FX Outlook

From the FXWW Chatroom – Asia source of risk: Risk appetite should remain offered as a result of Asian developments, with another higher USDCNY fixing pushing USDCNH to 6.69 and the CNH-CNY spread to historically wide levels. At the same time lower-than-expected Taiwan CPI reinforced our view that overcapacity and deflation remain the key themes for Asia this year, with a weaker RMB only aggravating the problem for the rest of AxJ. The increasing momentum of the RMB decline does not bode well for the global growth and inflation outlook. This morning the China Security Journal claimed that RMB weakness is not causing instability, which leaves the impression China could be preparing for more RMB weakness. In addition, with consensus (Bloomberg) looking for growth of 6.5% in 2016, leaving the impression that China’s economic recovery may take longer than planned. 
Loving USD and JPY, and… The global risk outlook should keep the USD and JPY in demand, driven in part by repatriation flows. AUDJPY shorts remain our best call for the week (target 82), and long JPYKRW remains a trade for 2016 (target 11.40). Other factors to consider for the risk outlook include Saudi Arabia cutting the price for European oil clients, reminding the audience that the Kingdom is no longer the swing producer willing to stabilise prices. Energy markets should remain volatile with continued oversupply, perhaps partly inspired by Saudi Arabia’s intention to weaken Iran’s economy argues for lower oil prices. Falling energy prices undermines the highly leveraged US shale oil sector, not boding well for the equity market. Likewise, an oil price advance, driven by concerns of an escalating conflict in the Middle East may shut down either distribution or local production, will not be liked by the equity markets either. The risk positive scenario only applies when energy costs rise due to increasing demand. 

…selling AUD and NZD. Oil currencies should remain volatile in coming weeks and have been one of our biggest shorts for the past year. This view has more medium-term potential once lower energy prices lead to disinvestment, economic underperformance and central bank response. For instance, the BoC will meet on January 20th and accommodative language has the potential to weaken the CAD further. However, short-term risks of holding short oil currency positions have increased, as an escalation in Saudi-Iranian tensions could boost oil currencies from outside the region, such as CAD or NOK. Instead of selling oil currencies, we emphasis AUD and NZD shorts. Yesterday’s weak milk powder auction will likely weaken the NZD beyond the day with falling local inflation expectations ‘forcing’ the RBNZ to consider additional easing. Our bearish AUD call is driven by continued Asian data disappointments, iron ore reversing its 17% December rally and coal prices breaking lower. There are already signs that the rebalancing of Australia’s economy has come to an end. 
GBP: Make or break. We reiterate our bearish GBP call and highlight the importance of the 1.4550 chart level. Once we get beyond today’s Service PMI, GBP may well be less driven by domestic data weakness and related rate adjustments. Instead, we see weakening risk appetite, the high commodity weighting of the FTSE and the Brexit debate as catalysts. PM Cameron allowing cabinet ministers to campaign in favour of Britain leaving Europe’s Common Market highlights the tensions concerning this subject within the Conservative Government Party. Meanwhile, Europe’s refugee situation has not only reduced the attractiveness of the EU for many Brits, it also does not provide PM Cameron with a constructive backdrop for negotiation as European leaders, including Merkel, are distracted by their own struggles for political survival. 
Market paradox. The risk negative environment works against GBP, as declining cross-border capital flows make it more difficult to fund its 4.7% current account deficit at today’s FX levels. The response of global equity markets to global data weakness could lead to GBPUSD breaking below the key 1.4550 level. 
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