e-markets.nordea.com/article/44566/fx-weekly-the-sumo-soma-days

27 May 2018

FX weekly: TheSumo SOMA days

Martin Enlund | Andreas Steno Larsen

Large SOMA redemption days have coincided with strong USD performanceand weak risk appetite. The next big redemption day is May 31st – a sumoSOMA day! We stay tactically long the USD and short commodity FX.

Table 1: Our current list of convictions

Dollar-positive forecast revisions

Turning to our vanilla dollar analysis, a lot has favoured the greenback this year. US data has keptsurprising; maybe because of Trump's sentiment eects, or because of the direct eects from the tax reformand from government spending. US GDP growth expectations have nonetheless been rising as a result. Basedon recent ISM/PMI outcomes, this process of dollar-positive forecast revisions has only started.

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Chart 1: Growth expectations to favour the US further

The most recent regional surveys suggest a rebound in the ISM manufacturing number for May, which is alsowhat the consensus is looking for. The rebound in regional surveys can probably be explained by the ceasefire in the trade war (as sentiment soared in the Richmond Fed, a trade-dependent region due to harbours).You also have to wonder how much is priced-in. Both the US 10y yield and relative moves in the equity spacesuggests that a relatively nice ISM number may be mostly priced-in.

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Chart 2: Equity space pricing in a nice jump in ISM manufacturing

International politics are heating up

Turning to politics this year, fears that President Trump would put his so-called cronies in charge of theFed have not materialised - this may have eased a “Trump risk premium” which may have been present inthe dollar. While a civil war of sorts continue to be ongoing in US politics, those who have been waiting foran impeachment process against the President has had to wait, and wait for a smoking gun in Russiagate.Instead, President Trump’s approval rate is in a rising trend, and the political winds have started to favour theRepublicans ahead of the November election, though they face a sti uphill battle. The worst trade fears havealso failed to materialise (so far).

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Chart 3: The USD may have gotten a boost from a fading Trump risk premium

This list provides us with non-fundamental factors which might cause problems for dollar bulls. TheWhite House seeking taris on auto imports and the decision to cancel the June 12 summit between theUS President and North Korea’s Rocket Man serve as helpful illustrations, albeit mild ones. We also think itmakes sense for Trump to walk away from the negotiation table, from a game-theoretical point of view whichis what matters in negotiations… Judged from the signals send late Friday, he may already have won someNorth Korean concessions via this approach.

While we judge taris on auto imports to be fundamentally dollar-positive down the road, we think the near-term reaction would be to weaken the dollar. Furthermore, Russiagate’s Mueller is expected to present areport this summer. The Democratic Party and all other “nevertrumpers” are naturally wishing for somethingreally juicy. The Mueller report might cause dollar selling in coming months, should the final report confirmsuch hopes.

Before turning way more unorthodox, let us comment on the Euro area. EA growth expectations havestarted to be revised lower. The consensus forecast for 2018 has been cut to 2.3% from 2.5% a couple ofweeks ago. Further, negative, revisions are likely.

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Chart 4: Sweden is indeed a canary in the European coal mine

This slowdown is however not surprising to us. For instance, we’ve argued Sweden is a canary in theEuropean coal mine, as a small an open export-dependent country which picks up changes in global demandfaster than the Euro Area juggernaut. Therefore Swedish PMI tells us where Euro Area PMI will head a coupleof months later. On our models, the Euro area will keep losing growth momentum, meaning it will be harderand harder for the ECB to blame influenza, or weather…

And adding to the woes for the ECB, both Italian and now also Spanish politics have entered the frame onceagain. Mariano Rajoy faces a motion of no-confidence, initiated by the PSOE and while Rajoy survived a voteof no confidence roughly a year ago (June 2017), his backing seems less obvious now.

The cocktail of both Italian and Spanish political turmoil took its toll on EUR bond markets on Friday. Thereis a clear risk that an even wider Italy-German 10yr spread, will start to spill-over substantially to other EMUassets. Especially since Draghi and co will likely not stand ready to underpin markets (or credit specifically)in a way that is comparable to earlier times. After all, sources told the media on Friday that there is stilluniformity within the ECB in the expectations that QE will be phased out this year.

A deflationary dash for dollar cash?

One interesting question is why it took so long before the dollar picked up speed this year. While e.g. surpriseindices and equity market movements suggested the dollar ought to gain as per usual patterns, EUR/USDwas stable and range-bound until mid-April, when something in the global financial system seems tohave happened.

e-markets.nordea.com/article/44566/fx-weekly-the-sumo-soma-days

Was it the trend higher in US 10y yields which caused it, or was it something else? And besides, if it was the10y yield breaking up which has caused the dollar move, what caused the move in the 10y yield?

Chart 5: EM FX reserves tend to dwindle when the Fed “unprints”

Since mid-April, USTs in custody on behalf of foreign agents (a proxy of EM FX reserves) are down bysome 70bn. A negative shift in US excess liquidity momentum has led to weaker EM FX reserve growth in thepast: when the Fed “unprints” money, EM FX reserves tends to drop.

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Chart 6: HKMA has been buying plenty of HKD since mid-April

Hong Kong’s HKMA has also been forced to intervene to buy HKD since mid-April, and it has been buyingsome HKD70bn since then.

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Chart 7: Fed’s earlier balance sheet expansion impacted foreign banks more than it did US banks

But, to make the picture more intriguing, we can first conclude that Fed’s earlier balance sheet expansionhad an outsize impact on foreign banks’ cash holdings. In the QE years of 2009 to 2015, newly createdmoney had an outsized impact on the amount of cash assets these banks hold. Reserves and cash aspercentage of total assets rose from 5% in 2008 to a peak of around 55% in 2014.

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Chart 8: Foreign banks have rebuilt cash holdings since mid-April – why?

And since mid-April, these non-US banks have rebuilt their holdings of cash assets! As a result of the Fed’sunprinting of US excess liquidity, the pool of super-safe cash assets will dwindle (unless the Treasurystarts to issue a lot of T-bills).

If demand for US cash assets from these banks is inelastic, the Fed’s unprinting might cause assetdeflation as these banks sell other assets to rebuild cash buers. For instance, if these banks were holdingEUR, EM FX and Treasuries in the beginning of April, they might have sold these assets to rebuild cashholdings. But if there’s truth to this story, the coming acceleration the Fed’s “unprinting”, may continue tocause volatility and stress across global markets (hopefully milder than in 2014…)

Are SOMA redemptions causing dollar strength and risk aversion?

The Fed is gradually letting its balance sheet shrink at a quicker and quicker pace, with a maximum shrinkageof USD50bn/month reached in Q4, 2018 (of which 30bn can be bonds and notes).

On some days, liquidity shrinks a lot, most other days, not at all. From the maturity profile of the Fed’sbond portfolio (the SOMA portfolio) we know when these negative liquidity impacts will take place.

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Table 1: Daily schedule of maturing T-bonds and notes held in the Fed’s SOMA portfolio

For those interesting in really short-term moves on financial markets, we like to point out that the three mostrecent redemptions has coincided with dollar strength and weaker risk sentiment. This is the mirrorimage of past “POMO days”, when Fed added liquidity to the system.

The next big redemption day is May 31, when 28.5bn comes due – a Sumo SOMA day! US excess liquiditywill shrink almost 10bn. A similar amount came due in mid-May, when the dollar moved 0.7% higher and theS&P500 moved 0.7% lower. Will we see a repeat? Time will tell.

SEK: Where's the fingerspitzengefühl?

In mid-January, the prevailing winds in financial markets were of a hawkish nature, and almost everybodyinterpreted the Riksbank too hawkishly at the time. The Riksbank eventually struck a dovish tone in February,and even more so in April when it flattened its repo rate path despite a ~7% weaker SEK than they hadanticipated before the meeting.

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Parts of the April report might have been read as SEK-positive in dierent circumstances. But when GovernorIngves was pressed about the Riksbank’s change in FX rhetoric and the lofty EUR/SEK cross at the Aprilpress conference, he concluded that EUR/SEK at 13 would not be problem because the Riksbank has gotinflation target. It is hard to see such remarks as SEK-positive.

Chart 9: Sweden CPIF inflation to climb well above target

Here we are, roughly one month later, and market participants are again betting on Riksbank rate hikes.Various Riksbank ocials have toned down the central bank’s reliance on the currency as a way to boostinflation and talked up the scope for a hike later this year. Globally, the changing inflation landscape is helpful.Swedish CPIF inflation might rise to 2.3% or so in coming months. Whether the Riksbank does hike later thisyear will depend on whether it will choose focus on headline CPIF inflation or on measures of underlyinginflation (we predict unchanged rates until 2019).

Had the Riksbank showed more fingerspitzengefühl in recent months, it would not have created thisunnecessary volatility in the krona. The Riksbank might have hinted earlier that a too high EUR/SEK wasn’tnecessarily welcome either. Deputy Governor Flodén has expressed this view in the past.

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Chart 10: Despite getting a lift, the SEK is still weaker than Riksbank anticipated for Q2

The recent move by the Swedish National Debt Oce to bet on a stronger SEK has also helped the krona.The amount isn’t large (a SEK7bn position), but the signal value is there. For instance, when the SNDO tooka SEK50bn positioning in H1, 2009 it (roughly) marked the bottom in the SEK. The SNDO eventually made atidy 16% profit.

One can also view the SNDO’s decision in a less benign way. After years of the Riksbank working to turnthe SEK more or less into confetti, here comes SNDO and does the opposite! Indeed, commenting uponthe SNDO’s move which can be seen at odds with the wishes of the Riksbank, Deputy Governor Jansson jokedthat “it’s also said that the murder of [King] Gustav III was the fault of the debt oce”. Sweden’s “policymix” is likely to continue to bewilder investors; some might even go so far so as to call Sweden a bananamonarchy.

The latest strengthening of the trade-weighted krona should however not be worrisome from a monetarypolicy perspective. The SEK is still 1% weaker than Riksbank anticipated for Q2, and 3.5% weaker thananticipated for Q3. The Riksbank's KIX forecasts are consistent with EUR/SEK at 10.15 in Q2, and at 9.90 inQ3. With inflationary winds blowing, currency traders are thus free to push the krona stronger still.

We stick to our short commodity currency bets

In light of negative bias on risk appetite (among other things SOMA-related, as showed above), we stick toour bearish view on commodity FX for now.

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Another way to showcase why commodity FX could face a tough summer is via the typical lag-time in theChinese impulse on industrial metal prices. Tailwinds are clearly fading for industrial metals and e.g. theAUD may suer as a consequence. The latest oil supply news also the support the idea that the tailwindswill fade for oil related FX. And when the CAD has failed to capitalize on a materially higher oil price, whatwill then happen, if the oil price momentum fades again? Via the same logic we are also sceptical towards theNOK short-term. We though expect Norges Bank to re-underpin the NOK later this summer.

Chart 11: Commodity tailwinds are fading

And while this may not be the most sophisticated analysis in the history of FX strategists, our keep-it-simpletrade idea on EUR/PLN has played out nicely so far. Poland (and Hungary) are high beta currencies toEuro area (and in particular German) performance. So when the tide turns on the Euro area momentum, itusually spills over to weaker PLN (and HUF) after a while. With the Euro area surprise index as depressed asnow, EUR/PLN could see more upside over the coming 1-2 months.

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Chart 12: If the Euro area momentum fades, then buy EUR/PLN (and EUR/HUF)

 

Previous FX weeklies:

·FX weekly: EM won't be sprinting, if the Fed is unprinting (20 May)

·FX weekly: The two final nails in the dovish FOMC-con (13 May)

·FX weekly: Is there anything left in the USD bull-run? (06 May)

·FX weekly: Dragon Energy (29 Apr)

·FX weekly: Relative curvature is the new king of FX (22 Apr)

·FX weekly: Why is EUR/USD not trading lower? (15 Apr)

·FX weekly: Like watching paint dry, they said (08 Apr)

·FX weekly: The list of potential USD-positives is getting longer (01 Apr)

·FX weekly: 2 reasons why EUR/USD has decoupled from rates spreads (25 Mar)

·FX weekly: Time to buy a USD lottery ticket? (18 Mar)

·FX weekly: Taxation mirror on the wall, who is the fairest of them all? (11 Mar)

e-markets.nordea.com/article/44566/fx-weekly-the-sumo-soma-days

·FX weekly: Trump's game of chicken (04 Mar)

·FX weekly: Will the market neglect the clutch of canaries? (25 Feb)

·FX weekly: Is the correlation break-down driven by FX hedges? (18 Feb)

·FX weekly: The liquidity tide is ebbing (11 Feb)

·FX weekly: Hawkish spectacles (04 Feb)

·FX weekly: Who will stop EUR/USD from moving higher? (28 Jan)

·FX weekly: Did the Democrats dent the Dollar? (21 Jan)

·FX weekly: Is 1.25 the new 1.20? (14 Jan)

·FX weekly: The euphoria rises (07 Jan)

·FX weekly: Paging Dr. Pangloss (01 Jan)

·FX weekly: The R-star of Bethlehem (24 Dec)

·FX weekly: A numbers game (17 Dec)

·FX weekly: The year-end liquidty shrink (10 Dec)

·FX weekly: Three reasons why EUR/USD isn't trading lower (03 Dec)

·FX weekly: Which currencies to sell if the housing downturn continues? (26 Nov)

·FX weekly:  The global industrial cycle is set to weaken (19 Nov)

·FX weekly: Is high-yield a canary in the global coal mine? (12 Nov)

·FX weekly: Is this the end of the inflation convergence trade in EUR/USD? (5 Nov)

·FX weekly: Was that it for the EUR bulls? (29 Oct)

·FX weekly: Hawks in opposition, doves in charge (22 Oct)

· FX weekly:Continued convergence or re-divergence?(15 Oct)

·FX weekly: Thingsdon't matter until they do(08 Oct)

·FX weekly:"October seasonality is strong" (01 Oct)

·FX weekly:“Is 1.20 the new 1.15?”(24 Sep)

· FX weekly:Honey, I shrunk the balance sheet(17 Sep)

· FX weekly: “USD liquidity will turn scarcer, but when?” (10 Sep)

· FX weekly:“Strong currencies and inflation”(3 Sep)

e-markets.nordea.com/article/44566/fx-weekly-the-sumo-soma-days

· FX weekly:“USD in the (Jackson) hole” (27 Aug)

· FX weekly:“Q4 is the USD quarter”(20 Aug)

· FX weekly:“In the year 2525”(13 Aug)

· FX weekly:“EUR/USD ceiling or debt ceiling?”(6 Aug)

· FX weekly:“Elevator up, stairs down “(30 Jul)

· FX weekly:Trump “spices” up EUR/USD(23 Jul)

· FX weekly:Flip-flop?(16 Jul)

· FX weekly:Consolidation time?(9 Jul)

· FX weekly:Hawks R Us(2 Jul)

· FX weekly:Another lowflation week?(25 Jun)

· FX weekly:No Fed put?(18 Jun)

· FX weekly:A bouncy dollar?(11 Jun)

· FX weekly:Heating up(4 Jun)

· FX weekly:Summertime sadness(28 May)

· FX weekly:Special counsel lessens Trumpbulence, while OPEC looms(21 May)

· FX weekly:Are China worries old hat?(14 May)

· FX weekly:Inflation week…(7 May)

Martin EnlundChief AnalystMartin.Enlund@nordea.com

Andreas Steno LarsenGlobal FX/FI Strategistandreas.steno.larsen@nordea.com+45 55 46 72 29

28.9.2017

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