Forex Institutional Research: Morgan Stanley FX Daily
Key quotes from the Morgan Stanley FX report:
The better risk outlook: The news flow has remained risk-friendly, seeing EM markets trading higher for the fifth post-Brexit day. Commodities have continued to move higher, with silver gaining more than 16% over the course of the past week. Silver combines precious metal and industrial aspects. It does best when investors expect inflation to move higher due to increasing economic activity. In this sense rising silver prices stand into contrast with the US 5Y/5Y inflation swap, which has fallen back over the past couple of days, now trading at 1.86%, only marginally higher than the 1.79% February low. The simultaneous rally of bonds, equities and other risky assets suggests that this advance is entirely driven by liquidity, suggesting markets will remain supported as long as central banks leave the impression that there will be more liquidity adds coming. The SPX offers strong resistance near 2125. Should its current bullish momentum break this level, then the equity market could rally by another 8-10%, signalling further EM and commodity FX strength.
BoE and fiscal support: Tomorrow all eyes will be on the release of the BoE’s BoE’s Financial Stability Report Financial Stability Report and the subsequent press conference by Mark Carney. The press have already announced that the FPC will lower the countercyclical capital buffer and likely reiterate that liquidity will be provided to the banks. The question is whether Carney could mention anything more about the timing of further monetary easing measures. The market has already priced in a full rate cut by August so for GBP to weaken this week, Carney needs to provide more guidance on the size of the rate cut or potential QE extension (which we don’t expect until the July meeting we don’t expect until the July meeting). Support is also provided by the government fiscal side. It is becoming increasingly clear that the UK political authorities are trying to tackle Brexit with rigid supply-oriented policies. This is why Chancellor Osborne suggested bringing the corporate tax rate down to 15%, taking its closer to the very competitive 12.5% rate applied in Ireland. Lower corporate taxes may reduce the damage Brexit may otherwise have on FDI and domestic investment activities.
Fed minutes from its June meeting June meeting will be due on Wednesday. The Fed should err on the side of caution, particularly with its views ahead of the Brexit vote and the weak 38k payrolls. Last year, US NFP rose by a healthy 229k monthly average. Some hiring slowdown should be expected as the labour market hits full employment, but for the market to regain confidence that the US economy is in good shape, this Friday’s NFP this Friday’s NFP may have to beat the consensus 166k while simultaneously showing that wage growth has accelerated further from its last 2.5% reading. A more moderate report will likely see USD staying offered. Signs of further USD weakness would be triggered by EURUSD breaking 1.1190, opening upside potential to 1.1420, and USDJPY failing to break the 103.60 chart mark.
Australia politics: Australia’s general election Australia’s general election seems to have produced a hung parliament, suggesting a minority government for the first time since 1940. The Senate looks even more fragmented, with non-major parties likely to win a record 25% of the 76 seats. This includes a noticeable, although still contained, swing towards nationalist/populist parties. We should see the final lower-house vote count through midweek, then a minority government agreed over the next week (or two, perhaps). At this stage we think there is a higher probability of the incumbent Liberal-National Coalition (LNC) forming a government, but the election has revealed deep divisions within the LNC, and the difficulty working with this Senate raises the probability of another early election. Despite this morning’s release of the June inflation gauge seeing a 0.6%M rise coming on the back of a 0.2%M decline in May, we see more pressure on the RBA to cut rates in August. Fiscal policy and reforms are likely constrained by the weak electoral position, and chances of a rating downgrade reducing fiscal flexibility suggest an easing bias to come in the statement accompanying tomorrow’s meeting for July tomorrow’s meeting for July, and we also see a higher probability of an immediate cut than the 8% currently priced in, which should leave AUD offered.
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