fiscal policy. But despite government efforts to offset the consumption tax hike with higher spending, the IMF still projects the fiscal drag in Japan to be 0.7% of GDP in 2019. This puts the onus on the BoJ to ease financial conditions. At minimum, this suggests that either the stealth tapering of asset purchases by the BoJ could reverse and/or new stimulus could be announced. Bottom Line: The swap markets are currently pricing some form of policy easing in Japan over the next 12 months. Ditto for Japanese banks (Chart I-10A and Chart 10B). Given the recent dovish shift by global central banks, the probability of a move by the BoJ has risen. Any surprise move will initially strengthen USD/JPY. However, given the probability that the dollar weakens in the second half of this year, our bias will be to fade this move. Portfolio investors can use this as an opportunity to buy insurance, should markets become turbulent in the next few months. Chart I-10AThe Market Is Pricing In A Dovish BoJ (1) Chart I-10BThe Market Is Pricing In A Dovish BoJ (2) Corporate Governance, Profits And The Equity/Yen Correlation Once global growth eventually bottoms, inflows into Japan could accelerate, given cheap equity valuations and improved corporate governance that has been raising the relative return on capital (Chart I-11). Depending on whether investors choose to hedge these inflows or not, this will dictate the yen’s path. At present, the cost of hedging does not justify sterilizing portfolio flows (see Chart I-3). Chart I-11Corporate Governance Could Lift Return On Capital The traditional negative relationship between the yen and the Nikkei still holds (Chart I-12). Weakening global growth is negative for the export-dependent Nikkei, and positive for the yen. This is because weakening global growth dips Japanese inflation expectations, and leads to higher real rates. This tends to lift the cost of capital for Japanese firms. Chart I-12The Yen/Equity Correlation Could Shift That said, another factor has been at play. Over the past few years, an offshoring of industrial production has been eroding the benefit of a weak yen/strong Nikkei. In a nutshell, if company labor costs are no longer incurred in yen, then the translation effect for profits is minimized on currency weakness. Investors will need to monitor the equity market/yen correlation over the next few years. It remains deeply negative, but could easily shift, dampening the yen’s counter-cyclical nature. Back in the 80s and 90s, the yen did shift into a pro-cyclical currency. Bottom Line: A dovish shift is increasingly likely by the BoJ. Meanwhile, our bias remains that if markets rebound in the second half of this year, this will be marginally negative for JPY. This could also put EUR/JPY near 132 by year end. A Few Notes On The Pound Recent market developments have become incrementally bullish for sterling. After Tuesday’s second defeat for Prime Minister Theresa May's Brexit deal, and again Wednesday’s rejection of a no-deal Brexit by 312 votes to 308, the probability is rising that the U.K. will either forge a deal for a more orderly separation with the EU or hold a new referendum altogether. Tuesday’s loss was expected because the EU had not offered a viable compromise to the Irish backstop - a deal that will keep Northern Ireland in the EU customs union beyond the transition date of December 2020. Meanwhile, Wednesday’s vote to leave the union sans arrangement was simply unpalatable for Parliament, given economics 101. Almost 50% of U.K. exports go to the E.U. A no-deal Brexit at a time when global exports are in a soft patch, and with much higher tariffs, was a no go for the majority.2 Complete sovereignty of a nation is and has always been a desirable fundamental right. For the average U.K. voter that has not benefited much from globalization, the risk was that Parliament repeatedly failed to pass a motion asking for an extension to the March 29 deadline. As we go to press, this risk has faded as MPs have voted 412 to 202 for a delay. An extension will likely be granted till the May 23-26 EU elections. The preference for an extension has been echoed by EU Commissioner President Jean-Claude Junker, Chief Negotiator Michel Barnier and Dutch Prime Minister Mark Rutte, all heavyweights in this imbroglio. For sterling investors, what is clear is that developments over the next few weeks will be volatile, but increasingly bullish. Admittedly, GBP has already rallied from its December lows. But long-term GBP calls still remain cheap, despite rising volatility (Chart I-13). Our fundamental models also suggest cable is cheap relative to its long-term fair value and it will be tough to the pound to depreciate if the dollar weakens in the second half of this year (Chart I-14). Chart I-13GBP Calls Are Cheap Chart I-14The Pound Is Cheap Bottom Line: The probability of a no-deal Brexit has fallen. Going forward, risk reversals suggest sterling calls remain relatively cheap to puts. Investors who need to hedge out any sterling volatility should therefore favor GBP calls. Housekeeping Our short AUD/NZD position hit its target of 1.036 this week. We are closing this trade for a 7% profit. As highlighted in last week’s report,3 a lot of bad news is already priced into the Australian dollar, which is down 37% from its 2011 peak. Outright short AUD bets are therefore at risk from either upside surprises in global growth, or simply the forces of mean reversion.   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Ricardian equivalence suggests in simple terms that public sector dissaving will encourage private sector savings. 2 Please see Geopolitical Strategy Weekly Report, titled “The Witches’ Brew Keeps Bubbling…,” dated March 13, 2019, available at gps.bcaresearch.com 3 Please see Foreign Exchange Strategy Weekly Report, titled “Into A Transition Phase,” dated March 8, 2019, available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Data in the U.S. continue to soften: The nonfarm payrolls came in at 20k in February, missing the forecast by 160k. Core consumer prices in February decelerated to a 2.1% year-on-year growth. Nonetheless, February average hourly earnings increased 3.4% year-on-year. Moreover, the unemployment rate in February fell to 3.8%. Lastly, retail sales in January grew at 0.2% month-on-month, outperforming expectations. The DXY index depreciated by 0.7% this week. The U.S. economy keeps growing above trend, but at a slower pace than last year. During the 60 minutes interview with CBS last weekend, Federal Reserve Chair Jerome Powell emphasized that while it is difficult for the economy to keep growing near 4% every year, it remains very healthy and any near-term recession is unlikely. We favor underweighting the dollar as we enter into a transition phase, where non-U.S. growth outperforms. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been promising: German factory orders in January came in at -3.9% year-on-year, improving from the last reading of -4.5%. The euro area industrial production month-on-month growth came in at 1.4% in January, outperforming expectations. In France, the Q4 nonfarm payrolls increased to 0.2% quarter-on-quarter, double the forecast. German consumer prices stayed at 1.7% year-on-year in February. EUR/USD appreciated by 1.2% this week. We favor overweighting the euro as easing financial conditions put a floor under growth. Report Links: Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 Balance Of Payments Across The G10 - February 15, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: M2 money supply missed expectations in February, coming in at 2.4%. Besides, machine tool orders fell by -29.3% year-on-year in February. Total machinery orders were also weak in January, coming in at -2.9% on a year-on-year basis. Lastly, foreign investment in Japanese stocks was -1.2 trillion yen, while investment in Japanese bonds fell to 245.7 billion yen. USD/JPY has been flat this week. A dovish move by the BoJ is likely and it could further cheapen the yen. If global growth bottoms in the later half of this year, this will be bad news for the yen, given its counter-cyclical nature. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Yen Fireworks - January 4, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mostly positive: In January, industrial production and manufacturing production both outperformed expectations, with industrial production coming in at -0.9% year-on-year and manufacturing production coming in at -1.1% year-on-year. GDP growth in January came in at 0.5% month-on-month, higher than expectations. GBP/USD appreciated by 1.1% this week. Cable rallied after the parliament vote on Wednesday. The sentiment remains positive since chances of a no-deal Brexit have diminished. We recommend long-term call options on cable to capture any upside potential. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Deadlock In Westminster - January 18, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia continue to deteriorate: Home loan growth in January contracted to -2.6%. The National Australian Bank business confidence index fell to 2 in February, while the business conditions index fell to 4. Consumer confidence in March decreased to -4.8%. AUD/USD moved up by 0.4% this week. The housing market and overall economy continue to weaken in Australia. However, the Australian dollar is at a 10-year low suggesting much of the bad news is priced in. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been negative: Electronic card retail sales came in at 3.4% yoy, slightly lower than the previous reading of 3.5%. Food price index in February fell to 0.4% month-on-month. NZD/USD increased by 0.9% this week. We remain underweight NZD/USD, on overvaluation grounds. We are also closing our short AUD/NZD position for a 7% profit. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Updating Our Intermediate Timing Models - November 2, 2018 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have confirmed robust labor market conditions: The unemployment rate in February came in line at 5.8% while the participation rate increased to 65.8%. New jobs created in February were 55.9k, the strongest since 1981, beating analysts’ forecasts of zero job creation. February average hourly wage growth also increased to 2.25% year-on-year. However, housing starts in February fell to 173.1k, underperforming expectations. USD/CAD fell by 0.6% this week. The Canadian economy, especially the housing sector continues to show signs of weakness, despite a strong labor market. The risk is that overvaluation in the housing market and elevated debt levels impair consumer spending power. While the rising oil price helps, we think the benefits are more marginal than in the past. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland has been negative: Producer and import price growth in February fell to -0.7% year-on-year. EUR/CHF appreciated by 0.3% this week. Our long EUR/CHF trade is now 0.5% in the money since initiated on December 7, 2018. We continue to favor the euro versus the swiss franc as the later benefits less from a bottoming in global growth. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Waiting For A Real Deal - December 7, 2018 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been mostly positive: Overall consumer price inflation in February fell to 3% year-on-year; however, core inflation increased to 2.6% yoy. Producer prices also increased by 8% year-on-year in February. USD/NOK depreciated by 1.8% this week. Our long NOK/SEK trade is 2.8% in the money over two months. We continue to overweight NOK due to the cheap valuations and rising oil prices. The pickup in inflation also allows the Norges bank to become incrementally hawkish. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been disappointing: In February, consumer price inflation fell to 1.9% yoy. The unemployment rate climbed to 6.6% in February. USD/SEK depreciated by 1.5% this week, mainly due to the recent weakness in the dollar. We remain positive on the SEK versus USD based on an expected pickup in the Swedish economy and cheap valuations. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades