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Q4 Laundry List - Global Exchanges

FICC Podcasts 28 septembre 2021
FICC Podcasts 28 septembre 2021


Disponible en anglais seulement

In this week’s episode, we discuss the list of issues that seem to be driving FX this week and may continue to do so for the rest of 2021. We tackle 5 of the most important macro and political developments.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Disponible en anglais seulement

Greg Anderson:

Hi, welcome to episode 20 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson in this week's episode, my co-host Steven Gallo, and I will be talking about the list of issues that seem to be driving FX this week. And may continue to do so for the rest of 2021, we will tackle five of the most important political and macro developments. The title for this episode is Q4 Laundry List.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London based FX strategist. Welcome to Global Exchanges presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York based FX strategist I'm Steven's co-host

Stephen Gallo:

In each weekly podcast, like today's we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So, don't hesitate to reach out by going to BMOCM.com/global exchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, it's affiliates or subsidiaries.

Stephen Gallo:

Thanks for the intro, Greg. What I normally do is I start with a quick run through, so here it goes. It's September 28th, 2021. We're getting close to the end of Q3. In the last week or so has been miles busier than the environment we were dealing with in early September, particularly at FX. And when I take a look at key FX market indicators, I'll start with the big dollar, the big BBDXY is on the verge of making a new high for the year. The DXY has already done so, having traded at 93,80 earlier today. So, issues it's difficult to nail down one specific issue for the rally and the dollar Greg, and that's often the case. So why don't we use this time to have a work through a number of the potential drivers of this move in the dollars. Does that sound good?

Greg Anderson:

Great idea to create a list when thinking about FX, politics are often a key driver alongside economics. So, let's start the list with politics. Stephen Euro is the biggest element in all of the various US dollar indices. So if the dollar is up, that pretty much always means Euro is down. And that brings me to Sunday's German election. Stephen, what's your take on the political situation in Germany and Euro zone now. And do you think that political uncertainty is what has the Euro on the threshold of this year's low? And I guess let's call this item number one for our list.

Stephen Gallo:

Greg, you know I think political on certainty in Germany at the moment is reasonably high because there are at least three possible outcomes we could see lawmakers arrive at in terms of the formation of a new government. I suppose, as an outlier, we could include a fourth possible scenario where no government is able to be formed. And then we are really in a state of extended political limbo in Germany, but I don't think this is having a dramatic impact on the Euro. If I just rewind for a moment what FX investors were, I think most worried about ahead of the exit polls on Sunday evening, German time was a definitive lurch to the left in German politics, which could have yielded a left wing coalition involving just the SPD and the Greens with support from Germany's far left fringe party Die Rechte. Or a full coalition involving all three of these parties, but on actual vote share and seat allocation results in the lower house that does not seem likely.

Stephen Gallo:

So I really don't think FX markets are trading German political risks with this move lower in Euro dollar, as much as they are trading other factors. I think the strength we've seen in the DXY and I mentioned this a few minutes ago. I think it's largely a dollar move. And I think there's a big risk appetite element to it. Speaking personally, I think the uncertainty over the outlook for inflation in developed economies is a key component of the deterioration risk appetite, but I'll park that for the time being. And what I'll do is just take listeners through a brief look at the Euro cross rates for September 28th, in terms of their changes from yesterday's closing level. Euro Canada, higher Euro Aussie that's higher, Euro Sterling that's higher, Euro Kiwi higher, and a decent chunk of Euro EM is trading higher.

Stephen Gallo:

This tells me that the moves in currency markets today related to the Euro are not so much linked to domestic European factors, but I think risk appetite ones, all those currency pairs, I mentioned during periods of improving risk appetite. Those are pairs where short Euro positions are generally favored. So let me turn to you, Greg, as domestic German political risks are I think a relatively low impact factor for FX markets right now. How do you think Japanese political uncertainty is playing out in the foreign exchange markets?

Greg Anderson:

Before moving on to Japanese politics? Let me just sum up your answer to item number one on our laundry list. German political uncertainty is not a major reason for the dollar being at this year's high. Let's call Japanese political uncertainty item number two on our laundry list. And I'll start by saying that Dorian came within two pips of setting a new 18 month high just earlier this morning. And that high comes within a day of the LDP leadership vote that will occur in the Japanese afternoon on Wednesday. The LDP will pick a new leader to replace prime minister Suga who has needed to step down because he hasn't put the LDP on good footing ahead of the parliamentary elections. So what will happen is that the LDP leader will be selected tomorrow when it's kind of formality. But we'll be elected on the floor of the Diet on Monday, October 4th.

Greg Anderson:

But whoever that new prime minister is, will have to almost immediately announce the date of the parliamentary election. Which seems most likely to land on November 28th, but at any rate will be in November. And while the LDP is probably in the best spot to keep their new guy or girl as prime minister after the parliamentary election, that is far from a short thing. So look for most currencies, this kind of uncertainty would be a big deal and would probably lead to something like a two to 5% discount in the currency. But for the Yen given Japan's massive net creditor position, there just aren't very many for or investors that need to hedge their Japanese political exposure.

Greg Anderson:

So I honestly don't think that politics have much to do with Dorian being where it is. Actually, I think the fact that Brent rose above $80 a barrel earlier today is probably a bigger story because energy is far and away Japan's biggest to import. So let's make high energy prices item number three, on our laundry list. Stephen, it sort of seems like this latest move higher in oil started with natural gas prices in Europe. Do you think that high energy prices are weighing on the Europe? Oh, and Swiss and Swedish et cetera.

Stephen Gallo:

Yes Greg, and I think the energy and commodity price developments feed through to the major European currencies with a negative impulse via multiple avenues, I'd say three avenues. First of all, they're a growth headwind. That's pretty clear. The second avenue is that energy imports are a key component of the balance of payments and typically higher energy prices, yield water trade deficits, or smaller trade surpluses. And three that's the channel of monetary policy and where I'm going with this is that the third avenue, as I think where things get really tricky. Because high commodity prices and supply size shortages in general are a really difficult environment for central bank banks to navigate through because they can't really influence the supply side. They have no control over that at all. And they have to hope that their rhetoric and some degree of call it policy normalization will help keep inflation expectations anchored.

Stephen Gallo:

And I think where we are now is that FX investors are doing their best to factor in what it will mean to have an inflation overshoot that potentially sticks around for longer than previously thought. While an earlier situation involving excess demand reverts to its pre pandemic norm, or basically a situation we like to refer to as trend growth. So my opinion is that what this strength in the dollar versus key European currencies indicates is that FX investors are discounting a situation in which central banks either do too little and higher prices weaken demand on their own or a situation in which central banks do too much in terms of tightening credit and demand weakens anyway. And I'd argue that this is where we are right now in terms of the thought process. Some investors are going through.

Greg Anderson:

Stephen good point with central bank's grappling with stagflation, a key chapter in central banker 101 has the idea that you don't raise rates because an oil price shock has triggered inflation. But what about QE? Personally I think you do wind down QE when faced with an energy price shock, but more importantly it appears that is what the Fed is thinking. So, that brings me to the 10 year yield spike since the FOMC last Wednesday, I've got the benchmark 10 year US Treasury yield up 22 basis points since basically an hour before last Wednesday's meeting. And the 10 year benchmark Canadian government yield is also up 22 basis points. So Stephen, how about 10 year gilt and bond yields? What is their move been since pre-FOMC?

Stephen Gallo:

Well, Greg so from the close last Wednesday, which would've been just before the Fed rate decision, the 10 year bond yield is up a little over 12 basis points. I think over that timeframe and the equivalent maturity UK sovereign yield that's up by about 20 basis points. So in other words, the move in this measure of longer term UK yields has been roughly on par with the US and Canadian moves while longer term rate differentials have moved in favor of the USD relative to the Euro based on the size of the selloff and bonds.

Greg Anderson:

So, if I can summarize where I think the market thinks we are on taper. The RBNZ has ended its bond purchases, and is on the verge of a rate hike. The BOC is most of the way through taper. The RBA has taken its first taper step, but will pause until February before taking another. And Powell says the Fed will end its taper in the middle of next year. For the ECB Lagarde said, the lady will not taper. So, that is probably what bond and FX markets are pricing in. But what's really interesting to me here is that the behavior of the FX market in this little 25 basis point 10 year yield spike over the last week is different than during the 90 basis point tenure yield spike that we saw back in Q1. In that episode, Aussie, CAD, Kiwi they all rallied as their tenure yield spiked alongside US 10 yields. But this time around Aussie, CAD, and Kiwi are falling both against the dollar and against Euro, as you noted Stephen.

Stephen Gallo:

Greg, you made some really great points there. So do you have a rationale for why these commodity block currencies are falling now as opposed to rallying during Q1, when we had the last spike in long term yields,

Greg Anderson:

You hit on risk aversion at the outset, Stephen. And I think that may be the key distinction. While, the Q1 yield spike eventually got so big that it led to risk aversion. The first 50 basis points or so of it were based on global growth optimism. For this last week's yield spike. I'm not so sure that the main culprit isn't risk aversion tied to the US fiscal impasse that we are likely to see turn into high drama over the next few weeks.

Stephen Gallo:

Okay, Greg. So in light of the link, you're drawing between risk appetite, the US fiscal situation and the move in longer term yields. Can you take me through the key issues related to the ongoing debt ceiling drama in the US?

Greg Anderson:

To understand the debt ceiling drama, I think we need to back up to several months ago. Acting on more of a bipartisan basis. The Senate passed what I will call a roughly $1 trillion quote unquote hard infrastructure package that was negotiated with house leaders. However, the house Democratic leadership also promised to progressives in the house that they wouldn't vote on the package until the Senate approved a much bigger three-ish trillion dollar quote unquote human infrastructure package that we still haven't seen the bill detailing yet. Progressives in the house of threatened that they won't pass the hard infrastructure bill if Democratic moderates in the Senate don't pass the human infrastructure bill. This has sort of led to the two wings in the Democratic party trying to wait each other out, but in the middle of the waiting Treasuries run up against the debt ceiling. This creates a deadline that I assume will force resolution one way or the other on the infrastructure packages.

Greg Anderson:

It also probably creates a leverage tool that advantages the Democratic moderates. And I think that's probably why the Republicans in the Senate have refused to help in passing a debt ceiling extension. I think we are likely to see roughly three to four weeks of intense negotiation and then the passing of a compromised, smaller human infrastructure package alongside the heart infrastructure package. And alongside that we will get the extension of the debt ceiling and maybe the nomination of the Fed chair, which is also entangled in any negotiation between Democratic moderates and progressives. But just to reiterate, that's a lot of ground to cover over the space in of a few weeks. And I'm not sure that everything will turn out fine in say four weeks from now, let alone seem like it's going to turn out fine two weeks from now.

Stephen Gallo:

So you know what, Greg, it looks to me anyway, like your number five item, the fiscal impasse carries the biggest weight in our list of five different factors behind this move up in the US dollar. Is that about right?

Greg Anderson:

Yeah, I think that's about right Stephen. Other than that, I would also elevate the oil price rally as being parallel or at least number two of the items on our five item list.

Stephen Gallo:

Well said, Greg. I think we used up all of our available time and this is where we should end episode 20. So thank you to our listeners as always. And we hope you'll join us again for episode 21. That's a wrap.

Greg Anderson:

Thanks for listening to Global Exchanges, listen to past episodes and find transcripts at BMOCM.com/Global Exchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

This podcast has been prepared with the assistance of employees of Bank of Montreal BMO NESBITT BURNS incorporated and BMO Capital Markets Corporation. Together BMO who are involved in fixed income and foreign exchange sales and marketing efforts. Accordingly, it should be considered to be a product of the fixed income and foreign exchange businesses generally. And not a research report that reflects the views of disinterested research analysts, not withstanding the foregoing. This podcast should not be construed as an offer or the solicitation of an offer to sell, or to buy, or subscribe for any particular product or services. Including without limitation, any commodities, securities, or other financial instruments. We are not soliciting any specific action based on this podcast. It is for the general information of our clients. It does not constitute a recommendation or a suggestion that any investment or strategy referenced herein may be suitable for you.

Speaker 3:

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Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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