USD lagging yields
US equity markets wasted no time after the long weekend rallied to new record highs. The general optimism relies on the strong economic outlook. Fed speakers sounding increasingly hawkish, suggesting a steeper rate path but also US economic acceleration, which will support corporate earnings. Fed president Hackers added his name to members that support a March hike causing Fed Funds rate to jump. Given OIS underpricing a March hike (rate only pricing in two hikes and not three) we see possibility of a short term USD rally. Interestingly, US yields continue to rise on higher than expected CPI read, forcing spreads between US and DM to widen. However, the USD has failed to meaningfully follow this generally solid indicators. We suspect the lag between US interest rate differentials and USD is a function of increasing expectations for accelerating global growth. Given the considerable room for short term US rates to adjust higher we just need a catalyst. This could be Trump’s “phenomenal” tax reform, which has been promised to be released within a month. The merely materialization of stimulus will likely be enough to excite bullish economic forecasts and force markets to reevaluate underpricing.
UK: Hefty bill reinforces soft Brexit
On the surface European Commission President Jean Claude Junker’s comments over the “very hefty” bill for Brexit sounds like a dire warning. Yet in our view his words actually reinforce the view that a “soft” Brexit is the only realistic path. In a speech to the Belgian Federal Parliament, Junker indicated that UK would face “tough negotiations” and would not be “at a discount or at zero cost”. Back of the envelope reports have the further payments to the EU at €60 billion. Money that will be used for UK spending commitments made during membership. It is unlikely that divorce settlements will be made in a single lump payments but rather steady payments which will ensure the UK’s deep involvement in EU issues. We anticipate the Notification of Withdrawal Bill will passed into law allowing Prime Minister Theresa May to trigger Article 50, starting the long drawn-out process (despite political suggestions to the contrary). Sterling could come under short term selling pressure heading into March due to Article 50 uncertainty yet improving UK domestic and external fundamentals will further support economic recovery and GBP strength.
Switzerland: SNB can’t stop the demand
SNB sight deposits indicated another significant round of FX intervention last week. In the last month the SNB has injected approximately 12bn CHF to support the EURCHF un-official floor at 1.06. Swiss economic data remains strong with CPI tuning positive and cross boarder M&A flow strong. In addition, mounting political risk in European will continue to haunt the SNB. CHF remains the primary safe haven trade for European investors. Heading into a contentious period for European with election cycle underway and UK article 50 preparing to be launch, short EURCHF remains one of our favorite plays.
No Greek Drama
Current negotiations over Greek debt could be the least suspenseful script since N. Shyamalan’s “The Happening.” After public clashes between EU, IMF and Greek officials over sustainability of Athen debts reports from Euro-group meeting indicate a deal is in reach for Greece’s third bailout. Officials will head to Athens to finalize details of a deep reform package that include pension cuts and broader scope of income tax (convergence of EU and IMF views). This will allow Greece to receive the bailout funds to meet Julys €7bn debt repayment. Despite marginal yield spread widening between German and Greek sovereign debt the market seems, correctly, unconcerned over the Greek bailout program. The reality is that even the current headwinds the EU is facing (Brexit, Trump administration, election cycle) the cost of “kicking the can” down the road is a low risk solution. EU officials at this point need to contain the growing sentiment that the EU experience is unsustainable especially in Netherland and France. The hype around negotiations is a perfect example, in our view, of a key 2017 trend of market noise clouding fundamentals realities. In our view, current euro weakness is a function of mounting EU political risk emulating from impending Dutch and French elections. Moving forward, Greek debt sustainability must come with debt relief, especially with interest rates marching higher.