The Renminbi is being manipulated, but Trump has it wrong: Chinese policymakers are helping stabilise the currency. The Renminbi is one of the least volatile global currencies as a result. Trump got China right…but for the wrong reasons. Chinese policymakers intervene in currency markets to keep the currency within a +/- 2% band from the close of the previous day’s closing rate. This process either generates foreign exchange reserves (if it sells Chinese currencies) or reduces reserves (if it supports the Renminbi). Foreign exchange reserves have fallen under the US$3tn level for the first time in six years, after peaking at US$3.99tn in June 2014. January’s US$12bn decline in foreign reserves could have been worse. Excluding valuation effects the decline would have been closer to US$40bn. The weakening of the Renminbi during 2016 prompted domestic investors and savers to look abroad in order to not lose purchasing power and boost investment returns in the face of the strong US Dollar. There are signs of a turnaround: the Renminbi has strengthened during 2017, likely assisting in reducing capital outflows. In addition to greater capital controls, the People’s Bank of China has increased rates on short-term repos for the first time since 2013, helping motivate more investors to keep currency in mainland China. The domestic outlook appears to be also helping, with our modified ‘Li Keqiang Index’ showing more stable growth in China over the past year. Estimates suggest that currency outflows have continued unabated since early 2015, totalling US$1.7tn over the period. Stemming the outflow of capital is a critical issue for Chinese authorities – a currency collapse could occur if China liberalises currency controls too fast, forcing the currency sharply lower and exacerbating capital outflows. Indeed, President Trump would be well served to improve Sino-US relations and support the Chinese efforts to stabilise its currency. With only the nascent signs of inflation appearing on a global level, a Chinese currency collapse could spark a new wave of global deflation, something the developed world does not need right now.
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnoldjoined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
A combination of higher inflation, a weakening US dollar (in first half of year) and improving manufacturing growth is likely to see silver prices trade higher to US$21/oz in 2017. Yesterday’s release of the Global Manufacturing PMI at 52.7 (above the long-term average of 51.4 and sitting at a 34-month high) indicates manufacturing activity will continue to pick up this year. Strong PMIs support silver prices.
In line with our revised gold price forecast (see Gold outlook 2017: further upside likely), we have updated our silver outlook. We adopt the simple model described in Gold and silver: similar, but different. We assume that the gold price will reach US$1300/oz by mid-year and then falls to US$1230/oz by year end.
We expect COMEX silver inventory to fall after reaching decade high in December 2016. By the end of 2017 we expect inventory to be back to the levels we saw at the beginning of 2016 (17% decline).
We believe global PMI manufacturing will continue to improve, although pace of growth will slow as we approach a 6-year high of 55 at the year-end.
Mining capital expenditure has continued to slide. We factor an 18-month lag to this input into our model reflecting the time it takes forgone investment to bite into supply. Silver has been in a supply deficit for the past 11 years and further decline in mining investment is likely to see that deficit continue.
Nitesh Shah, Research Analyst at ETF Securities
Niteshis a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
Next Friday, 2017’s first US nonfarm payroll report will be released and could determine the near term fate of the US Dollar. The widely monitored DXY dollar basket has moved 2.9% lower over the month, retracing a portion of the sharp 7.1% rally experienced in the fourth quarter of last year. A strong payroll figure could re-ignite rate hike expectations and put the US Federal Reserve’s (Fed) March meeting back into play (rate hike currently priced at around 20%*), while a weak slate could confirm predictions that the Fed will adopt a more dovish stance than is currently being suggested. We believe it is likely that the US Dollar has further room to run lower in the coming months as the Fed remains on the side-lines (i.e. does not hike rates in March) and extended speculative positioning unwinds. This is most likely to be witnessed against the GBP and EUR, as the JPY has already experienced a considerable correction and oil-related currencies remain subject to supply concerns.
Rhetoric from Trump’s administration, specifically him and his Treasury secretary nominee, Steven Mnuchin, also has potential to weigh on the US Dollar from a sentiment perspective. Both figures have emphasised the detrimental effect of an “excessively strong US Dollar” on the wider American economy and further comments could add to bearish momentum currently surrounding the currency.
Overstretched and overdone
Speculative futures positioning data suggests that net long US Dollar positions have moderated somewhat in recent weeks. However, gross long US Dollar positions remain considerably elevated and short positing near record lows (see Figure 1), so further correction potential remains. Technically speaking, while momentum indicators turned lower for the US Dollar at the start of the year, they remain on an established downward trend and some way from bottoming. The EUR/USD is trading near its 38.2% Fibonacci retracement at 1.07, and any break could see it head towards its 100 daily moving average (DMA) of 1.082. Meanwhile, the GBP/USD recently broke through its 50 DMA and has potential to head towards its own 38.2% Fibonacci retracement at 1.28.
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The Supreme Court has upheld the High Court’s decision that requires the UK Parliament to vote to trigger Article 50 in order to invoke the two-year negotiation timeline to exit the EU. Brexit is still likely to happen, but is likely to be delayed by a government debate on whether and when to trigger it.
Today’s Supreme Court decision was widely anticipated, with GBP rebounding in recent days from its post-EU Referendum lows. UK Prime Minister May appears to have been resigned to the fact that the UK Parliament would have some say in the Brexit outcome, after last week indicating that lawmakers would vote on the final Brexit framework. However, the Supreme Court decision is another blow to the PM, who has taken a hard line in trying to implement what she terms ‘the will of the people’. We now expect the Government to table an extremely short Bill into Parliament with the aim of retaining its March deadline – however it is widely expected that pro-European MPs and Lords are expected to table amendments in an effort to either delay the process or bind the Government to specific negotiating positions. Most notably, a Labour spokesperson has confirmed that the Opposition will seek to amend the Bill to “build in the principles of full, tariff-free access to the single market.”
The one highlight for Prime Minister May is that the devolved Parliaments do not need to be consulted for triggering Article 50.
The free movement of people and EU budget contributions were also both critical determinants for the UK voters in deciding to leave the EU. Although these will remain two of the main goals for the Conservatives, it remains to be seen who the UK Government will be negotiating with, with many elections on the continent over the next two years. Indeed, the German Socialists have lost the EU Parliament Presidency which could potentially split the Parliament and make any Brexit negotiations with the UK more messy and acrimonious if they take a hostile position against the current Italian European People’s Party President.
Nonetheless, we expect the Pound will remain supported in the near-term, as negotiations begin and investors gain an understanding of the underlying issues and the timeframe for the exit process. A ‘hard Brexit’ is not our favoured scenario, but Sterling is likely to remain volatile and range bound in trading in 2017, as details of the Government’s negotiations with the EU trickle through to the public. Although range bound, investors will have plenty of opportunity to get exposure to the Pound, as it is likely to trade in a wide range – from 1.21-1.27 against the US Dollar in 2017.
Martin Arnold, Global FX & Commodity Strategist at ETF Securities
Martin Arnold joined ETF Securities as a research analyst in 2009 and was promoted to Global FX & Commodity Strategist in 2014. Martin has a wealth of experience in strategy and economics with his most recent role formulating an FX strategy at an independent research consultancy. Martin has a strong background in macroeconomics and financial analysis – gained both at the Reserve Bank of Australia and in the private commercial banking sector – and experience covering a range of asset classes including equities and bonds. Martin holds a Bachelor of Economics from the University of New South Wales (Australia), a Master of Commerce from the University of Wollongong (Australia) and attained a Graduate Diploma of Applied Finance and Investment from the Securities Institute of Australia.
ETF Securities FX Research: Near-term downside for US Dollar
Summary
The US Dollar has jumped sharply in recent months, reaching the highest level since late 2002. The US Dollar has moved ‘too far too fast’ and could unravel in coming months if the US Federal Reserve’s actions don’t live up to its rhetoric.
Inflation is set to jump higher in 2017, driven by wage growth and an unwind of the weakness in oil prices over the past year.
Futures market pricing remains buoyant, but could unwind rapidly. The options market indicates that the US Dollar is expected to appreciate against most G10 currencies in coming months – the only exceptions being the Japanese Yen and the Swiss Franc.
Strong economic environment…
Strong economic data, particularly the ongoing buoyancy of the jobs market has driven the US Dollar (USD) higher in recent months against all G10 currencies. Although the USD has reached the highest level in 14 years, the rally is likely to take a pause after moving too high too soon after the widely expected rate hike from the US Federal Reserve (Fed) last December. While the Fed has increased its rate hike projections for 2017, they may not live up to expectations.
Fed Chair Yellen noted in a speech in October last year that the FOMC would be more comfortable in running a ‘high-pressure’ economy in 2017 due to persistent ‘hysteresis effects’ resulting from the global financial crisis. We expect the USD to suffer as the central bank begins to lose its inflation fighting credibility. Hawkish rhetoric alone will not be enough to sustain the current levels of the USD. Nonetheless, as the Fed comes to terms with having to be more aggressive with rate rises, we feel the USD will eventually rebound in the H2 2017.
…could generate inflation surprise
Inflation looks set to rebound rapidly, as energy prices have increased considerably over the past year. The removal of so called ‘base effects’ could see inflation jump over 3% in coming months. A rising USD could moderate some of the inflationary pressure later in 2017.
(Click to enlarge graph)
Indeed, inflation expectations are rising on a global basis, partly fuelled by a rebound in energy prices.
(Click to enlarge graph)
Wage growth acceleration also threatens to be a key driver of inflation in 2017, as the US jobs market continues to tighten. The strong correlation between wages and CPI will continue as the US jobs market reaches full employment. In December, US wage growth reached the highest level since April 2009, at 2.9%.
(Click to enlarge graph)
Flat real rate environment
The real interest rate environment is critical for the trajectory of the USD. Currently the USD has risen out of line with real rate differentials. On a real yield differential basis, the USD is currently beginning to look stretched against a basket of G10 currencies.
If the USD rally is to regain momentum in H2 2017, the Fed will need to engineer a rising real rate environment. This could be difficult, especially if Fed Chair Yellen is comfortable with inflation staying above target in 2017.
(Click to enlarge graph)
However, the USD could be its own worst enemy: the Fed has, in recent years, cited USD strength as a reason to keep rates on hold. NY Federal Reserve economists estimated that a 10 percent appreciation of the dollar within a quarter would drag down growth over one year by 0.5 percentage point. The stronger dollar encourages import substitution by consumers, leading to less domestic production. As a result, lower-than-expected growth could stay the Fed’s hand, especially if President Elect Trump’s pro-growth policies don’t begin to impact the real economy until 2018.
Although cheaper imports should leave consumers better off, the reduction of prices tends to be proportionally less than the corresponding strength of the US Dollar.
Investor positioning
Investor positioning has surged since mid-October, stabilising at around the highest level since August 2015. The bullish sentiment was bolstered by the more hawkish rhetoric that accompanied the Fed’s December rate hike. The optimism (and long positioning) could quickly unravel if the Fed doesn’t stay true to its words and the ‘dot plot’, as was the case last year. Optimism also prevails in the options market, with pricing indicating that the USD is expected to appreciate against all G10 currencies, with the exception of the Japanese Yen and the Swiss Franc.
(Click to enlarge graph)
With Trump policies likely contributing to inflationary pressure, alongside with higher wage growth and upwardly trending core inflation factors like healthcare and housing, we feel the Fed will need to, at the very least, remain committed to its ‘dot plot’ of three rate hikes in 2017.
While we expect some near-term weakness for the USD. As the Fed comes to terms with having to be more active with monetary policy in mid-2017, we feel the USD could stage a rebound in the second half of the year.
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