Fixed Income Research & Macro Strategy (FIRMS) from 4X Global Research

·         The Dollar remains range bound, with the Nominal Effective Exchange Rate stuck in a 1.5% wide-range since early August, in line with our view.

·         Market pricing of Fed hikes in 2019 has risen to about 52bp, pulling long-end US treasury yields higher in the process, but this has not helped the Dollar much. There are several reasons behind this (partial) disconnect.

·         For starters, the Dollar up-trend is already six-months old and long-Dollar positions elevated.

·         Second, high-yielding emerging market currencies have staged somewhat of a comeback following their August collapse.

·         Third government bond yields in other developed economies have also risen which has eaten into the Dollar’s relative yield attractiveness.

·         Finally, we see the risk tilted towards US GDP growth having slowed in Q3 from an impressive 4.2% qoq annualised in Q2.

·         What (overly?) higher US real yields have done is created a modicum of panic in US equity markets and we are sticking to our view that the outlook for the Dollar (and other major currencies) remains cloudy in coming months given sizeable event risk.

·         The Sterling NEER, which rose about 3.7% between end-August and 10th October, has in the past ten days retraced about a third of these gains. A contraction in retail sales and larger-than-expected fall in CPI-inflation in September have certainly played their part.

·         However, it is the breakdown in Brexit negotiations between the UK and EU with time running out which has arguably seen Sterling lose its footing.

·         The jury is out as to what will happen next but there is little doubt in our view that British Prime Minister May’s failure to put forward a deal acceptable to a divided cabinet, parliament and electorate and palatable to the EU is largely a self-inflicted injury borne out of poor preparations, poor leadership and poor execution – a risk we flagged nearly two years ago.

·         While US President Trump and Brexit continue to hog the headlines, the Euro has stolen the limelight in the past week, for all the wrong reasons, having weakened about 0.8% in NEER terms to a two-month low.

·         By European standards, this is a pretty tame crisis but the Euro’s ongoing weakening may well have broader and more complex causes, including modest Eurozone economic growth and inflation and ongoing Brexit saga.

·         Emerging market currencies have on the whole slowly recovered since end-August, broadly in line with our view that “fears of emerging market currency contagion had been overdone”.

·         Emerging market central banks’ willingness to hike rates, and thus accept some near-term economic pain, has at the margin restored some market confidence in emerging market currencies, in our view.

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Ryan Littlestone

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