IGM Insights | Wednesday, 24th March 2021
Dollar momentum continues to build
Broad USD FX sentiment remains a key focus point in global macro markets. At the start of the year, the clear consensus was one of continued USD weakness, but this has unraveled as we progress towards the end of Q1. Surging US yields on the back of greater fiscal stimulus and the vaccine rollout is a strong point of differentiation for the USD at present.
The short USD trade, in tandem, continues to be unwound. The DXY is building a base above 92.00 and USD strength against emerging markets is broadening. One way to measure the breadth of USD strength is to look at how many key moving averages (MAs) the USD is trading above or below. We have derived a diffusion index of how many MAs the USD is above across the 20, 50, 100, and 200-day tenors. Our sample utilises 29 currencies across the developed and emerging market FX space.
At present the USD is above just over 68% of MAs against our sample of currencies. In the G10 space, the USD is above 75% of MAs. These are dominated at the 20-day tenor, where the USD is trading firmer against all the G10 currencies and 50-day tenor, where it is above 8 out of 9 MAs. For 100 day it is 7 out of 9 but only above 3 out of 9 in terms of 200-day MAs. This contrasts with the start of the year, where the USD was above virtually no moving averages against the major currencies.
In EM Asia, the USD is trading above just under 70% of MAs. Again, this is dominated by the 20 and 50-day tenor. It's a similar theme in EMEA EM, but LATAM FX is slightly more resilient at the moment, trading at above 60% of the MAs in our sample.
Interestingly, extreme readings in our USD MA diffusion index can signal exhaustion points in the market. Such thresholds are often seen in the 80-90% region in terms of topside USD strength. We aren't at this point yet in terms of this metric.
In terms of individual currencies, only 3 currencies out of the 29 in our sample, namely INR, ZAR, and CLP are above all their respective MAs against the USD.
Source: Extract of IGM FX Viewpoint
ECB's long Q2 supports Bund-UST widening
ECB Chief Economist Lane indicated that with rising virus numbers, Q2 is going to be a 'long quarter'. This should not be that surprising as a third wave spreads across the Euro Area. The ECB's latest forecasts, Lane notes, did allow for some extension into Q2. Lane's comments arose not long after Germany extended the lockdown until April 18 and after other countries imposed more stringent restrictions.
In Europe, the ongoing issue is vaccine deployment versus caseloads and until this is under control, downside risks are prominent in the near-term, even though there have been several pieces of news, including positive spill-overs from the US fiscal package, that point to 'renewed confidence' in the medium-term. In fact, underlying several of Lane's comments is the sense that the ECB would like to see a larger co-ordinated fiscal package, with European nations individually doing quite a bit.
All that said, with the US fiscal package already passed (and there is talk of another huge dose doing the rounds), the perception is that the EMU is struggling to keep up with the US in terms of the economic rebound. This alone should indicate Transatlantic spread widening. Add in ECB purchases, where the latest batch of PEPP statistics have indicated this is on the rise, and the balance of risks skews towards further spread widening, which recently (and briefly) saw the UST-Bund 10yr spread break over 200bp for the first time since February 2020.
Source: IGM Rates
Russian Rouble in the face of new sanctions
New US sanctions are expected to be unveiled on Russia, that could range from freezing the US assets of Russians to the extreme step of targeting the nation's sovereign debt, which it has stopped short of in the past amid concerns it could destabilise global markets.
There has also been talk that the Biden administration is weighing additional sanctions to block the construction of the nearly completed Nord Stream 2 pipeline from Russia to Germany.
For investors with a medium or longer-term view, the consensus has always been that penalties will be manageable, so long as Washington or Europe do not make it illegal to own Russian sovereign debt and we suspect there are investors still willing to draw on past experiences that sanctions will not pose a material risk to Russia's markets and macroeconomic outlook.
For us, the Rouble still carries the appeal of competitive carry, along with some security in the shape of Russia's well over USD500bn worth of gold and foreign currency reserves and conservative fiscal policy, in addition to a transparent central bank that is now on the path to policy normalisation.
While the USD/RUB is currently trading at highs since early March, the Rouble has in fact remained resilient this year compared to its EM peers. This has been largely to firmer oil prices, which have offered a cushion against the risk-averse pressures associated with rising UST yields and any concerns related to new US sanctions.
As such, should the new US sanctions stay limited to personal restrictions and perhaps also include additional measures against Nord Stream 2, we would look for USD/RUB to settle back under the 74 handle, possibly under 73.000 in due course, barring any sharp deterioration in the general risk mood.
Source: Extract of IGM EM Viewpoint
China: Let's capitalize on government deleveraging
The COVID pandemic will sooner or later end. However, the significant deterioration of fiscal balances and public debt built-up across both EMs and DMs is a legacy that will confront investors and challenge policymakers for many years to come. In China, Premier Li Keqiang in his government work report (GWR) at the NPC on 5 March, simply said one of his jobs in 2021 is to maintain the macro-leverage basically stable, without giving any further details. However, just two weeks after that, Li at the State Council's regular meeting on 15 March specifically stated that the government must reduce its own leverage this year, while maintaining the macro-leverage basically stable.
Without proposing any rail construction expenditure this year (vs CNY100bn in 2020), it should not be difficult for the government to reduce its own leverage as long as local government debt financing does not exceed the planned target CNY3650bn (vs CNY3750bn in 2020), which have offered a cushion against the risk-averse pressures associated with rising UST yields and any concerns related to new US sanctions.
With Premier Li clearly specifying the need to reduce the government's leverage on 15 March and his GWR setting a lower fiscal budget deficit/GDP ratio of 3.2% for 2021 (vs "above 3.6%" for 2020), we wouldn't be surprised by a slight decrease in net supply of Chinese Government Bonds (CGB) this year.
Based on the above scenario plus PBOC's bias in favour of a tighter liquidity environment, we also expect the non-deliverable IRS vs CGB spread, which is currently at a discount territory, will be moving towards par or even premium region over the rest of H1. As such, we think it's time to position ourselves to be long in CGB and a payer in onshore IRS.
Source: IGM China Insight
Subscribe to the bi-weekly IGM Insights here.