FX Outlook: Markets Firm Up the Hassett Trade

Adam

Summary:

Markets price in Kevin Hassett as next Fed Chair, weakening the dollar and steepening yields. EUR gains on lower hedging costs, PLN awaits NBP signals, and Asian FX trades mixed.

News overnight that the Trump administration had abruptly cancelled interviews with finalists for the Fed chair nomination has firmed up the view that Kevin Hassett will replace Jerome Powell next May. The market response to Hassett’s dovish leaning is a weaker US Dollar, a steeper yield curve, and a rally in risk assets.

USD: Hassett in play

The US dollar sold off in Asia as news emerged that interviews for the Fed chair position had been cancelled. In theory, the likes of Christopher Waller were meant to be meeting Vice President Vance today. Instead, the news is being taken that President Trump has already made up his mind – he said as much on Air Force One last weekend.

And the president’s pick will likely be Kevin Hassett, who is currently Director of the National Economic Council and whose views are seen as most closely aligned with the president. Heading into Thanksgiving, betting markets gave roughly a 35% probability for both Hassett and Waller as the next Fed chair. This week, Hassett’s probability has shot up to 85%.

Overnight price action has provided a mini-preview of what we can expect should it become even clearer that Hassett will succeed Powell. Given perceptions of Hassett as quite dovish, the US dollar is a little weaker across the board, the yield curve has seen some modest bullish steepening and risk assets have turned gently bid. This could be the dominant theme until next week’s FOMC meeting. Speaking to buy-side customers recently, some were looking to fade US dollar weakness on the Hassett announcement effect, ultimately betting that he would not be as dovish or be allowed to be as dovish given the nature of the FOMC voting process.

Away from the Hassett news, we have two pieces of US data today. Expectations are that the November ADP jobs release will soften to 10k from 42k prior. That should not move the needle on the 92% probability attached to a 25bp Fed cut next week. And we’ll also get to see the ISM Services figure for November. The market could potentially react to the employment component figure, which last month was still in contractionary territory at 48.

We still don’t think the US dollar has fully connected with the recent drop in short-dated US rates, and a break of 99.00 in DXY could trigger some bearish momentum.

EUR: Hedging costs are falling

EUR/USD found a bid in Asia on the Hassett news. In the background, however, there is some more supporting evidence for the rally. Softer energy prices are sending the eurozone’s terms of trade to the highest levels of the year and supporting the eurozone’s external accounts. And perhaps more importantly, hedging costs for eurozone residents wanting to insure against FX losses on US assets have now dropped to 1.85% p.a. when looking at the three-month forwards. These had been at 2.40% in July.

While a 55bp drop in hedging costs might not seem like a lot, it is a big deal for bond investors who typically deal in more conservative returns. And for reference, at the end of the second quarter this year, eurozone investors held about €800bn of US sovereign debt and €1.5tr of other US debt securities. Therefore, some modest increase in hedge ratios can lead to quite a supply of US dollars. Over the next couple of weeks, we should probably look out for buy-side US dollar selling at key FX fixes.

In Europe, the focus remains very much on the Ukraine peace talks. Unsurprisingly, there seems to have been little progress in US-Russian talks yesterday. The focus today could be on the European Commission’s proposal to use frozen Russian assets to fund Ukraine. Political analysts widely feel that this loan is essential to fund Ukraine’s ability to defend itself after the second quarter of next year. Failure to deliver this funding, either through Belgium’s reluctance to use the assets frozen in Euroclear or Hungary’s opposition to further funding for Ukraine, would weaken Ukraine’s negotiating position.

If EUR/USD can nudge through the 1.1655/70 area – perhaps with the help of some softer US data – we could see a decent move through 1.17. We retain a year-end target of 1.18.

PLN: Zloty offers asymmetric response to unpredictable NBP

The National Bank of Poland is expected to cut rates again by 25bp to 4.00% today. After weaker inflation and wages last week, this seems to be the market consensus view. The central bank will work with the November forecast and today’s meeting will only bring the MPC’s statement. Therefore, the focus will be on the wording and possible forward guidance. However, the main event will be tomorrow’s press conference of Governor Adam Glapinski.

After the weaker data, the market has shifted again to a more dovish direction and is currently pricing in the terminal rate at 3.50%. This week, the rates market has seen a smaller rebound following the core rates rally last week. Although 3.50% seems like a fair value in line with our forecast, it cannot be ruled out that with the declining inflation profile, the central bank will also be more dovish. In the past, we have seen frequent changes in the terminal rate communication in the range of 3.00-4.00%. At the same time, we also heard that 4.00% could be the first level to stop the cutting cycle and wait for more data and the impact of previous steps. The markets will closely review these details.

We maintain the view that PLN is in an asymmetric situation and we are slightly bullish. If the central bank were to surprise in a dovish direction, it would be nothing new for the market, and after the move in rates last week, we do not see much room here and FX would probably remain rather unchanged. On the other hand, a hawkish surprise, e.g. the announcement of a longer pause despite lower inflation numbers, would probably lead to a more significant repricing of rates and new support for FX.

At the same time, we continue to monitor the negotiations between Ukraine and Russia and any progress here would also support the zloty. EUR/PLN is at the bottom of the usual range of 4.230-270 but as we discussed here in previous days, the conditions indicate that we can see a breakthrough of the lower bound and test 4.220 again.

Asia: Mixed news

Asian FX is ending the year with some volatility. USD/INR has pushed above the 90 area as a lack of a US trade deal weighs. Presumably, there will be much focus on external accounts as well to see whether a shift away from Russian crude imports has increased the energy bill a lot. In our FX outlook, we had felt that the rupee was due for a comeback, but clearly delays in the trade deal with the US are taking their toll.

Elsewhere, we see USD/CNH continuing to grind lower. This had been happening even before a clear move lower in the US dollar. We’re not sure whether it relates to foreign portfolio inflows into China or just Chinese exporters finally offloading their export earnings. Yet local authorities have had USD/CNY fully under control this year and are clearly allowing this renminbi appreciation. Here, we think they might be favouring a stronger CNY to support domestic demand, as they shift away from their long-held export model. Our team sees USD/CNY heading down to the 6.90 area next year.

Source: investing

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