Daily Currency Briefing: Copernican revolution

US survey-based inflation expectations
Inflation in the Scandies
TRY: Pressure on lira continues despite positive data
CNY/CNH weakness is inevitable


G10 FX Research

USD: It is well known that for a long time the FOMC mainly looked at poll-based inflation expectations rather than market based ones. It would be naughty to put this down to the fact that the former seemed much better for a long time. That is no longer the case. The long term inflation expectations which the University of Michigan polls every month were very volatile recently but on the whole displayed a clear downward trend. In other words the publication of the “UMich“ will be interesting. A low result might weaken the position of the FOMC hawks and therefore put pressure on the greenback. Not because it would question the December lift-off but because the December lift-off creates an effect that makes the quick continuation of the rate hike cycle seem unlikely from the market’s point of view.

NOK, SEK: Yesterday the Offices for Statistics in Sweden and Norway published the November inflation data. In Sweden were excessively low inflation has been a problem for a while the November rate was surprisingly low. In Norway, the only G10 economy with above-target inflation levels, the result was surprisingly high. All central banks seem to get what they least need at the moment. Which takes us back to the phenomenon that inflation is too low in most G10 countries apart from the commodity exporters (CAD, AUD, NOK; see chart 1 in attached pdf file).

In Norway the problem can be explained with standard economic theory: the fall of the oil price has led to a notable deterioration of Norway’s terms of trade (the relation between export and import prices) – which would usually have a deflationary effect if there wasn’t the exchange rate effect. The (real) depreciation of the Norwegian krone roughly corresponded to the deterioration of the terms of trade (chart 2 in the pdf). Based on the usual approximations that means that the inflationary effect of the weak currency dominates and inflation should rise in the short run rather than ease. Long term the deflationary terms-of-trade effect should of course dominate – which is why Norges Bank tends to see through the currently high inflation rates and seems to be implementing an expansionary monetary policy that is not in line with current inflation developments. Of course as far as communications is concerned that resembles a tight rope walk that has not become any easier with yesterday’s data. That is why the renewed fall in oil prices will not necessarily lead to another immediate Norges Bank rate cut as early as next week. Norges Bank may speculate on a rate cut becoming easier in Q1. Should oil prices collapse once again the Norwegian krone should therefore be relatively well supported short term.

However, in the case of Sweden standard economics fail. In Sweden we see an (inflationary) improvement of the terms of trade, (inflationary) real depreciation and an (inflationary) expansionary monetary policy. Why inflation nonetheless remains close to zero is part of the global conundrum that economists face at present. Explanations that are being discussed: “global savings glut”, “secular stagnation” and “neo-Fisherian models”. Our economists too are contributing to the debate. Once again (as was the case in the 1930ies with the Keynesian and in the 1970ies with the New Classical revolution) we are facing a Copernican revolution in economics. Only that it hasn’t been decided yet which explanation will provide the solution. Until that becomes clear Riksbank at least will stick to the old models and strategies of direct inflation control. It has made that clear. And that implies: it sees the need to act while the rate of inflation is so clearly below Riksbank’s target. No matter how positive the real economic data is. Dips in EUR-SEK remain a good entry point for EUR-SEK longs.


Emerging-Market-Research

TRY: The lira continued to weaken during trading yesterday despite the release of positive economic data. Q3 GDP data showed a strong 1.3% m/m increase vs. just 0.4% increase expected by the consensus. Growth was powered by inventory re-build following the extreme drawdown of Q2, and also punchy public sector spending which is understandable in a year of multiple elections and increased military activity. While some of these boosts were temporary, the establishment of a stable government in Q4 -- which came as a complete surprise -- will now unleash pent-up demand for consumption and fixed investment through H1 2016; in other words, those temporary boosts will be followed by other temporary boosts. We see significant upside potential for the consensus growth forecast for 2016, which is currently in the 3% region. Turkey also released October current-account data, which showed a sharply narrower current-account deficit compared with normal seasonal pattern. The improvement of the past quarter has been entirely driven by a smaller energy import bill, but this dynamic will be in place through most of H1 2016, and the contribution of net exports will turn increasingly positive over the coming quarters.

The lira's (lack of) response probably had to do with negative spill-over coming from the ZAR and generally softer EM mood, with Turkish equities also selling off by a fresh 3% yesterday. Nevertheless, the fundamental data were positive and support our above-consensus 3.6% GDP growth forecast for 2016.

CNY: USD-CNH experienced a wild session yesterday. USD-CNH breached above 6.54 in the morning of London trading session yesterday, but then strong selling USD flows emerged in the market, which pushed USD-CNH back down to 6.49 in today’s Asian early morning session. There is no doubt that China’s central bank stepped into the market to narrow the CNY-CNH spread, which signals that Chinese authorities deem that yesterday’s market movement was “out of control”. In onshore market, we also saw strong USD purchase flows from Chinese corporates in the past few days, while exporters prefer to hold USD on hand. As a result, in order to moderate the pace of CNY/CNH depreciation, China’s central bank needs to pump greenbacks into the system. In our view, when PBoC set USD-CNY fixing at above 6.40 this Tuesday, this kicked off a “stress test”: the central bank needs to see the market response to a weaker CNY, and unfortunately this test needs to be done before the Fed’s rate hike. So far, we have seen the results of this test: the demand for USD is substantial. That said, the central bank will continue to sell USD when market enters a “panic mode”, but the trend of CNY/CNH weakness is inevitable.