Forex Institutional Research: Barclays Capital FX Thoughts
Key quotes from the Barclays Capital FX report:
Barclays Capital FX Thoughts ‘When the tide turns’
A more benign Fed hiking path, stable China data and rising commodity prices have all helped alleviate early year market concerns, providing support for high yielding EM currencies (Figure 1). Those tailwinds appear to be fading, however. Shaky EM fundamentals have once again resurfaced after a prolonged period of benign risk sentiment. With flows into EM showing signs of fatigue (see Asia FX: Beware of slowing flows, 5 May 2016 and EM flows: The risks below the surface, 6 May 2016 and Figure 2), any negative developments could have a much larger effect now than they would have had a few weeks ago (EM Weekly: On shaky ground, 5 May 2016). Moreover, seasonality will likely prove a serious headwind for EM FX in coming weeks, in our view (Figure 3).
We think a resurgence of concerns about China could be such a negative catalyst. Indeed, China’s macro data will take centre stage this week with implications for global risk sentiment, the Antipodeans and EM Asian currencies. We expect China’s data to confirm activity moderation in April, in line with the signals from the manufacturing and services PMI reports. China’s exports growth will likely moderate, and we think money supply and new loans will similarly slow after a sharp rise in March. Markets expect April industrial production to soften as well (Saturday).
As a result, we see scope for further USD gains versus high beta currencies and the EM complex, despite mixed signals from US data recently. A softer-than-expected US labour market report last week led us to revise our Fed call. We now expect one hike in September, with risks skewed towards an additional hike in December should the economy improve along the lines of our baseline forecast (April US employment report puts June rate hike off the table, 6 May 2016). The focus this week will turn to retail sales (Friday) for a gauge of the health of the US consumer. Yet, with EM shaky fundamentals resurfacing, USD long positioning significantly reduced and markets still far from pricing a full rate hike this year, we see scope for modest USD gains concentrated against the high-beta EM complex, with most susceptible to a re-emergence of China growth concerns.
Elsewhere, Thursday’s BoE Inflation Report is important for GBP but may deliver mixed signals as the Bank likely will revise lower its domestic and international growth forecasts, largely reflecting recent weakness, but will leave CPI inflation forecasts unchanged. Indeed, we continue to believe the Bank will forecast above-target inflation in 2018/19 and ascribe a high probability of overshoot, usually a signal of discomfort with too-dovish interest rate market pricing, which currently implies a 40% chance of a 25bp cut in the next six months but also reflects the Bank’s “remain” view and a likely rebound in growth following the 23 June EU referendum as UK uncertainty dissipates
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