Fundamental Analysis 19.10.2017 - Market Outlook

EUR gained and USD fell slightly. Higher US Treasury yields should have supported USD. It may be that investors had shorted EUR/USD in expectations that the Spanish crisis would affect the pair more than it has, and were closing those positions out.

JPY fell sharply and CHF wasn’t far behind as risk appetite returned. A bullish forecast by IBM caused a surge in confidence, sending US stocks up sharply and US bond yields higher as well. Gold and silver meanwhile fell for the third consecutive day, as one would expect with demand for safe havens declining.

NZD fell on a newspaper report that New Zealand First, the party that holds the balance of power after last month’s inconclusive elections, prefers to support the Labour Party rather than the ruling National Party.

CAD gained after Canadian manufacturing sales jumped 1.6% mom in August 2017, instead of declining 0.3% as expected. MXN was lower as were Mexican stocks as investors began to reconsider their favorable reaction to the extension of the deadlocked NAFTA talks, which as I said yesterday I believe indicates the difficulty of reaching an agreement, not an increased likelihood of reaching one. There was also a fall in oil prices overnight.

GBP rose marginally after earnings rose a bit more than expected. They are still falling in real terms however as prices are rising faster than earnings are.

Today's Market:

The big day! The Spanish government gave the Catalan government until 10 AM local time to back down from its declaration of independence. If it doesn’t, then PM Rajoy will set in motion the necessary steps to defenestrate the local administration and rule the region from Madrid.

The question is, will a crisis in Spain upset the euro? So far, it hasn’t even upset Spain that much, as the graph shows – the spread between Spanish and German bonds widened out sharply at the beginning of the month but has since come in, while the Spanish stock market similarly underperformed notably early in the month but has since performed in line with the rest of Europe. It appears that the market thinks the situation is under control.

I think there could be a negative surprise, but as long as it doesn’t threaten the integrity of Spain or contagion to other volatile regions of Europe, it shouldn’t change the medium-term trajectory of the currency. I would expect to see EUR weaken slightly today just based on a knee-jerk reaction, but I think the effect is likely to be muted and not long lasting.

After that, the focus turns to Britain, where the retail sales figures for September 2017 are expected to show a slowdown in sales. This shows the downside of the Brexit devaluation.

Britain will stay in the spotlight as EU leaders begin their two-day summit. According to the FT, they will approve the start of discussions within the European Commission over the EU’s future relationship with Britain, but will refuse to talk to Britain itself about the subject, specifically with regards to trade, because of a lack of progress on the issue of how much Britain has to pay to settle its obligations before it leaves. The lack of any progress coming out from the group is likely to be negative for the pound, in my view.

The Philadelphia Fed manufacturing index for October 2017 is expected to be slightly lower. This compares with Monday October 16th’s unexpected surge in the Empire State index. The manufacturing ISM also rose in August 2017 and September 2017, despite the hurricanes.

Kansas City Fed President Esther George speaks about the US economy at a forum sponsored by the Bank. She’s one of the more hawkish people on the FOMC, but her views are well known by now and shouldn’t surprise anyone.

The Conference Board US leading index shouldn’t surprise anyone either, but apparently it does, because the data clearly show that it has a significant impact on the currency markets. The index is comprised of indicators that have already been released, so in theory there should be no new information in it. It’s expected to drop notably to the lowest since August last year, which could be negative for the dollar.

Finally, Bank of Japan Gov. Kuroda speaks at the annual meeting of the National Credit Union. He usually says the same thing, which is that the BoJ will eventually hit its 2% inflation target and until then we’re sticking with the plan. For example, at the recent Branch Managers’ meeting (10 Oct) he said he expected inflation to pick up as the output gap improves and that the BoJ would continue to expand the money supply until the CPI overshoots the target. I don’t see how he can go beyond that, so I doubt if today’s speech will have much impact on the FX market.

This article comprises the personal view and opinion of the STO Investment Research Desk and at no time should be construed as Investment Advice.

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