Agenda
Page
4 January 2016
GLOBAL FIXED INCOME MARKETS 2017 OUTLOOK
2017 FX Outlook: Making the dollar good but not great again
Paul Meggyesi Managing Director, Global FX Strategy (44-20) 7134-2714 [email protected] J.P. Morgan Securities plc
See the end pages of this presentation for analyst certification and important disclosures.
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What happens to markets if and when America’s made great again Global macro themes and strategy for 2017
1) US fiscal/monetary policy mix
Strategy: USD longs vs Asia (CNY, KRW and TWD) and EMEA (TRY and PLN)
2) US trade protectionism advances from threat to reality
Strategy: short CAD vs NOK, short AUD vs JP via 3m-6m calendar spread of one-touch puts, long USD/CNH 3m seagull, long JPY/KRW vs USD/JPY straddles (6m)
3) Limits to unconventional policy (Bunds keep pace with UST)
Strategy: long European FX vs USD bloc (long NOK vs CAD and long SEK vs NZD). Stay short EUR/CZK and EUR/CHF
4) Populism bends but doesn't break EMU
Strategy: short EUR/CHF, long EUR/USD straddles (1Y)
5) Oil achieves a higher range up to $60/bbl
Strategy: long NOK vs EUR and CAD in cash
6) Valuation
Strategy: long SEK vs NZD via 6m put
7) Carry
Strategy: long ARS vs USD (projected 10% total return over 1Y)
Idiosyncratic themes by market for 2017
EUR/USD and European government bonds: H1 populism, H2 tapering. EUR/USD 2Q 1.06, 4Q 1.15
JPY: BoJ inaction, but Q4 anxiety before Kuroda’s term ends in April 2018. USD/JPY 2Q 105, 4Q 99
GBP: Brexit likely sticks to the hard road and growth slows due to high inflation and tighter fiscal policy. EUR/GBP 2Q 0.89, 4Q 0.91
SEK: An end to the four-year downtrend as there’s an excessive risk premium for an inflation-centric Riksbank. EUR/SEK to 9.65-9.45
NOK: EUR/NOK to 8.60 as oil hits $60 and double-digit house price inflation warrants higher rates before mid-2019.
CHF and CZK: tapering/abandonment of FX intervention. EUR/CHF to 1.03; EUR/CZK to 26.0.
AUD and NZD: rate convergence/crossover on below-target inflation. NZD succumbs to valuation as carry flows no longer fund the c/a deficit. AUD/USD Q1 0.71, 2Q 0.68. NZD/USD 2Q 0.64, 4Q 0.62
CAD: Largest c/a deficit in nearly 2-decades; BoC downbeat on potential growth. USD/CAD 2Q 1.43, 4Q 1.41
TRY: political/policymaking uncertainty. USD/TRY 4Q 4.26
CNY: managed depreciation. 2Q 7.20, 4Q 7.10
KRW: political uncertainty, the QE debate and investment diversification. USD/KRW 4Q 1210
ARS and BRL: policy reform and a return to growth
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Currencies one year after the Fed’s first hike
Source: J.P. Morgan
As occurred after first Fed hikes of ‘83, ‘94 & ‘99 cycles, USD paused then made new highs JPM USD Index two years before and after first Fed hike for cycles that began in 1983, 1986, 1994, 1999, 2004 and 2015.
Almost one year after the Fed’s first hike in December 2015, the trade-weighted dollar is repeating the pattern of previous bull markets driven by Fed cycles in 1983, 1994 and 1999. In early 2016 the dollar retraced lower soon after the first Fed hike on a combination of Fed dovishness and positive non-US developments (slower supply growth in oil, China fiscal stimulus). The dollar began to regain momentum even before Trump’s election as a strengthening US economy and rising inflation forced another rethink on Fed policy. Trump’s victory has lifted the USD index by 6%. USD index is +42% from 2011 low. The early 1980’s Reagan-rally was +60%
The FX market was not entirely USD-centric last year - local factors resulted in a marked differentiation in performance 2016 change in local ccy vs USD
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-525 -450 -375 -300 -225 -150 -75 0 75 150 225 300 375 450 525business days around first Fed hike
2004
1983
1986
1994
1999
2015 Fed cycle
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ARS
TRY
GBP
MXN
SEK
CNY
PLN
EUR
CZK
RON
DKK
MYR
INR
CHF
HUF
SGD
KRW
AUD
THB
JPY ILS TWD
NZD
NOK
IDR
CAD
CLP
ZAR
RUB
BRL
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1. US fiscal policy becomes expansive, but only moderately
Source: J.P. Morgan
Republican Presidents do not have a record of more fiscal discipline than Democrats Average budget balance and real GDP growth during President's term(s)
Trump makes delivering the Fed dots more likely End 2016, 2017 and 2018 OIS rates versus FOMC projections
-1.0%
-2.9%-1.9%
-3.8% -3.7%
-0.9%-1.8%
-5.8%
-2.6% -2.8%
2.9% 2.9%3.8% 3.7%
2.2%
3.8%
1.8% 1.7%2.7% 3.1%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
Nixo
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Ford
Carte
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Reag
an
Bush
I
Clint
on
Bush
II
Obam
a
Rep
avg
Dem
avg
fiscal balance
real GDP growth
JPM Economics expects total household and corporate tax cuts worth $200bn. This should lift the level of GDP by 0.4-0.5% by end-2018 assuming an average fiscal multiplier of close to 0.5. Spending increases are too slow to impact the 2017 forecast ($150bn over 5 years equates to around 0.1% of GDP per annum).
Outside of the US, we expect few meaningful changes to fiscal thrust. Only Japan’s fiscal setting becomes expansionary while the UK’s become less restrictive. China’s should be neutral after 2016’s boost. There are slim odds of fiscal easing in the Euro area, even in Germany post-election.
US GDP to accelerate from 1.5% to 1.9%. The Euro area is broadly steady at 1.5%. China to 6.5% vs 6.7%.
1.45%
1.01%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Dec-12 Jun-13 Jan-14 Jul-14 Feb-15 Sep-15 Mar-16 Oct-16
Dec 18 OIS Dec 18 FedDec 17 OIS Dec 17 FedDec 16 OIS Dec 16 Fed
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If fiscal policy ratifies Fed through 2018, USD has 5% upside
Source: J.P. Morgan
Trump's fiscal ambitions worth about 2% if they make the 2017 dots credible and another 3% on 2018 dots JPM USD Index (ticker JBDNUSD) versus trade-weighted 2-yr spreads between the US and rest of the world
A 3% terminal funds rate would imply 10% cumulative additional USD appreciation USD index appreciation implied by USD OIS rates converging to the Fed dots
The Fed's rate projections envisage three hikes this year and a cumulative 150bp by end-2018. The OIS curve prices two hikes and 100bp. The USD index would rally another 2% if the 2017 dots were priced and 5% in total if the 2018 dots were to be priced. A terminal funds rate of 3% would lift the dollar index by a cumulative 10%.
The USD-bearish wildcard is protectionism that stalls the economy/Fed hikes. The USD-bullish wildcard is comprehensive corporate tax reform that reverses 15 years of long-term capital outflows. Corporate profits repatriation is an overhyped issue since much of this cash already sits in USD (see US elections and corporate profits repatriation from Aug 25, 2016).
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133
Jan 13 Jan 14 Jan 15 Jan 16 Jan 17
JPM USD indextrade-weighted US 2-yr rates minus ROW (majors), bp
+5% if 2018 dots credible+2% if 2017 dots credible
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4
6
8
10
12
Dec-17 Dec-18 Dec-19 Long-term
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Much – but maybe not enough – has changed since the 2013 tantrum
Source: J.P. Morgan
Sensitivity of EM portfolio flows to US rates has not diminished, despite the likelihood of a historically low terminal Fed rate this cycle US 2-yr yields (rolling 3-mo change, basis points) versus EM stock and bond flows (3-mo sum, $ billions)
Relative to 2016, JPM's expects stronger 2017 growth for US, Japan, Canada, Brazil, Russia, Hungary, Peru & Chile Real GDP growth year-on-year as latest value, 2016 forecast and 10-yr average
EM portfolio flows continue to move inversely with rethinks on Fed policy. This sensitivity may surprise some who think that most of the macro and financial imbalances that hobbled non-USD currencies during first phase of the Fed cycle had abated. But while much has changed over the past three years in some countries, perhaps not enough has in all countries.
On growth, JPM's expects stronger 2017 performance relative to 2016 only for US, Japan, Canada, Brazil, Russia, Hungary, Peru & Chile.
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Jan-12 Oct-12 Jul-13 Apr-14 Jan-15 Oct-15 Jul-16
US 2-yr, 3-mo change, bp (lhs)
EM portfolio flows, 3-mo sum, $bn (rhs)
-5.0%
-2.5%
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2.5%
5.0%
7.5%
10.0%
India
Philip
pines
China
Indon
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Roma
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laysia
Turke
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Euro
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Chile
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Switz
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Japa
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South
Afric
aTa
iwan
Russ
iaBr
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latest value 10-yr avg JPM 2017 forecast
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Current accounts and real rate differentials: better for many but not all
Source: J.P. Morgan
Eight countries have current account deficits 3% of GDP, down from 12 pre-tantrum CA as % of GDP; latest value (square) versus pre-tantrum level (circle)
Real rate spreads up for BRL, IDR, INR, ZAR, MXN & RUB Difference in real policy rates (policy rates deflated by core inflation) between the US and other country
On current account deficits, for example, eight countries still post deficits of more than 3% of GDP (Colombia, UK, Turkey, Australia, Canada, Mexico, South Africa, New Zealand), down from 12 countries pre-tantrum.
On real interest rate differentials to the US, spreads have only widened for six countries (BRL, IDR, INR, ZAR, MXN and RUB), while they have compressed for most others.
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12%
15%
COP
GBP
TRY
AUD
CAD
MXN ZA
RNZ
DUS
DAR
SCL
PID
RBR
LIN
RPL
NPH
PCZ
KM
YR CNY
RUB
EUR
JPY
ILS
SEK
KRW
HUF
NOK
CHF
THB
latest value Q1 2013 10-yr avg+3% surplus
-3% deficit
-2%-1%0%1%2%3%4%5%6%7%8%9%
NOK
TRY
CAD
GBP
SEK
CZK
EUR
CHF
HUF
AUD
KRW
JPY
CLP
MYR PH
PTH
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XN NZD
CNY
RUB
IDR
INR
BRL
latest value pre-taper tantrum
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Keeping it real: what distinguishes Reagan’s Dollar from Trump’s
Source: J.P. Morgan
Some high-yielders still trade above their long-term average Deviation of JPM real effective exchange rate (PPI-based) from long-term average; latest value (blue square) versus pre-tantrum level (red circle)
Real interest rates rose over 1000bp under Reagan, but only 35bp so far under Trump US real 10-yr yields (TIPS since 1997, nominal less CPI before) versus JPM USD real effective exchange rate
Valuations have clearly improved, however: eight countries real exchange rates trade more than 10% above their long-term average down from 14 pre-tantrum.
The USD-bullish wildcard is that real interest rates rise significantly, either because Fed tightening proceeds more quickly than even the dots or than realised inflation. It seems inconceivable that a Yellen Fed – or the Fed of her successor from February 2018 – would respond to fiscal easing with the Volcker-like moves that creates the highest real rates and strongest dollar in history. But this interplay between fiscal and monetary policy will be central to the dollar outlook throughout this Administration (see Four common but tough questions since Trump's election Nov 11, 2016).
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IDR
BRL
NZD
THB ILS USD
RON
RUB
AUD
CHF
CNY
INR
NOK
CZK
PEN
CAD
TRY
KRW
PLN
EUR
HUF
CLP
MYR
PHP
SGD
SEK
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TWD
GBP
COP
JPY
MXN
latest valueQ1 2013 (pre-taper tantrum)
10% above average
10% below average
-8-6-4-202468
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73 77 81 85 89 93 97 01 05 09 13 17
US 10-yr real yield (TIPS since 1998), %JPM USD real effective exchange rate (CPI-based)
Reaganomics
Trumpanomics
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2. US trade protectionism advances from threat to reality
Source: J.P. Morgan, US National Archives
Since Candidate Trump swept almost every Rust Belt state on the road to Washington, President Trump is incentivised to make trade conflict becomes part of the policy fabric. Conflict need not involve the extreme campaign pledges to impose 45% tariffs on Chinese imports and to withdraw from NAFTA. The President enjoys a spectrum of measures including: labelling a country to currency manipulator; imposing countervailing duties on narrow to broad ranges of goods; renegotiating aspects of a trade accord; and withdrawing from a trade agreement; and withdrawing from the WTO Except for MXN’s extremely cheap real exchange rate, most currencies do not exhibit a meaningful risk premium for trade conflict in 2017. See Yes, Mr. (Madam) President: US elections, executive orders and markets from October 3, 2016 and Trump and trade policy: the menu of options from Nov 11, 2016.
Number of executive orders issued by President
Number of EOs issued by subject over past 20 years
1803
522
1203968
3721
907484
214 325 346 169 320 381166
364 291 252
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ilson
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Bush
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Obama Bush ClintonTrade 6 3 14Immigration 0 2 3Terrorism 1 6 0Defense 5 16 15US Treasury* 22 2 0Energy 3 5 5China 0 0 1Japan 0 0 1Russia 2 0 1Ukraine 4 0 0Syria 4 3 0Libya 2 0 0Iran 9 0 3Iraq 2 7 0Balkans** 1 2 15North Korea 1 1 0* general US Treasury or the Office of Foreign Assets Control** fomer Yugoslavia and successor states
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3. Bund yields move as much as USTs due to tapering
Source: J.P. Morgan
QE currencies appreciate well before QE expires JPM nominal effective rates for USD, EUR and JPY during easing (green), pauses (yellow) and hikes (red)
The actual or suspected end of easy money almost always drives spikes in rate volatility 3Mx10Y swaption volatility in US, Euro area and Japan; basis points per day
09 10 11 12 13 14 15 16 17 18 19 20 21
Fed / USD
ECB / EUR
BOJ / JPY
Ease
Pause
Hike
0
2
4
6
8
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14
00 02 04 06 08 10 12 14 16
Taper Tantrum ('13)
BoJ ended QE ('06)
USEuroJapanlast Fed ease of cycle ('03)
Bund VaR shock ('15)
Since only the US will ease fiscal policy meaningfully in 2017, it seems the Fed is the only central bank whose policy shifts might boost bond yields or drive currencies. This view is too narrow. Recall that for most of the past six months, the ECB and BoJ had been the ones who delivered more persistent hawkish surprises by not easing in the face of persistent inflation undershoots, leading some (including us) to discuss the slow-motion regime change underway within those central banks in response to capacity constraints, philosophical objection, political pushback and adverse consequences on banks (obvious) and savers (feared rather than obvious). See Tiptoeing around regime change in Europe and Japan: implications for bonds, FX & commodities from August 30, 2016.
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QE’s inevitable consequences: extreme valuations and positions
Source: J.P. Morgan
Valuation problem: nominal rates below nominal GDP growth for most of QE era 10-yr government bond yields minus nominal GDP growth, %
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1012
88 90 92 94 96 98 00 02 04 06 08 10 12 14 16
Fed QENikkei bubbleglobal savings glut
ECB/BoJ QE
USEuroJapan
The framework: (1) QE programmes create extreme valuations and positioning/hedging imbalances due to the perception of one-way risk; (2) valuations are as stretched in Bunds and JGBs now as they were in Treasuries before the Fed taper tantrum in spring 2013, and positioning is long; (3) misalignments render Euro area and Japanese bond yields vulnerable to spikes on explicit policy shifts and even more subtle ones, since markets can sometimes frontload a policy environment that may require several quarters to materialise; (4) higher yields should sponsor euro and yen appreciation by either reversing the unprecedented capital outflows of the past three years or by deterring outflows in countries already running large current account surpluses of about 3% of GDP; and (5) the ECB has signaled the early onset of tapering from April 2017, albeit they are responding more to political and capacity constraints than attainment of the inflation objective.
US P/E at new high ex dot-com bubble years 1-yr forward P/Es for S&P500, Eurostoxx and MSCI EM
7
10
13
16
19
22
25
28
90 92 94 96 98 00 02 04 06 08 10 12 14 16
S&P500 EuroStoxx MSCI Emerging Markets
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Currency extremes are often the flip side of bond extremes
Source: J.P. Morgan
Positioning problem: QE promotes duration extension US duration positions measured by net CFTC positions (thou of contracts). European positions measured by JPM biweekly investor survey (deviation from benchmark in years)
The flip side of overvalued Bunds and short duration positions: the euro is slightly cheap and investors are short JPM Euro real effective exchange rate index (PPI-based) versus net IMM positions in euros (thousands of contracts)
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US rate positions (CFTC), thou contractsEuro rate positions, deviation from bench, years (inverted)
Fed taper tantrum Now
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IMM net spec positions in euros (thou contracts)JPM EUR real effective exchange rate (PPI-based)
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Beneficiaries of QE capital flight become victims of regime change
Source: J.P. Morgan
European purchases of foreign bonds since 2014: €429bn of US, €132bn UK, €61bn Canada & €50bn Scandinavian/Cen Europe Cumulative bond outflows from Euro area in billions of euros
Japanese purchases of foreign bonds since 2013: ¥37bn US, ¥6trn Euro area, ¥2.5trn EM and ¥1.6trn Australia Cumulative bond outflows from Japan in trillions of yen
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US
UK
Scandi & Central Europe
Canada
Japan
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USEuro areaUKAustraliaEmerging markets
Since the BoJ launched QQE 1 in April 2013, Japanese outflows into foreign bond markets have totalled ¥37trn for US ($336bn), ¥6trn for Euro area ($55bn), ¥2.5trn for emerging markets ($23bn), ¥1.6trn for Australia ($15bn), ¥0.5trn for UK ($4.5bn) and ¥0.3trn for New Zealand ($3bn).
Since the ECB implemented negative rates in June 2014, launched QQE 1 in April 2013, Euro area outflows into foreign bond markets have totalled €429bn for US ($404bn), €132bn for UK ($124bn), €61bn for Canada ($58bn), €47bn for Scandinavia and Central Europe ($45bn), €19bn for Japan ($21bn) and €11bn for Switzerland ($12bn).
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Would small changes in policy matter when CBs remain dominant?
Source: J.P. Morgan
0%
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100%
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250%
300%
2009 2010 2011 2012 2013 2014 2015 2016 2017
US UK Japan Euro area
ECB and BoJ dominate government bond markets more in 2017 than Fed did in 2013 Central bank government bond purchases as percentage of net issuance (gross issuance less redemptions)
Would changes in policy matter if they are smaller, slower and more subtle than the Fed's explicit tapering guidance in 2013? This is a judgment call, since such an exit would be unique for QE programmes. Our judgment is that even small changes matter because bonds remain overvalued and investors long duration plus short the currencies.
Optimistic case: Short-term fair value frameworks suggest a rise in 10-yr Bund of about 25bp if the growth and inflation outlook hasn’t changed and if tightening is still years away. Peripheral spreads widen about 50bp. These targets seem tame compared to the 2013 taper tantrum and 2015 Bund VaR shock, but ECB and BoJ dominate their respective government bond markets much more today than the Fed in 2013.
Overshooting case: Given positioning and valuations and markets' tendency to front-load policy shifts, Bunds could correct 100bp. The periphery could widen by 100bp. EUR and JPY would rise at least 5% versus USD if the usual rates/FX betas hold, but maybe 10% given the short base in the euro and Japan's massive foreign asset holdings. An FX carry basket could decline 8% given sensitivity to high-vol rate rises but average investor exposure.
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4. Populism bends but doesn’t break EMU
Source: J.P. Morgan, Eurobarometer semi-annual survey conducted May 2016
Hardly anyone in Europe has a positive impression of the EU Survey question: Does EU conjure up a positive, neutral or negative image?
But most Euro area citizens seem to like the euro Survey question: Are you for or against the euro?
After Brexit and Trump, most think that populism has gone viral and that pollsters miscount the effect. If true, then the Euro area will almost certainly face a crisis in 2017 given the Italian referendum on electoral reform on December 4, 2016, and national elections in the Netherlands (March), France (May), Germany (by October) and possibly Italy (depending on referendum outcome.
But before running with alarmist headline, note the following on polls:sometimes polls correctly measure populism’s minor influence (Spain); sometimes polls correctly measure populism’s major influence (Greece); and sometimes polls are close-to-useless (Trump, Brexit). So the strength of one’s conclusion varies with the sample size of recent elections.
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Gree
ceCz
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sGe
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ySp
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Latvi
aLa
tvia
Austr
iaSlo
venia Ita
lyFin
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Nethe
rland
sEs
tonia
Hung
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EU-28
Belgi
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ance
Swed
enCr
oatia
Portu
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Malta
Roma
niaLit
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iaLu
xemb
urgPo
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Bulga
riaIre
land
50% threshold
UK
0%10%20%30%40%50%60%70%80%90%
UKCz
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enDe
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Bulga
riaHu
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yCy
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Croa
tia Italy
Roma
niaGr
eece
Lithu
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Spain
Portu
gal
Austr
iaFr
ance
Germ
any
Malta
Finlan
dNe
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Belgi
umLa
tvia
Slov
akia
Eston
iaSl
oven
iaIre
land
Luxe
mbur
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50% threshold
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The polls and the outlook by country
Source: J.P. Morgan
France: Presidential polls put Le Pen tied for lead in first round but not in second Percentage of survey respondents supporting each candidate
Germany: polls suggest another grand coalition Percentage of survey respondents supporting each candidate
JPM framework on this issue: (1) The most recent polls are mixed: in France, the anti-EMU Marine Le Pen scores as well as any conventional candidate; in Holland, anti-EMU Freedom Party polls as well as the ruling party; but in Germany, the AfD substantially trails the grand coalition of Merkel’s CDU plus the SPD; and in Italy, the ruling PD still leads the anti-EMU Five Star Movement; (2) An anti-EMU government that makes good on its promise to hold an EU referendum would implicitly be asking its citizens if they would like to leave the currency union; and (3)The only country to have held a referendum that was also implicitly an EMU membership vote (Greece in summer 2015 when the population opined on the Troika programme) suffered runs on banks and imposed capital controls, which remain in place. Our judgment is that most Euro members get the rub, which is why the majority of citizens in these countries support the euro even though only a minority seem to think favourably of the EU. See also Why the euro struggles to price Frexit, Nexit or Gerexit from June 28, 2016.
Socialist (Hollande),
11%
other/undecided , 11%
Left (Mélenchon),
12%
En Marche (Macron), 13%
Republicans (Juppé), 27%
National Front (Le Pen), 28%
Free Democrats
(Lindner), 5%Left (Kipping),
9.00%
Greens (Ozdemir),
12%
AfD (Petry), 14%
SPD (Gabriel), 22%
CDU/CSU (Merkel), 33%
undecided, 5.00%
Source: J.P. Morgan, Ipsos and Elabe average poll results conducted Sept 2016 Source: J.P. Morgan, Forschungsgruppe Wahlen Polibarometer
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5. Oil achieves a higher range towards $60/bbl
Source: J.P. Morgan
Gulf producers have recaptured some market share from the US Oil production by country in millions of barrels per day
0%
2%
4%
6%
8%
10%
12%
14%
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Saudi Arabia US Iraq Iran
Most major producers still require oil in $50/bbl to $70/bbl to achieve fiscal balance Oil price at which fiscal balance is zero
149
85 93
5970
120
7060 56
7253 55
0
25
50
75
100
125
150
175
200
225
2014 2017
$50/bbl
After two years of falling average oil prices – Brent averaged $99/bbl in 2014, $54/bbl in 2015 and $44/bbl in 2016 – enough could be changing on the supply front to generate a higher range in 2017 NEAR $60. Two years of price declines have promoted notable rebalancing, which is obvious on several indicators. US crude output has fallen by about 1mbd from its mid-2015 peak of 9.6mbd to the current 8.6mbd. Market share has shifted from the US (plus Venezuela, Libya and China), back towards Gulf states. One rebalancing that hasn’t occurred, however, is fiscal. The fiscal breakeven oil price – that which eliminates producer countries' budget deficits – remains north of $50/bbl for most sovereigns. This lack of indefinite financing flexibility is why it seemed like an OPEC accord was always a question of when and not whether: countries didn’t have the reserve cover or sufficient market access to pursue price war indefinitely.
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USD/oil correlation could fall to zero
Source: J.P. Morgan
RUB positions are near record-long, CAD ones are moderately short Net speculative IMM positions in CAD and RUB, $ billion equivalent
-8-6-4-202468
1012
-0.4-0.20.00.20.40.60.81.01.21.41.6
2009 2010 2011 2012 2013 2014 2015 2016
CAD IMM positions, $bnRUB IMM positions, $ bn
The USD-oil correlation can turn positive if oil markets are tightening when the Fed is too Rolling 6 & 12-mo correlation between weekly changes in JPM USD Index and oil
Implications for FX and for the USD/oil correlation: Although all petro-currencies would rally initially on an accord, only RUB should be a consistent beneficiary. Accounts are short CAD, but this currency plus MXN should carry a risk premium until the Trump Administration clarifies isn't objectives on NAFTA. NOK will remain a very low-yield oil currency (0.5%) compared to RUB (10% now, 9.5% forecast by mid-2017) and COP (7.75% now, 5.75% by mid-2017) since the economy looks too fragile to justify rate hikes next year. Implications for the broad USD are minor relative to other influences: yes, high oil prices lend the Fed more confidence in the inflation outlook required to lift rates, but President-elect Trump fiscal programme will be much more important. The dollar-oil correlation will probably move towards zero or might become positive, as occurs every several years when the macro environment combines strong demand and Fed tightening as in the mid-1990s (so higher USD and oil), or when it blends supply stress and other USD-supportive factors like 2013.
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
rolling 6-mo correl rolling 12-mo correl
Rising USD & oil: OPEC cuts and Fed hikes
Rising USD & oil: supply
stress
Rising $ & oil: strong demand
&Fed hikes
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6. FX Valuation – a generally successful systematic strategy
Source: J.P. Morgan
The strategy of buying (selling) the cheapest (richest) quintile of currencies ranked on this signal have delivered positive returns for seven consecutive years Spot and total returns from being long/ short the cheapest/ richest quintile of the global FX basket; % (annual returns except for 2016 which is YTD)
Current ranking based on the deviation from 15-year averages: USD/JPY looks vulnerable, SEK and EUR are attractive Based on REERs
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15
Spot returns
Total returns
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
MXN JP
YTR
YGB
PZA
RM
YR EUR
SEK
PLN
CAD
NOK
HUF
KRW
AUD
TWD
BRL
RUB
NZD
SGD
CHF
USD
INR
CNY
Systematic valuation strategies delivered positive returns again in 2016, in part because cheap currencies unusually offered positive carry (high-yielders were cheap)
The 2017 outlook for valuation strategies is relatively more benign with carry less onerous than average, although an offset is that the “value” basket isn’t really that cheap. We sold NZD/SEK as a value trade in G10, although after recent movements JPY is once again screening cheap and the USD falls within the expensive basket
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7. FX carry – a tougher outlook this year
• Model: Annual returns on global carry basket = -13.1 + 0.1.517*(average yield on basket over the past year in %) + 1.12 *(EM industrial production growth year-on-year in %) – 1.37 * 1y change in VXY global (%pt). R-sq = 0.77. Model estimated on monthly data over the past 15 years.
Source: J.P. Morgan
FX carry trades worked in 2016 for the first time in three years, and better than the typical drivers of carry trades would suggest Actual vs. model* returns on global FX carry strategies; %oya
What happens to carry in disorderly bond market sell-offs? Net longs in high beta FX were cut and returns were negative Index of returns from a global FX carry basket vs. position metric for high beta currencies* (5-year zscore)
-30
-20
-10
0
10
20
30
2004 2008 2012 2016
ActualModel
+2.3%
-3.9%
-2.5-2.0-1.5-1.0-0.50.00.51.01.52.0
220225230235240245250255260265270
2013 2014 2015 2016
Commodity FX IMM positionsFX carry return index
Taper tantrum
Bund sell-off
Returns from carry strategies have overshot their fundamental drivers and were likely a result of stability in EM growth and a decline in G3 yields to record lows. The outlook is for negative returns in 2017 given a lower level of yields on the basket, prospects of higher market vol and long positioning.
Strategy – cherry pick carry trades were yields are highest (ARS) or fundamentals generally benign (RUB).
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CHF – Groundhog Day The SNB is single-handedly recycling Switzerland’s current account surplus. The absence of private capital outflows betrays a lack of trust in the SNB's FX policy Cumulative change in SNB sight deposits from the start of 2016 year as a proxy for SNB intervention versus the estimated cumulative current account surplus, CHF bn
The SNB has retreated from defending the 1.08-1.09 region. We expect it to tolerate a further slow decline to 1.03 by end-2017 2-week change in SNB sight deposits vs EUR/CHF
The bullish private sector forces that define CHF (maximal current account surplus and virtually no private-sector capital outflows) are coming to the fore as the SNB is seemingly tapering FX intervention. We expect the SNB to progressively scale-back intervention and tolerate a one-cent per quarter decline in EUR/CHF to 1.03.
-20
-10
0
10
20
30
40
50
60
70
Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16
Cumulative current account surplus
Cumulative change in SNB sight deposits (proxy for FXintervention)Implied cumulative net private capital outflow
1.06
1.07
1.08
1.09
1.1
1.11
1.12-2
0
2
4
6
8
10
12
1/1/2016 3/1/2016 5/1/2016 7/1/2016 9/1/2016 11/1/2016
2-wk change in sight depos EUR/CHF, inverted, rhs
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Global FX forecasts (see latest FX Markets Weekly)
Up (down) arrows indicate a forecast revision for resulting in a stronger (weaker) target for the local currency. Source: J.P. Morgan
Exchange rates vs. U.S dollarCurrent
Majors 22-Nov Dec 16 Mar 17 Jun 17 Sep 17 Dec 17EUR 1.06 1.05 ↓ 1.04 ↓ 1.06 ↓ 1.08 ↓ 1.15JPY 111 109 ↓ 108 ↓ 105 ↓ 102 ↓ 99
GBP 1.25 1.21 ↓ 1.21 ↓ 1.19 ↓ 1.20 ↓ 1.26AUD 0.74 0.74 0.73 ↑ 0.71 ↑ 0.69 ↑ 0.68CAD 1.34 1.38 ↓ 1.40 ↓ 1.43 ↓ 1.42 ↓ 1.41NZD 0.71 0.70 0.68 ↑ 0.66 ↑ 0.64 ↑ 0.62
JPM USD index 124.2 125.6 ↑ 127.5 ↑ 127.9 ↑ 127.2 ↑ 125.1DXY 100.7 102.2 ↑ 102.7 ↑ 101.5 ↑ 99.6 ↑ 94.5
Europe, Middle East & AfricaCHF 1.01 1.02 ↓ 1.01 ↓ 0.99 ↓ 0.96 ↓ 0.90ILS 3.86 3.85 ↓ 3.85 ↓ 3.75 ↓ 3.70 ↓ 3.65
SEK 9.20 9.52 ↓ 9.52 ↓ 9.29 ↓ 9.03 ↓ 8.39NOK 8.50 8.57 ↓ 8.56 ↓ 8.30 ↓ 8.06 ↓ 7.48CZK 25.39 25.73 ↓ 25.98 ↓ 25.49 ↓ 25.02 ↓ 22.61PLN 4.15 4.24 ↓ 4.33 ↓ 4.29 ↓ 4.26 ↓ 4.04HUF 289 297 ↓ 303 ↓ 297 ↓ 294 ↓ 278RUB 63.58 66.88 ↓ 67.00 ↓ 66.50 ↓ 66.00 ↓ 65.00TRY 3.36 3.50 ↓ 3.65 ↓ 3.65 ↓ 3.65 ↓ 3.65ZAR 14.07 14.75 ↓ 15.25 ↓ 15.10 ↓ 14.85 ↓ 14.70
Americas ARS 15.38 15.40 ↑ 15.90 ↑ 16.25 ↑ 16.80 ↑ 17.70BRL 3.35 3.40 ↓ 3.45 3.50 3.55 3.60CLP 674 675 ↓ 680 690 ↓ 675 ↓ 660COP 3149 3150 ↓ 3200 ↓ 3200 ↓ 3250 ↓ 3250MXN 20.34 20.75 ↓ 21.25 ↓ 21.40 ↓ 21.60 ↓ 21.80PEN 3.42 3.38 ↓ 3.40 ↓ 3.40 ↓ 3.36 ↓ 3.34
VEF VEF† 660 700 ↑ 750 ↑ 825 ↑ 3000 ↓ 5000
Asia CNY 6.89 6.90 ↓ 7.05 ↓ 7.20 ↓ 7.15 ↓ 7.10HKD 7.76 7.77 ↑ 7.79 7.81 ↓ 7.76 ↓ 7.75IDR 13443 13800 ↓ 14000 ↓ 14400 ↓ 14200 ↓ 14200INR 68.23 69.00 ↓ 69.75 ↓ 70.50 ↓ 69.50 ↓ 68.50
KRW 1176 1185 ↓ 1230 ↓ 1200 ↓ 1180 ↓ 1210MYR 4.42 4.45 ↓ 4.50 ↓ 4.60 ↓ 4.50 ↓ 4.45PHP 49.89 49.75 ↓ 51.00 ↓ 51.50 ↓ 51.00 ↓ 50.50SGD 1.42 1.430 ↓ 1.470 ↓ 1.480 ↓ 1.460 ↓ 1.450TWD 31.90 32.00 ↑ 32.50 ↑ 33.00 ↓ 33.25 ↓ 33.00THB 35.44 35.75 ↓ 36.50 ↓ 36.75 ↓ 36.25 ↓ 36.25
ADXY 103.9 103.3 ↓ 101.3 ↓ 100.2 ↓ 101.1 ↓ 101.4EMCI 65.7 64.6 ↓ 63.4 ↓ 63.0 ↓ 63.4 ↓ 64.1
Exchange rates vs EuroJPY 118 114 ↑ 112 ↑ 111 ↑ 110 ↑ 114
GBP 0.85 0.87 ↑ 0.86 ↑ 0.89 ↑ 0.90 ↑ 0.91CHF 1.07 1.07 ↑ 1.05 ↑ 1.05 ↑ 1.04 ↑ 1.03SEK 9.80 10.00 ↓ 9.90 ↓ 9.85 ↓ 9.75 ↓ 9.65NOK 9.05 9.00 ↓ 8.90 ↓ 8.80 ↓ 8.70 8.60CZK 27.04 27.02 27.02 27.02 27.02 26.00PLN 4.42 4.45 ↓ 4.50 ↓ 4.55 ↓ 4.60 ↓ 4.65HUF 308 312 315 315 317 ↓ 320RON 4.51 4.55 ↓ 4.55 ↓ 4.55 ↓ 4.50 ↓ 4.50TRY 3.58 3.68 ↓ 3.80 ↓ 3.87 ↓ 3.94 ↓ 4.20
RUB 67.70 70.22 ↑ 69.68 ↑ 70.49 ↑ 71.28 ↑ 74.75BRL 3.61 3.57 ↑ 3.59 ↑ 3.71 ↑ 3.83 ↑ 4.14MXN 21.65 21.79 ↓ 22.10 ↓ 22.68 ↓ 23.33 ↓ 25.07
Current22-Nov Dec 16 Mar 17 Jun 17 Sep 17 Dec 17
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