Currencies

Highlights The unifying chorus among global central banks is currently for more monetary stimulus. In the race towards lower interest rates, the ultimate winners will be pro-cyclical currencies. Italian 10-year real government bond yields are rapidly joining those in Spain and Portugal in being below the neutral rate of interest for the entire euro zone. This is hugely reflationary. That said, growth barometers remain in freefall, suggesting some patience is still warranted.  We are watching like hawks a few key crosses that are sitting at critical technical levels. A break below will signal we are entering a deflationary bust. A bounce could be a prologue to a reflationary rally. Watch the bond-to-gold ratio to gauge where the balance of forces are shifting for the U.S. dollar. Tepid action by the BoJ this week reinforces our view that the path towards additional stimulus will be lined by a stronger yen. Stay short USD/JPY. We were a few pips away from our stop loss on long GBP/USD this week. Stand aside if triggered. The Norges Bank has emerged as the most hawkish G10 central bank. Hold long NOK/SEK and short CAD/NOK positions. Feature As early as 1625, Hugo De Groot, then a Dutch philosopher, saw the act of pre-emptively striking an enemy as a move of self-defense. With a mandate of self-preservation, it made sense for a country to wage war for injury not yet done, if sufficient evidence pointed to colossal damage from no action. So faced with some important central bank meetings this week, and European manufacturing data well into freefall, the European Central Bank pulled a trick out of an old playbook. At an ECB forum in Sintra, Portugal, President Mario Draghi highlighted that if the inflation outlook failed to improve, the central bank had considerable headroom to launch a fresh expansion of its balance sheet. With its next policy meeting not until July 25th, it sure did feel like the ECB was cornered. What followed was as expected, a more dovish Federal Reserve, Bank Of Japan and Bank of England. Paradoxically, those two words might have opened a reflationary window and triggered one of the necessary catalysts for a sharp selloff in the U.S. dollar (Chart I-1). Time Lags The key question today is whether central banks have sufficiently eased policy to stem the decline in manufacturing data. Obviously, the trade war remains a key risk to whatever direction indicators might be pointing to today, but a few key observations are in order. Chart I-1A Countertrend Rally Underway Chart I-2Dovish Central Banks Should Help Growth Our global monetary policy barometer tends to lead the PMI by about six months. It tracks 29 central banks, gauging which have tightened policy over the last three months and which have not. Since the global financial crisis, whenever the measure has hit the critical threshold of 15-20%, it has correctly signaled that the pace of manufacturing activity is likely to slow. It is entirely another debate whether or not the world we live in today can tolerate higher interest rates, but our barometer has clearly plunged into reflationary territory – below the 20% threshold. This has usually been followed by a pick-up in manufacturing activity (Chart I-2). Data out of Singapore has been a timely tracker of global trade and warrants monitoring. Most real-time measures of economic activity remain weak, especially in the export sector, but it appears shipping activity may have been picking up pace over the past few months. Both the Harpex Shipping Index and the Baltic Dry Index have been perking up. Similarly, vessel arrivals into Singapore that tend to lead exports have stopped their pace of deceleration. It is still too early to read much into this data, since it could be a reflection of re-stocking ahead of possible tariffs. That said, data out of Singapore has been a timely tracker of global trade and warrants monitoring (Chart I-3). Chart I-3ASigns Of Life Along Shipping Lanes Chart I-3BWatch Activity At Singaporean Ports Chinese money growth, especially forward-looking liquidity indicators such as M2 relative to GDP, has bottomed. Historically, this has lit a fire under cyclical stocks, and by extension pro-cyclical currencies. This is also consistent with the fall in Chinese bond yields that has historically tended to be supportive for money growth in the ensuing months (Chart I-4). Overall industrial production remains weak, but the production of electricity and steel, inputs into the overall manufacturing value chain, are inflecting higher. Intuitively, these tend to lead overall industrial production. In recent weeks, both steel and iron ore prices have been soaring. Many commentators have attributed these increases to supply bottlenecks and/or seasonal demand. However, it is evident from both the manufacturing data and the trend in prices that demand is also playing a role. Overall residential property sales remain soft, but the evidence from tier-1 and even tier-2 cities is that this may be behind us. A revival in the property market will support construction activity, investment and imports (Chart I-5). Chart I-4A Bullish Signal For Chinese Liquidity Finally, high-beta currencies such as the RUB/USD, ZAR/USD and BRL/USD have stopped falling and are off their lows of the year. These currencies are usually good at sniffing out a change in the investment landscape, specifically one becoming more favorable to carry trades. The message so far is that the drop in U.S. bond yields may have been sufficient to make these currencies attractive again (Chart I-6). On a similar note, if currencies in emerging Asia that sit closer to the epicenter of Chinese stimulus can rally from here, it would indicate that policy stimulus is sufficient, and that the transmission mechanism is working. Chart I-6High-Beta Currencies Have Stopped Falling Chart I-7AUD/JPY Near A Critical Level Importantly, the AUD/JPY cross is sitting at an important technical level. Ever since the financial crisis, 72.5 has proven to be formidable intra-day resistance, with the cross failing to break below both during the euro area debt crisis in 2011-2012 and the China slowdown of 2015-2016. Speculators are neutral on the cross, suggesting any move in either direction could be powerful and significant. A break below will signal we are entering a deflationary bust. A bounce could be a prologue to a reflationary rally (Chart I-7). Bottom Line: We are watching a few key reflationary indicators to gauge whether it pays to be contrarian. The message is tipping in favor of pro-cyclical currencies, and further improvement will give us the green light to adopt a more pro-cyclical stance.  The Message From The U.S. Dollar The market interpreted the Fed’s latest monetary policy announcement as dovish, even though the central bank kept rates on hold. What transpired during the conference was the market increasing its bets for more aggressive rate cuts. The swaps market is currently pricing in 94 basis points of rate cuts over the next 12 months, versus 76 basis points a fortnight ago. This shift has pushed down the dollar, lifting other currencies and gold in the process. U.S. bond yields have also punched below 2%. Interest rate differentials are moving against the dollar, but our important takeaway – that gold continues to outperform Treasurys – is an ominous sign. Even before the financial crisis, a long-standing benchmark for gauging ultimate downside in the dollar was the bond-to-gold ratio. This is because gold has stood as a viable threat to dollar liabilities, capturing the ebbs and flows of investor confidence in the greenback tick for tick. Any sign that the balance of forces are moving away from the U.S. dollar will favor a breakout in the bond-to-gold ratio. Chart I-8Major Peak In The Bond-To-Gold Ratio? The rationale is pretty simple. Investors who are worried about U.S. twin deficits and the crowded trade of being long Treasurys will shift into gold, since pretty much every other major bond market (Germany, Switzerland, Japan) have negative yields. That favors gold at the expense of the dollar. The reverse is true if investors consider Treasurys more of a safe haven. The bond-to-gold ratio and dollar tend to move tick for tick, so a breakout in one can be a signal for what will happen to the other. This is why we are watching this ratio like hawks, and the breakdown this week is a bad omen for the U.S. dollar (Chart I-8). The euro might be the biggest beneficiary from the fall in the dollar. The standard dilemma for the euro zone is that interest rates have always been too low for the most productive nation, Germany, but too expensive for others such as Spain and Italy.1 As such, the euro has typically been caught in a tug-of-war between a rising equilibrium rate of interest for Germany, but a very low neutral rate for the peripheral countries. The silver lining is that the ECB may now have finally lowered domestic interest rates and eased policy to the point where they are accommodative for almost all euro zone countries: 10-year government bond yields in France, Spain, Portugal and even Italy now sit close to or below the neutral rate (Chart I-9). The ECB may now have finally lowered domestic interest rates and eased policy to the point where they are accommodative for almost all euro zone countries. Chart I-9The ECB May Have Won The Euro Battle The drop in the euro since 2018 has also eased financial conditions and made euro zone companies more competitive. This is a tailwind for European stocks. Fortunately for investors, European equities, especially those in the periphery, remain unloved, given they are trading at some of the cheapest cyclically adjusted price-to-earnings multiples in the developed world. Analysts began aggressively revising up their earnings estimates for euro zone equities earlier this year, relative to the U.S. If they are right, this could lead into powerful inflows into the euro over the next nine to 12 months (Chart I-10).  Chart I-10The Euro May Be On The Verge Of A Major Pop Bottom Line: Falling rate expectations relative to policy action have historically been bearish for the dollar with a lag of about nine to 12 months. The dollar has been relatively resilient, despite interest rate differentials are moving against it, but has started to converge towards lower rates. One winner will be EUR/USD. Stay Short USD/JPY The BoJ kept monetary policy on hold this week, but the message was cautious, even encouraging fiscal support. It looks like the end of the Heisei era2 has brought forward a well-known quandary for the central bank, which is that additional monetary policy options are hard to come by, since there have been diminishing economic returns to additional stimulus. This puts short USD/JPY bets in an enviable “heads I win, tails I do not lose too much” position. Chart I-11Stealth Tapering By The BoJ The BoJ maintained Yield Curve Control (YCC), stating it will continue to “conduct purchases of JGBs in a flexible manner so that their amount outstanding will increase at an annual pace of about 80 trillion yen.”3 But with the BoJ owning 46% of outstanding JGBs, about 75% of ETFs and almost 5% of JREITs, this will be a tall order (Chart I-11). The supply side obviously puts a serious limitation on how much more stimulus the central bank can provide. Total annual asset purchases by the BoJ are currently running at about ¥27 trillion, while JGBs purchases are running at ¥20 trillion. This is a far cry from the central bank’s soft target of ¥80 trillion, and unlikely to change anytime soon, given bond yields closing in on the -20 basis-point floor. This means interest rate differentials are likely to move in favor of a stronger yen short term (Chart I-12). The BoJ targets an inflation rate of 2%, but it is an open question as to whether it can actually achieve this. The overarching theme for prices in Japan is a rapidly falling (and ageing) population leading to deficient demand. More importantly, almost 40% of the Japanese consumption basket is in tradeable goods, meaning domestic inflation is as much driven by the influence of the BoJ as it is by globalization. Even for prices within the BoJ’s control, an ageing demographic that has a strong preference for falling prices is a powerful conflicting force. For example, transportation and telecommunications make up 17% of the core consumption basket in Japan, a non-negligible weight. This is and will remain a powerful drag on CPI, making it very difficult for the BoJ to re-anchor inflation expectations upward. The risk to short USD/JPY positions is that the BoJ will eventually act, but it may first require a riot point. On the other side of the coin, YCC and negative interest rates have been an anathema for Japanese net interest margins and share prices. This, together with QE, has pushed banks to search for yield down the credit spectrum. Any policy shift that is increasingly negative for banks could easily tip them over.  Chart I-12Can Japan Drop Rates Further? Chart I-13MMT Might Be What The Doctor Ordered Bottom Line: Inflation expectations remain at rock-bottom levels in Japan, at a time when the BoJ may be running out of policy bullets. Meanwhile, the margin of error for the BoJ is non-trivial, since a small external shock could tip the economy back into deflation. The risk to short USD/JPY positions is that the BoJ will eventually act, but it may first require a riot point (Chart I-13). A Final Note On The Pound A new conservative leadership is at the margin more negative for the pound (the assessment of our geopolitical strategists is that the odds of a hard Brexit have risen from 14% to 21%). However, our simple observation is that the pound is below where it was after the 2016 referendum results, yet more people are now in favor of staying in the union (Chart I-14). Chart I-14Support For Brexit Is Low, But Has Risen Chart I-15Low Rates Could Help British Capex   The BoE kept rates on hold following its latest policy meeting and will continue to err on the side of caution until the Brexit imbroglio is resolved. The reality is that the pound and U.K. gilt yields should be much higher solely on the basis of hard incoming data. Yes, the data has softened, but employment growth has been holding up very well, wages are inflecting higher and the average U.K. consumer appears in decent shape. Investment and construction have been the weak spot in the U.K. economy but may marginally improve on low rates (Chart I-15). We remain long the pound, given lower overall odds of a no-deal Brexit. That said, our long GBP/USD position was a few pips from being stopped out this week. Stand aside if triggered. Housekeeping Our stop-loss on long EUR/CHF was triggered at 1.11 yesterday. Stand aside for now, but we will be looking for opportunities to put this trade back on. Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1  Please see Foreign Exchange Strategy Weekly Report, titled “EUR/USD And The Neutral Rate Of Interest,” dated June 14, 2019, available at fes.bcaresearch.com. 2 The Heisei era refers to the period of Japanese history corresponding to the reign of Emperor Akihito from 8 January 1989 until his abdication on 30 April 2019. 3  Please refer to the Bank of Japan “Minutes of The Monetary Policy Meeting,” dated June 20, 2019, page 1. Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. have been mostly negative: Retail sales grew by 0.5% month-on-month in May. University of Michigan consumer sentiment and expectation indices both fell to 97.9 and 88.6 in June. However, current conditions index increased to 112.5. NY empire state manufacturing index came in at -8.6 in June, falling below 0 for the first time since October 2016. NAHB housing market index fell to 64 in June. Housing starts contracted by 0.9% month-on-month in May, while building permits increased by 0.3% month-on-month. Current account deficit decreased to $130.4 billion in Q1. Philadelphia Fed Business Outlook survey index fell to 0.3 in June. DXY index fell by 1% this week. This Wednesday, the Fed has kept interest rates steady at 2.5%, but left the door open for rate cuts in the future as Powell stated that “Many participants now see the case for somewhat more accommodative policy has strengthened.” The dollar has weakened in response to the dovish pivot. Report Links: EUR/USD And The Neutral Rate Of Interest - June 14, 2019 Where To Next For The U.S. Dollar? - June 7, 2019 President Trump And The Dollar - May 9, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been negative with muted inflation: Trade surplus narrowed to €15.3 billion in April. Headline and core inflation fell to 1.2% and 0.8% year-on-year respectively in May. ZEW survey expectations index fell to -20.2 in June. Current account surplus decreased to €20.9 billion in April. Construction output growth fell to 3.9% year-on-year in April. Consumer confidence fell further to -7.2 in June.  EUR/USD increased by 0.7% this week. The cross fell initially on Draghi’s dovish message that ECB would ease policy again should inflation fail to accelerate, then rebounded on broad dollar weakness this Wednesday following the Fed’s dovish pivot. However, the euro has weakened further against other currency pairs. Our EUR/CHF trade was stopped out at 1.11 on Thursday morning. Report Links: EUR/USD And The Neutral Rate Of Interest - June 14, 2019 Take Out Some Insurance - May 3, 2019 Reading The Tea Leaves From China - April 12, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mostly negative: Industrial production was unchanged at -1.1% year-on-year in April. Total adjusted trade balance decreased to -¥609.1 billion in May. Imports fell by 1.5% year-on-year, while exports contracted by 7.8% year-on-year. All industry activity index increased by 0.9% month-on-month in April. Machine tool orders continued to contract by 27.3% year-on-year in May. USD/JPY fell by 1.1% this week. BoJ kept the interest rate unchanged at -0.1% this week. In the monetary statement, the BoJ stated that the Japanese economy would likely continue expanding at a moderate rate, despite exogenous shocks. The current policy rates will be maintained at least through the spring of 2020. Report Links: Short USD/JPY: Heads I Win, Tails I Don’t Lose Too Much - May 31, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mixed: Retail price index increased by 3% year-on-year in May. Headline and core inflation fell to 2% and 1.7% year-on-year respectively in May. Total retail sales growth fell to 2.3% year-on-year in May. GBP/USD increased by 0.9% this week. The MPC voted unanimously to keep the interest rate unchanged at 0.75% this week. However, some policymakers have suggested that borrowing costs should be higher. The BoE however cut its growth forecast in the second quarter of 2019 amid rising global trade tensions and a fear of “no-deal” Brexit. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Take Out Some Insurance - May 3, 2019 Not Out Of The Woods Yet - April 5, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 There is little data from Australia this week: House price index contracted by 7.4% year-on-year in Q1. Westpac leading index fell by 0.08% month-on-month in May. AUD/USD rose by 0.7% this week. Our long AUD/USD came close to the stop-loss at 0.68 this Tuesday, then rebounded on dollar weakness and is now trading around 0.69. RBA governor Philip Lowe said that it was unrealistic to think that the single quarter-point cut to 1.25% would work to achieve its growth target, signaling more rate cuts and fiscal stimulus in the future. We are holding on to the long AUD/USD position from a contrarian perspective, and believe that the Aussie dollar will benefit as a pro-cyclical currency if the global growth outlook turns positive. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been mixed: REINZ house sales keep contracting by 7.8% year-on-year in May. Business Manufacturing PMI fell to 50.2 in May.  Westpac consumer confidence fell to 103.5 in Q2. Current account surplus widened to N$0.675 billion in Q1. GDP growth was unchanged at 0.6% in Q1 on a quarter-on-quarter basis. However, it increased to 2.5% on a year-on-year basis.  NZD/USD increased by 1.1% this week. Our bias remains that the New Zealand dollar has less room to rise compared to other pro-cyclical currencies if global growth picks up. Our SEK/NZD position is 1.3% in the money since initiated. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been mixed: Foreign portfolio investment in Canadian securities fell by C$12.8 billion in April. Bloomberg Nanos confidence increased to 56.9 in June. Manufacturing sales fell by 0.6% month-on-month in April. Headline and core inflation both increased to 2.4% and 2.1% year-on-year respectively in May, surprising to the upside. USD/CAD fell by 1.6% this week. The surprising Canadian inflation print, and oil price recovery are all underpinning the Canadian dollar in the short term. This Thursday, Iran shot down a the U.S. drone in Gulf, and fears have been rising of a military confrontation between the U.S. and Iran, which is bullish for oil prices and the Canadian dollar. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been positive: Exports and imports increased to CHF 21.5 billion and CHF 18.1 billion respectively in May, resulting in a higher trade surplus of CHF 3.4 billion. USD/CHF fell by 1.7% this week. The Swiss franc has strengthened significantly against the U.S. dollar and the euro following the more-than-expected dovish shifts by the ECB and the Fed this week. Our bias remains that the SNB will use the currency as a weapon to defend the economy. Report Links: What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been negative: The trade surplus narrowed to 11.3 billion NOK in May. USD/NOK fell by 1.6% this week. The Norges bank raised interest rates from 1% to 1.25%, the third rate hike during the past 12 months, and the Bank is also signaling more to come in the future. The Norges Bank remains the only hawkish central bank among all the G10 countries at this moment. The widening interest rate differentials and bullish oil outlook have been pushing the Norwegian krone higher. Our long NOK/SEK position is now 4.5% in the money. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been neutral: Headline and core inflation increased to 2.2% and 2.1 year-on-year respectively in May. Consumer confidence increased to 93.8 in June, while manufacturing confidence fell to 100.2. Unemployment rate increased to 6.8% in May. USD/SEK fell by 0.7% this week. Easing financial conditions worldwide remain a tailwind for global growth. Risk assets are rebounding with higher hopes of a trade deal as Trump will meet Xi at the G20 summit. We believe that the Swedish krona will benefit if global growth picks up in the second half of this year. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights A resurfacing of trade tensions could weigh on risk sentiment in the near term. A somewhat less dovish tone from the FOMC this month could further rattle risk assets. While we would not exclude the possibility of an “insurance cut,” the Fed is probably uncomfortable with the amount of easing that markets now expect. That being said, a trade truce is still more likely than not, and while the Fed will resist cutting rates this year, it will not raise them either. The neutral rate of interest in the U.S. is higher than widely believed, which means that monetary policy will remain accommodative. That’s good news for global equities. Investors should maintain a somewhat cautious stance over the next month or so. However, they should overweight stocks, while underweighting bonds, over a 12-month horizon. The equity bull market will only end when U.S. inflation rises to a level that forces the Fed to pick up the pace of rate hikes. That is unlikely to occur until late-2020 at the earliest. Feature Stocks Bounce Back We turned positive on global equities in late December after a six-month period on the sidelines. While we have remained structurally bullish over the course of this year, we initiated a tactical hedge to short the S&P 500 on May 10th following what we regarded as an overly complacent reaction by investors to President Trump’s decision to increase tariffs on Chinese imports. Our reasoning at the time was that a period of market pressure would likely be necessary to forge an agreement between the two sides. Our thesis was looking prescient for a while. However, the rebound in stocks since last week has brought the S&P 500 close to the level where we initiated the trade. Is it time to drop the hedge? Not yet. First, market internals do not inspire much confidence. Even though the S&P 500 is just below its year-to-date (and all-time) high, the Russell 2000 is 5.1% below its May highs, and 11.8% below where it was last August (Chart 1). The S&P mid cap and small cap indexes are 6.8% and 16.2%, respectively, below their highs reached last August. Such weak breadth is disconcerting. Chart 1U.S. Stocks: Not As Strong As They Appear Second, President Trump’s decision to suspend raising the tariffs on Mexican imports may have had less to do with his desire to seek a more conciliatory tone, and more to do with pressure from Congressional Republicans. Various news reports suggested that Mitch McConnell and other Republican leaders opposed the action, and threatened to revoke the President’s authority to unilaterally impose tariffs.1 In the end, the deal with Mexico contained many of the same measures that the Mexicans had already agreed to implement months earlier. Our geopolitical team remains skeptical of a grand bargain in trade talks with China.2 In the United States, protectionist sentiment is politically more popular towards China than it is towards other countries (Chart 2). A breakthrough is still probable, but again, it may take a stock market selloff to produce a trade truce.   Third, we have become increasingly concerned that the market has gotten ahead of itself in pricing in Fed easing. While we would not rule out the possibility that the Fed takes out an “insurance cut” to guard against downside risks to the economy, the 80 basis points of easing that the market has priced in over the next 12 months seems excessive to us. Chart 3Financial Conditions Have Not Tightened Much Unlike late last year, U.S. financial conditions have tightened only modestly over the past nine weeks (Chart 3). The economy is also performing reasonably well. According to the Atlanta Fed GDPNow model, real final sales to domestic purchasers3 are set to grow by 2.5% in the second quarter, up from 1.5% in Q1 (Chart 4). Real personal consumption expenditures are on track to rise by 3.2%. Gasoline futures have tumbled, which will support discretionary spending over the next few quarters (Chart 5).   Chart 5Lower Gasoline Prices Should Bode Well For Discretionary Spending Granted, the labor market has cooled down. Payrolls increased by only 75K in May. However, the Council of Economic Advisers estimated that flooding in the Midwest shaved 40K from payrolls. And even with this adverse impact, the three-month average for payroll growth still stands at 151K, well above the 90K-to-100K or so that is needed to keep up with labor force growth. Meanwhile, initial unemployment claims remain muted and the employment component of the nonmanufacturing ISM hit a seven-month high in May. Chart 6Trimmed Mean PCE Inflation Back To 2% Inflation expectations are on the low side, but actual inflation is proving to be reasonably sturdy. The core PCE index rose by 0.25% month-over-month in April. Trimmed mean PCE inflation increased above 2% on a year-over-year basis for the first time in seven years (Chart 6). According to a recent Fed study, the trimmed mean calculation is superior to the core PCE index as a summary measure of underlying inflationary trends.4 Ultimately, the fact that the U.S. economy is holding up well is a positive sign for equity returns over the next 12 months. In the short term, however, it does create the risk that the Fed will sound less dovish than investors are anticipating, leading to a temporary selloff in stocks. Hence our view: near-term cautious, longer-term bullish. Who Determines Interest Rates? Central banks decide where rates will go in the short run, but it is the economy that determines where interest rates will go in the long run. The neutral rate of interest is the rate that corresponds to full employment and stable inflation. One can also think of it as the rate that aligns the level of aggregate demand with the maximum potential output the economy is capable of achieving without overheating. Both the Fed dots and the widely-used Laubach Williams model suggest that rates are close to neutral. But are they really? If a central bank keeps rates below their neutral level for too long, inflation will eventually break out, forcing the central bank to raise rates. Conversely, if a central bank raises rates above their neutral level, growth will slow, inflation will decline, and the central bank will be forced to cut rates. The problem is that changes in monetary policy typically affect the economy with a lag of 12-to-18 months. Inflation is also a highly lagging indicator. It usually peaks well after a recession has begun and troughs long after the recovery is under way (Chart 7). Thus, central banks have to make an educated guess as to where the neutral rate lies and try to steer the economy towards that rate in a way that achieves a soft landing. Needless to say, this is easier said than done. Today, both the Fed dots and the widely-used Laubach Williams model suggest that rates are close to neutral (Chart 8). Chart 8The Fed Thinks Rates Are Close To Neutral But are they really? That’s the million dollar question. Not only will the answer determine the medium-term path of interest rates, it will also determine how long the current U.S. economic expansion will last. Recessions rarely occur when monetary policy is accommodative, and equity bear markets almost never happen outside of recessionary periods (Chart 9). Thus, if rates are currently well below neutral, investors should maintain a bullish equity tilt. Chart 9Recessions And Bear Markets Usually Overlap Chart 10U.S.: Federal Fiscal Policy Has Been Expansionary Where Is Neutral? The neutral rate of interest is a function of many variables, most of which are not in the Laubach Williams model. Let us consider a few: Fiscal Policy A larger budget deficit boosts aggregate demand, while higher interest rates lower demand. Thus, once an economy has achieved full employment, an easing of fiscal policy must be counterbalanced by an increase in interest rates, which is another way of saying that looser fiscal policy raises the neutral rate of interest. The U.S. cyclically-adjusted budget deficit has risen by about 3% of GDP since 2015. Both tax cuts and increased federal discretionary spending have contributed to the deterioration in the fiscal balance (Chart 10). Standard “Taylor Rule” equations suggest that a 1% of GDP increase in aggregate demand will raise the appropriate level of the fed funds rate by 0.5-to-1 percentage points.5 This implies that easier fiscal policy has lifted the neutral rate of interest by 1.5-to-3 percentage points over the past five years. Labor Market Developments A tight labor market tends to increase the share of national income accruing to workers (Chart 11). Workers generally spend more of every dollar of income than businesses. Thus, a shift of income from businesses to workers raises the neutral rate of interest. The fact that a tight labor market usually generates the biggest gains for workers at the bottom of the income distribution – who have the highest marginal propensity to spend – further amplifies the positive effect on aggregate spending. Chart 11Workers Garner A Larger Piece Of The Income Pie When The Labor Market Is Tight The labor share of income has rebounded since reaching a record low in 2014. The lowest-paid workers have also seen the largest wage increases during the past 12 months (Chart 12). Neither of these nascent developments have come close to unwinding the beating that labor has suffered in relation to capital over the past four decades, but if the unemployment rate keeps falling, workers are going to start gaining the upper hand. Thus, one would expect the neutral rate of interest to rise further as the labor market continues to tighten. Credit Growth The Great Recession ushered in a painful deleveraging cycle. Household debt fell from 86% of GDP in 2009 to 70% of GDP in 2012. The household debt-to-GDP ratio has edged slightly lower since then due to continued declines in mortgage debt and home equity lines of credit. A return to the rapid pace of credit growth seen before the financial crisis is unlikely. Nevertheless, a modest releveraging of household balance sheets would not be surprising. Some categories such as student and auto loans have seen fairly robust debt growth (Chart 13). Housing-related debt could also stage a modest comeback due to rising home prices and buoyant consumer confidence. Conceptually, the rate of credit growth determines the level of aggregate demand.6 Thus, if household credit growth picks up at the margin, this would push up the neutral rate of interest. Corporate debt levels also have scope to rise further. Net corporate debt is only modestly higher than it was in the late 1980s, a period when the fed funds rate averaged nearly 10% (Chart 14). Chart 13U.S. Housing Deleveraging Has Slowed Chart 14U.S. Corporate Debt (I): No Cause For Alarm   Thanks to low interest rates and rapid asset accumulation, the economy-wide interest coverage ratio is above, while the ratio of debt-to-assets is below, their respective long-term averages (Chart 15). The corporate sector financial balance – the difference between what businesses earn and spend – is still in surplus. Almost every recession in the post-war era has begun when the corporate sector financial balance was in deficit (Chart 16). Chart 15U.S. Corporate Debt (II): No Cause For Alarm Chart 16U.S. Corporate Debt (III): No Cause For Alarm     The Value Of The U.S. Dollar A stronger dollar reduces net exports. This drains demand from the economy, which lowers the neutral rate of interest. The real broad trade-weighted dollar index has risen 10% since 2014. According to the New York Fed’s econometric model, this would be expected to reduce the level of real GDP by 0.5% in the first year and by a further 0.2% in the second year, for a cumulative decline of 0.7%, equivalent to a decrease in the neutral rate of 0.35%-to-0.7%. The New York Fed model assumes an “all things equal” environment. All things have not been quite equal, however. The U.S. has benefited from a modest improvement in its terms of trade7 over the past five years (Chart 17). The shale boom has also significantly cut into oil imports. As a result, the trade deficit has fallen from 5.9% of GDP in 2005 to 2.9% of GDP at present. Chart 17The Dollar Has Appreciated Since 2014 Chart 18The Savings Rate Has (A Lot Of) Room To Drop, Judging From The Historical Relationship With Wealth Asset Prices An increase in asset values – whether they be equities, bonds, or homes – makes people and businesses feel wealthier, which leads to more consumption and investment spending. As such, higher asset prices raise the neutral rate of interest. Today, U.S. household net worth stands near a record high as a percent of disposable income (Chart 18). The personal savings rate, in contrast, still stands at an elevated 6.4%. If the savings rate falls over the coming months, this would further boost aggregate demand. Demographics Slower labor force growth has led to a decline in trend GDP growth in the U.S. and most other economies. Slower economic growth tends to reduce the neutral rate of interest. The Bureau of Labor Statistics expects labor force growth to be broadly stable over the next 5-to-10 years, with immigration compensating for the withdrawal of baby boomers from employment (Chart 19). Chart 20Savings Over The Life Cycle In the current political climate, there is quite a bit of uncertainty over how many immigrants will settle in the United States. On the one hand, less immigration would reduce labor force growth, thus lowering the neutral rate. On the other hand, a decline in immigration would lead to an even tighter labor market, thus potentially raising the neutral rate. An additional question is how population aging, which will continue even if immigration remains elevated, will affect the neutral rate. Older people work less, but consume more than younger people, once health care spending is accounted for (Chart 20). If overall national output falls in relation to consumption, national savings will go down. This will raise the neutral rate of interest. The Shift To A Capital-Lite Economy Firms increasingly need less physical capital to carry out their activities. Larry Summers has labeled this the “demassification” of the economy. Lower investment spending would translate into a lower neutral rate. While plausible, it is not clear how important this phenomenon is. Companies may need less physical capital, but they need more human capital. Instead of more lending to businesses to finance purchases of machinery, we get additional lending to students. If our thesis that the neutral rate of interest is higher than widely believed turns out to be correct, this means that the Fed will eventually need to start hiking rates again. The question is when. The share of R&D and other intangibles in business investment has risen from around 14% in the 1960s to 33% today (Chart 21). Importantly, the depreciation rate for intangible investment is much higher than for other forms of capital spending. As intangible investment has increased, the overall depreciation rate for the economy has risen (Chart 22). Conceptually, an increase in the depreciation rate should lead to a higher neutral rate of interest.8 Chart 21A Larger Share Of Business Investment Is Intangible... Chart 22...And That Puts Upward Pressure On The Depreciation Rate   Watch Housing And Business Capex The discussion above suggests that the neutral rate of interest is probably higher than widely believed. That said, there is significant uncertainty around any estimate of the neutral rate. As such, we recommend that investors track the more interest-rate sensitive sectors of the economy to gauge whether monetary policy is becoming restrictive. Housing, and to a lesser extent, business capital expenditures are the key indicators to watch. As a long-lived asset, housing is very sensitive to mortgage rates. Chart 23 shows that changes in mortgage rates tend to lead residential investment and home sales by about six months. Chart 23Housing Is Interest-Rate Sensitive If the decline in mortgage rates since last fall fails to spur housing, this would support the claim that monetary policy turned restrictive last year. Fortunately, the jump in homebuilder confidence, the outperformance of homebuilder stocks, and the surge in mortgage applications for purchases all suggest that the housing sector remains on firm ground (Chart 24). Despite the broad-based weakness in the global manufacturing sector, U.S. capex intentions remain reasonably buoyant (Chart 25). This week’s release of the May NFIB small business survey, which showed that the share of firms citing “now is a good time to expand” jumped five points to a seven-month high, provides further evidence in support of this view. Chart 24Some Positives For U.S. Housing Chart 25U.S. Capex Intentions Remain Solid   A Two-Stage Fed Cycle Chart 26Inflation Expectations Are Not Where The Fed Wants Them To Be If our thesis that the neutral rate of interest is higher than widely believed turns out to be correct, this means that the Fed will eventually need to start hiking rates again. The question is when. Right now, the Fed has the luxury of time on its side. Even though some measures of core inflation such as the trimmed mean calculation discussed above have reached the Fed’s 2% target, this follows a prolonged period of below-target inflation. A few years of above-trend inflation would hardly be the worst thing in the world. The Fed’s failure to reach its inflation target has pushed long-term inflation expectations below the central bank’s comfort zone (Chart 26). Given the asymmetric risks created by the zero lower bound on interest rates - if inflation rises too fast, the Fed can always hike rates; but if inflation falls too much, it may be impossible to ease monetary policy by enough to avert a recession - the Fed can afford to remain patient. Thus, while the Fed is unlikely to cut rates as much as investors currently expect, it is also unlikely to raise them this year. Thanks to a cyclical revival in productivity growth, unit labor cost inflation has actually declined over the past 12 months (Chart 27). However, as we get into late next year and 2021, circumstances may change. If an increasingly tight jobs market continues to push up wage growth, unit labor costs will start to reaccelerate. Cost-push inflation will kick in. At that point, the Fed may have no choice but to pick up the pace of monetary tightening. All this suggests that Fed policy will evolve in two stages: an initial stage lasting for the next 12-to-18 months where the Fed is doing little-to-no tightening (and could even cut rates if the trade war heats up), followed by a second stage where the central bank is scrambling to raise rates to cool an overheated economy. U.S. Treasury yields are likely to rise modestly during the first stage in response to stronger-than-expected economic growth. We see the 10-year yield clawing its way back to the high-2% range by early next year. Yields could rise more precipitously, to around 4%, in the second stage once inflation begins to move decisively higher. The dollar is unlikely to strengthen during the first stage. Indeed, our baseline forecast calls for a period of modest dollar weakness stretching into late next year driven by a reacceleration in European and Chinese/EM growth. The sharp rebound in Chinese real estate equipment purchases from -18% on a six-month basis late last year to +30% in April suggests that the government’s stimulus efforts are working (Chart 28). Chart 27No Imminent Threat Of A Wage-Price Inflationary Spiral Chart 28China: A Sign That Stimulus Is Finding Its Way Into The Economy   The greenback will likely appreciate, perhaps significantly so, once the Fed picks up the pace of rate hikes in late 2020. The accompanying tightening in global financial conditions is likely to sow the seeds for a worldwide downturn in 2021. The combination of faster global growth and a weaker dollar will support global equities over the next 12 months. European and EM bourses will benefit the most. Investors should begin derisking in the second half of next year. Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com   Footnotes 1      Patricia Zengerle, “U.S. Lawmakers Seek To Block Trump On Tariffs,” Reuters, June 5, 2019. 2      Please see Geopolitical Strategy Weekly Report, “Is Trump Ready For The New Long March?” dated May 24, 2019. 3      Final sales to domestic purchasers is equal to gross domestic product (GDP) excluding net exports of goods and services, less the change in private inventories. 4      Jim Dolmas and Evan F. Koenig, “Two Measures Of Core Inflation: A Comparison,” Federal Reserve Bank Of Dallas, Working Paper 1903, February 25, 2019. 5      Depending on which specification of the Taylor Rule one uses, a one percent of GDP increase in aggregate demand will increase the neutral rate of interest by half a point (John Taylor’s original specification) or by a full point (Janet Yellen’s preferred specification). John B. Taylor's 1993 specification is based on the following equation: rt = 2 + pt + 0.5(pt - 2) + 0.5yt. Janet Yellen's preferred specification is based on the following equation: rt = 2 + pt+ 0.5(pt - 2) + 1.0yt. Please note: For both specifications above, rt is the federal funds rate; pt is core PCE expressed as a year-over-year percent change; and yt is the output gap (as approximated using the unemployment gap and Okun's law). For further discussion, please see Janet L. Yellen, "The Economic Outlook And Monetary Policy," April 11, 2012. 6      Recall that GDP is a flow variable (how much production takes place every period), whereas credit is a stock variable (how much debt there is outstanding). By definition, a flow is a change in a stock. Thus, credit growth affects GDP and the change in credit growth affects GDP growth. 7      Ratio (multiplied by 100) of the price index for exports of goods and services to the price index for imports of goods and services. 8      The higher the depreciation rate, the more investment is necessary to maintain the existing capital stock. More investment demand for any given level of savings implies a higher interest rate. One can see this in the Solow growth model, which posits that the neutral rate of interest (r*) should be equal to: Where a is the output elasticity of capital, s is the savings rate, n is labor force growth, g is the growth in total factor productivity, and d is the depreciation rate. The equation implies that the neutral rate of interest will increase if capital intensity increases, the savings rate declines, the rate of labor force growth picks up, technological progress accelerates, or the depreciation rate increases.     Strategy & Market Trends MacroQuant Model And Current Subjective Scores Tactical Trades Strategic Recommendations Closed Trades

Highlights 10-year real Spanish and Portuguese bond yields have already fallen below the neutral rate of interest for the entire euro zone. This suggests monetary conditions could now be favorable for all euro zone countries. Should external demand pick up, this will also help lift the equilibrium rate for the monetary union, which will be a tailwind for the EUR/USD. Falling U.S. rate expectations relative to policy action have historically been bearish for the dollar, with a lag of about six to 12 months. A risk to this view is further deterioration in the U.S.-China trade war, or a rollover in Chinese stimulus. Remain long EUR/CHF, with a tight stop at 1.11. Our bias is that the Swiss National Bank will continue to use the currency as a weapon to defend the economy. Feature The standard dilemma for the euro zone is that interest rates have always been too low for the most productive nation, Germany, but too expensive for others such as Spain and Italy. As such, the euro has typically been caught in a tug-of-war between a rising equilibrium rate of interest for Germany, but a very low neutral rate for the peripheral countries. Over the years, the impasse has been resolved from time to time through a combination of internal devaluation, currency depreciation and a successively accommodative European Central Bank. This has helped prevent a collapse of the monetary union, but in the process generated tremendous volatility in the currency. Since the onset of the Great Recession, the EUR/USD has seen five boom/bust cycles of about 20% to 25%. For both domestic policymakers and global investors alike, this has been an untenable headache. The silver lining is that the ECB may now have finally lowered domestic interest rates and eased policy to the point where they are accommodative for almost all euro zone countries: 10-year government bond yields in France, Spain and even Portugal now sit at 11bps, 54bps and 65bps respectively, much below the neutral rate. This is severely easing financial conditions in the entire euro zone, with huge implications for European assets in general and the euro in particular. In short, the EUR/USD may be very close to a floor (Chart I-1). Chart I-1How Much Lower For Relative R-Star*? Structural Reforms Have Progressed The neutral rate of interest is simply the market price at which both the supply of savings and the demand for them clear. In academic parlance, this means the interest rate at which the economy is at full employment, but inflationary pressures are relatively contained. At this critical interest rate level, the economy tends to be in balance. The difficulty arises because most indicators of either full employment or inflation tend to be lagging. As such, steering interest rates toward the neutral level becomes a very difficult task for any one country and/or central bank to achieve in real time. For the euro zone as a whole, where member countries can have vastly diverging economic outcomes at any point in time, the task becomes even more arduous.   This is why since the introduction of the euro, most of the economic imbalances from the region have stemmed from the standard contradiction of a common currency regime. For most of the early 2000s, Spanish and Irish long-term rates were too low relative to the potential of their respective economies, and the reverse was true for Germany. As a result, Spanish real estate took off in what culminated to be one of the biggest booms in recent history, while it stagnated in Germany. And after the Great Recession, the reverse was true: rates became too low for the most productive nation, Germany, and too high for Ireland and Spain (Chart I-2). In a normal adjustment process, the exchange rate always tends to play a key role. In a common-currency regime, there is not such a possibility.  In a normal adjustment process, the exchange rate always tends to play a key role, since countries with lower productivity growth require a lower neutral rate, and as such see currency depreciation. This tends to ease financial conditions, alleviating the need for an internal adjustment process. However, in a common-currency regime, there is not such a possibility. The result is a painful process of internal devaluation, as was very vivid in the European peripheral countries from 2009-2012 (Chart I-3). Chart I-2The Common-Currency Dilemma Chart I-3Internal Devaluation In The South... The good news is that for the euro zone, it forced businesses to restructure and jumpstarted the process of structural reform. In the early 2000s, the German economy had to restructure in order to improve its competitiveness. As a result, unit labor costs began to lag in 2001. Over the same period, the German government began to reform the labor market. The Hartz IV labor market reforms implemented minimized safety nets for the unemployed, encouraging them to accept market-determined wages. This dramatically increased the flexibility of the labor market. The same script has been replayed over the last decade with the European periphery. Labor market reforms in Mediterranean Europe have seen unit labor costs in Greece, Ireland, Portugal and Spain collectively contract by almost 10%. This has effectively eliminated the competitiveness gap that had accumulated over the past two decades (Chart I-4). Italy remains saddled with a rigid and less productive workforce, but overall adjustments have still come a long way to closing a key fissure plaguing the common currency area. At the same time, other factors also suggest the neutral rate for individual countries should also have converged higher to that of Germany. Peripheral sovereign borrowing costs have plummeted from their prohibitive 2012 levels. As a result, interest payments as a share of GDP have become more manageable. Most southern European countries now run primary surpluses, reducing the need for external funding. Fortunately, the improvement in structural budget balances has diminished the need for any additional austerity measures, meaning government spending should no longer be a net drag on GDP growth. Increased integration continues to sustain a steady stream of cheap migrant workers to Germany.  On the labor market front, the unemployment rate in Germany remains well below that in other regions, but increased integration continues to sustain a steady stream of cheap migrant workers to Germany. Over the last decade, there has been a surge of migrant workers into Germany from countries such as Portugal or Spain (Chart I-5). This will help redistribute aggregate demand within the system. Chart I-4...Has Realigned Competitiveness Chart I-5The Unemployment Gap Is Closing The bottom line is that the various forces that may have been keeping the neutral rate of interest artificially low in the euro area are ebbing. The proverbial saying is that a chain is only as strong as its weakest link. This means that if these forces pressuring equilibrium rates in the periphery are slowly dissipating, that should lift the neutral rate of interest in the entire euro zone. Over a cyclical horizon, this should be bullish for the euro (previously referenced Chart I-1). Manufacturing Recession May Soon End With the rising specter of a full-blown trade war and a global manufacturing recession, it is possible that euro zone policy settings have become even more appropriate for Germany than the rest of Europe. For example, the latest PMI releases suggest that Germany is the weakest link in the euro zone on the manufacturing front (Chart I-6). The implication is that if the ECB’s monetary settings are now being calibrated for Germany, they may also now be appropriate for all euro zone countries. For example, since 2015, peripheral country exports have increased to 28% of GDP, from a low of 16%, despite strength in the trade-weighted euro. This contrasts favorably with Germany, where the export share of German GDP has essentially been flat over this period (Chart I-7). In fact, it is entirely possible that the German economy may have already 'maxed out' its export market share gains, given its externally driven growth model over the last decade. If so, further currency weakness can only lead to inflation and wage pressures in Germany, redistributing demand from exports to the domestic sector, while benefitting the periphery. Chart I-6Germany Is Once Again The Sickman Chart I-7GIPS Are Gaining Export Share Over the past few years, corporate profits as a share of GDP in both Portugal and Spain have overtaken German levels. And with the output gap is still open in these countries, it will take a while before the unemployment rate moves below NAIRU and begins to generate wage pressures. This will allow companies to continue reaping a labor dividend while gaining export market share. It is not easy to tell if and when the trade war will end sans escalation, but there remain a number of green shoots in the European economy: While the German PMI is currently one of the weakest in the euro zone, forward-looking indicators suggest we are on the cusp of a V-shaped bottom over the next few months or so (Chart I-8). A rising Chinese credit impulse is usually bullish for European exports, and this time should be no different (Chart I-9). This also follows improvement in the European credit impulse. Most European growth indicators relative to the U.S. hit a nadir at the beginning of this year, and have been steadily improving since.1 Chart I-8German Manufacturing Could Soon Bottom Chart I-9A Pick Up In Global Demand Will Help The bottom line is that investors are currently too pessimistic on Europe’s growth prospects at a time when policy settings have become appropriate for the weakest link. If, in fact, European growth and inflation improve relative to the U.S., this will give investors an opportunity to reassess interest rate expectations for the euro area versus the U.S. Implications For The Euro The euro tends to be largely driven by pro-cyclical flows. Fortunately for investors, European equities, especially those in the periphery, remain unloved, given they are trading at some of the cheapest cyclically adjusted price-to-earnings multiples in the developed world. Analysts began aggressively revising up their earnings estimates for euro zone equities verus the U.S. earlier this year. If they are right, this tends to firmly lead the euro by about nine to 12 months, suggesting we are due for a pop in the coming quarters (Chart I-10).  Chart I-10Rising Earnings Revisions Are Bullish For The Euro The euro’s bounce after the ECB’s latest meeting suggests its dovish shift is paradoxically bullish for the common currency. If a central bank eases financing conditions at a time when growth is hitting a nadir, it is tough to argue that it is bearish for the currency. This in combination with easier fiscal policy should boost aggregate demand and lift the neutral rate of interest in the euro zone. Dollar weakness could be the catalyst that triggers a EUR/USD rally. Markets are usually wrong about Federal Reserve interest rate expectations, and this time is likely to be no different. However, the current divergence between market expectations and policy action is the widest since the Great Recession. Falling rate expectations relative to policy action have historically been bearish for the dollar with a lag of about nine to 12 months (Chart I-11). The basic balance in the euro area is on the verge of hitting fresh highs. Finally, positioning, valuation and balance-of-payments dynamics remain favorable for the euro (Chart I-12). The basic balance in the euro area is on the verge of hitting fresh highs on the back of improvement in FDI flows. With a large number of short positions on the euro, this could trigger a significant short-covering rally. Chart I-11The Dollar Might ##br##Soon Peak Chart I-12A Favorable Balance Of Payments ##br##Backdrop For The Euro   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Special Report, titled “A Contrarian Bet On The Euro,” dated March 1, 2019, available at fes.bcaresearch.com.  Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. have been mostly negative, but a few one-time factors were at play: On the labor market front, nonfarm payrolls fell to 75 thousand in May, but this was dragged down by flooding in the Midwest. Average hourly earnings grew by 3.1% year-on-year and the unemployment rate was stable at 3.6%. Headline and core consumer price inflation came in slightly lower at 1.8% and 2% year-on-year, but remain on target. Export prices fell by 0.7% year-on-year in May, and import prices contracted by 1.5% year-on-year, giving the greenback a terms-of-trade boost. On a positive note, the NFIB Small Business Optimism survey rose to a 5-month high of 105 in May. On another positive note, mortgage applications jumped by 26.8% this week. DXY index rose by 0.3% this week. Our bias is that the dollar is in the final innings of its rally, amid narrowing interest rate differentials, portfolio outflows, and easing liquidity strains.  Should global growth benefit from the dovish pivot by central banks, this could be the catalyst for dollar downside. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 President Trump And The Dollar - May 9, 2019 Take Out Some Insurance - May 3, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 There has been tepid data out of the euro zone this week: Sentix investor confidence fell to -3.3 in June. Industrial production contracted by 0.4% year-on-year in April. This is an improvement compared with the last reading of -0.7% and the consensus of -0.5%. EUR/USD fell by 0.3% this week. The front section this week is dedicated to the euro, since it has begun to tick many of the boxes for a counter-trend rally. The euro is trading below its fair value, easy financial conditions within the euro area will help, and Chinese stimulus could boost European exports, lifting the growth potential for the entire union. Report Links: Take Out Some Insurance - May 3, 2019 Reading The Tea Leaves From China - April 12, 2019 Into A Transition Phase - March 8, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mixed: The leading economic index fell to 95.5 in April, while the coincident index increased to 101.9. Annualized GDP growth was 2.2% year-on-year in Q1. Quarter-on-quarter growth also improved to 0.6%. The current account balance came in at 1.7 trillion yen in April. This was lower than the previous 2.9 trillion figure, but an improvement over consensus. Machine tool orders contracted by 27.3% year-on-year in May, while machinery orders increased by 2.5% year-on-year in April. It is worth noting that the pace of deceleration in machine tool orders is ebbing. USD/JPY has been flat this week. We continue to recommend the yen as an insurance against market turbulence. Even though the yen might weaken on the crosses in a scenario where global growth picks up later this year, it still has upside potential against the U.S. dollar. Report Links: Short USD/JPY: Heads I Win, Tails I Don’t Lose Too Much - May 31, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mixed: Halifax house prices increased by 5.2% year-on-year in May. Industrial production contracted by 1% year-on-year in April. Manufacturing production also contracted by 0.8% year-on-year. The trade deficit narrowed to 2.74 billion pounds in April. The ILO unemployment rate was unchanged at 3.8% in April, while average earnings growth keeps holding firm, though it fell slightly to 3.1%. GBP/USD fell by 0.4% this week, now oscillating around 1.268. We will respect the stop loss for our long GBP/USD position if triggered at 1.25. While cheap valuation and favorable fundamentals support the pound on a cyclical basis, the implied volatility remains elevated amidst political uncertainties. The official kickoff for a new Conservative party leader is poised to ratchet up “hard Brexit” rhetoric, which will be negative for the pound. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Take Out Some Insurance - May 3, 2019 Not Out Of The Woods Yet - April 5, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have shown a steady labor market: Consumer inflation expectations were unchanged at 3.3% in June. On the labor market front, the participation rate increased to 66% in May; unemployment rate was stable at 5.2%; 42.3 thousand new jobs were created in May but the mix was unfavorable, with a combination of 2.4 thousand full-time jobs and 39.8 thousand part-time jobs. AUD/USD fell by 1.3% this week. Clearly, the Australian jobs report was interpreted negatively by the market, given the boost from temporary election hiring. As such, markets are continually pricing in further rate cuts from the RBA, a negative for interest rate differentials between Australia and the U.S. Over the longer term, easier financial conditions could help to lift the economy, and stabilize the housing sector by reducing the interest payment burdens.  Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 There was scant data out of New Zealand this week: Manufacturing sales were unchanged at 2% in Q1. Electronic card retail sales growth grew by 3.2% year-on-year in May, higher than the consensus of 1.6%. Immigration remains a tailwind for domestic demand, but is slowly fading. NZD/USD fell by 1.4% this week. We introduced a long SEK/NZD trade last Friday, which is now 0.3% in the money. We believe that the Swedish krona will benefit more than the New Zealand dollar once global growth picks up.  Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been positive: The labor market remains robust with 27.7 thousand new jobs created in May. This pushed the unemployment rate to a low of 5.4%. The participation rate fell slightly to 65.7% but average hourly wages increased by 2.6% year-on-year. The mix was also positive, with all of the jobs generated as full-time employment. Housing starts came in at 202.3 thousand in May, while building permits increased by 14.7% month-on-month in April. USD/CAD initially fell by 1% on the labor market data last Friday, then recovered gradually, returning flat this week. While the labor market remains strong and the housing sector is showing signs of a recovery, the recent weakness in energy prices has been a headwind for the loonie. Moreover, a rate cut by BoC has become increasingly likely following the dovish shift by the Fed. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 There has been little data out of Switzerland this week: The unemployment rate was unchanged at 2.4% in May. Foreign currency reserves fell slightly to 760 billion CHF in May. Producer and import prices contracted by 0.8% year-on-year in May. USD/CHF appreciated by 0.4% this week. The Swiss National Bank maintained  interest rates at -0.75% this week. The policy remains expansionary, in order to stabilize price developments and support economic activity. As a technicality, the SNB will also stop targeting Libor rates in favor of SARON (Swiss Average Rate Overnight). More importantly for the franc, the SNB stated that they will “remain active in the foreign exchange market as necessary, while taking the overall currency situation into consideration.” This suggest the SNB will weaponize the franc against deflationary pressures. Remain long EUR/CHF. Report Links: What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have softened: Manufacturing output increased by 2.2% month-on-month in April. Headline and core inflation both fell to 2.5% and 2.3% year-on-year in May. This has nudged the core measure below the central bank’s target. Producer price inflation fell to 0.4% year-on-year in May. USD/NOK rose by 0.6% this week. The recent plunge in oil prices caused by the U.S. inventory buildup has been a headwind for the Norwegian krone. However, we expect U.S. shale-oil production to eventually slow as E&P companies exercise greater capital discipline as marginal profit decreases. Moreover, irrespective of the oil price direction, we expect the Norwegian krone to outperform other petro-currencies, such as the Canadian dollar. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive: PES unemployment rate fell further to 3.4% in May. Household consumption increased by 0.2% month-on-month in April, but was unchanged on a year-on-year basis. USD/SEK appreciated by 0.9% this week. We favor the krona due to its cheap valuation, and its higher β to global growth (the potential to benefit more from a global economy recovery). We initiated the long SEK/NZD position last week, based on improving relative fundamentals between Sweden and New Zealand. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights It remains too early to put on fresh pro-cyclical trades, but the Federal Reserve’s dovish shift is a positive development at the margin. As the market fights a tug of war between weak fundamentals and easier monetary policy, bigger gains are likely to be made at the crosses rather than versus the dollar. Safe-haven currencies are also winners in the interim. Continue to hold short USD/JPY positions recommended last week. Watch the gold-to-bond ratio for cues on where the balance of forces are shifting, with a rising ratio negative for the dollar. Once investors eventually shift their focus towards the rising U.S. twin deficits, de-dollarization of the global economy and low expected returns for U.S. assets, the dollar will peak. New idea: Buy SEK/NZD for a trade. Feature Global markets have once again decided that the U.S. is due for rate cuts, and the Federal Reserve appears to be heeding their message. Both Fed Governor Lael Brainard and Fed Chair Jerome Powell have suggested that policy should be calibrated to address the downside risks posed by the trade war.   The question du jour is the path of the dollar if the Fed eventually does ease monetary policy. A slowing global economy on the back of deteriorating trade is positive for the greenback, since it is a counter-cyclical currency. A Fed rate cut will just be acknowledging the gravity of the slowdown. On the other hand, a dovish Fed knocks down U.S. interest rate expectations relative to the rest of the world. This has historically been bearish for the dollar, and positive for global growth. Our bias remains that the dollar will emerge a loser in this tug of war, especially if Beijing and Washington come to a trade agreement. However, for currency strategy, it is important to revisit our indicators to see where the balance of forces for the dollar lie. We do this via the lens of interest rate differentials, global growth, liquidity trends, and positioning. Expectations Versus Reality Markets are mostly wrong about Fed interest rate expectations, but do get it right from time to time. Since the 1990s, most Fed rate-cutting cycles were initially predicted in advance by the swaps market. Moreover, the current divergence between market expectations and policy action is as wide as before the Great Recession, and among the deepest in over three decades (Chart I-1). The fact that the Fed seldom cuts interest rates only once during a mid-cycle slowdown suggests expectations could diverge even further. Outside of recessions, falling rate expectations relative to policy action have historically been bearish for the dollar, and vice versa. This makes intuitive sense. As a reserve and counter-cyclical currency, the dollar has tended to rise during times of capital flight. However, if we are not on the cusp of a recession, then easier monetary policy by the Fed should improve global liquidity, which is bullish for higher-beta currencies and negative for the dollar. On this front, our discounter suggests rate cuts of about 80 basis points are penciled in by the swaps market over the next 12 months. This will put downward pressure on the dollar. It also helps that sentiment on the greenback remains relatively bullish, and speculators are very long the currency (Chart I-2). Chart I-1Big Divergences Are Rare Chart I-2Lots of Room For The Dollar To Fall     Chart I-3Relative Rates Moving Against The Dollar Relative interest rate differentials between the U.S. and the rest of the world continue to suggest that the greenback should be slightly higher. However, the Treasury market tends to be a global interest rate benchmark rather than specific to the U.S. With global growth in a downtrend and the Fed becoming relatively more dovish, U.S. interest rates are falling much faster than elsewhere and closing the interest-rate gap vis-à-vis the rest of the world. A peak in U.S. interest rates relative to its G10 peers has always been a bad omen for the greenback (Chart I-3). Market action following the Reserve Bank of Australia’s (RBA) interest rate cut this week is a case in point. The initial reaction was a knee-jerk rally in AUD/USD. Australian 10-year government bond yields are already 65 basis points below U.S. levels, the lowest since the 1980s. But the structural growth rate in Australia remains higher than in the U.S., suggesting there is a natural limit as to how low relative interest rates can go. We remain long AUD/USD, but are maintaining a tight stop at 68 cents should rising volatility nudge the market against us.1 Australian 10-year government bond yields are already 65 basis points below U.S. levels, the lowest since the 1980s. Bottom Line: Interest rate expectations between the rest of the world and the U.S. are already at very depressed levels. This suggests that unless the world economy tips into recession, rate differentials are likely to shift against the greenback. A dovish Fed could be the catalyst that triggers this convergence. Portfolio Flows The change in the U.S. tax code to allow for the repatriation of offshore cash helped the dollar in 2018, but not to the extent that might have been expected. On a rolling 12-month basis, the U.S. has repatriated about $400 billion in net assets, or close to 2% of GDP. Historically, this is a very huge sum that would have had the potential to set the greenback on fire – circa 10% higher. The issue today is that the tax break was a one-off, and net flows into the U.S. are now rolling over as the impact fades (Chart I-4). Historically, portfolio flows into the U.S. have been persistent, so it will be important to monitor how fast repatriation flows run off. The Fed’s tapering of asset purchases has been a net drain on dollar liquidity. In the meantime, foreign investors have been fleeing U.S. capital markets at one of the fastest paces in years. On a rolling 12-month total basis, the U.S. is seeing an exodus of about US$200 billion in equity from foreigners, the largest on record (Chart I-5). In aggregate, both foreign official and private long-term portfolio investment into the U.S. has been rolling over, with investor interest limited only to agency and corporate bonds. Foreigners are still net buyers of U.S. securities, but the downtrend in purchases in recent years is evident. Chart I-4Repatriation Flows Have Peaked Chart I-5Investors Stampeding Out Of U.S. Equities The one pillar of support for the dollar is falling liquidity (Chart I-6). Internationally, the Fed’s tapering of asset purchases has been a net drain on dollar liquidity, despite a widening U.S. current account deficit. The Fed’s balance sheet peaked a nudge above US$4.5 trillion in early 2015 and has been falling since. This has triggered a severe contraction in the U.S. monetary base, and has severely curtailed commercial banks’ excess reserves. However, with the Fed turning more dovish and its balance sheet runoff slated to end in September, dollar liquidity will likely improve at the margin. Chart I-6A Dollar Liquidity Squeeze Bottom Line: Currency markets continue to fight a tug of war between deteriorating global growth and easier monetary conditions. Our bias is that the dollar will emerge a loser. Falling interest rate differentials, portfolio outflows, soft relative growth and easing liquidity strains support this thesis. Another Dovish Shift By The ECB The European Central Bank (ECB) kept monetary policy unchanged following this week’s meeting, while highlighting that it will be on hold for longer – at least until mid-2020. The EUR/USD rallied on the news, suggesting the market expected a much more dovish ECB. Our bias is that with European long-term rates already at rock-bottom levels relative to the U.S., the currency market will continue to be disappointed by ECB policy actions for now. Economic surprises are rising in Sweden relative to New Zealand.    Terms for the new Targeted Longer-Term Refinancing Operation (TLTRO III – in other words, cheap loans), were announced at 10 basis points above the main refinancing rate. They can fall as low as 10 basis points above the deposit rate if banks meet certain lending standards. There was no mention of a tiered system for its marginal deposit facility, which would have alleviated some cash flow pressures for euro area banks. We remain of the view that TLTROs are a better policy tool than a tiered central bank deposit system. Chart I-7A Tentative Bottom In Euro Area Data In the case of a TLTRO, the ECB can effortlessly decentralize monetary policy, since liquidity gravitates towards the countries that need it the most. While a tiered system can allow a bank to offer higher rates and attract deposits, there is no guarantee that these deposits will find their way into new loans. It is also likely to benefit countries with the most excess liquidity. The euro’s bounce suggests that the ECB’s dovish shift is paradoxically bullish for the euro. If a central bank eases financing conditions at a time when growth is hitting a nadir, it is tough to argue that it is bearish for the currency. Meanwhile, fiscal policy is also set to be loosened. Swedish new orders-to-inventories lead euro area growth by about five months, and the recent uptick could be a harbinger of positive euro area data surprises ahead (Chart I-7). Bottom Line: European rates are further below equilibrium compared to the U.S., and the ECB’s dovish shift will help lift the euro area’s growth potential. Meanwhile, investors are currently too pessimistic on euro area growth prospects. Our bias is that the euro is close to a floor. Buy SEK/NZD For A Trade A few market indicators suggest there is a trading opportunity for the SEK/NZD cross: Since 2015, the cross has been trading into the apex of a tight wedge formation, defined by higher lows and lower highs. From a technical standpoint, the break above the 50-day moving average is bullish, suggesting the cross could gap higher outside its tight wedge (Chart I-8). Economic surprises are rising in Sweden relative to New Zealand. Going forward, this trend is likely to persist given that investor expectations toward the Swedish economy are very bearish (on the back of depressed sentiment towards the euro area). Relative economic surprises have a good track record of capturing short-term swings in the currency (Chart I-9). Chart I-8A Breakout Seems##br## Imminent Chart I-9Sweden Could Perform Better Than New Zealand Interest rates are moving in favor of the SEK/NZD cross. For almost two decades, relative interest rate differentials between Sweden and New Zealand have been a powerful driver of the exchange rate (Chart I-10). The housing downturn appears well advanced in Sweden relative to New Zealand. Rising relative house prices have historically been supportive of the cross (Chart I-11). The undervaluation of the krona has begun to mitigate the effects of negative interest rates, mainly a buildup of household leverage and an exodus of foreign direct investment. Chart I-10Relative Rates Favor SEK/NZD Chart I-11Swedish House Prices Could Stabilize The USD/SEK and NZD/SEK cross tend to be highly correlated, since the SEK has a higher beta to global growth than the kiwi (Sweden exports 45% of its GDP versus 27% in New Zealand). On a relative basis, the Swedish economy appears to have bottomed relative to that of the U.S., making the SEK/NZD an attractive way to play USD downside. Meanwhile, the carry cost of being short NZD is lower compared to being short the U.S. dollar. Housekeeping We recommended a short USD/JPY position last week, which is currently 1.3% in the money. Our conviction remains high that this could be the best performing trade over the next one-to-three months. For one, the cross has “underperformed” its safe-haven status. The AUD/JPY is back to its 2016 lows, suggesting the market is flirting with another riot point, but the USD/JPY is still well above 100. We expect the latter to eventually give way as currency volatility rises (Chart I-12). Chart i-12Hold Short USD/JPY Positions   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Weekly Report, titled “A Contrarian View On The Australian Dollar,” dated May 24, 2019, available at fes.bcaresearch.com. Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. have been negative: Headline and core PCE were both unchanged at 1.5% and 1.6% year-on-year, respectively. Personal income increased by 0.5% month-on-month in April. However, personal spending increased by only 0.3% month-on-month, lower than expected. Michigan consumer sentiment index fell to 100 in May. Markit composite PMI fell to 50.9 in May, with manufacturing and services PMIs both falling to 50.5 and 50.9, respectively. ISM manufacturing PMI fell to 52.1 in May, while non-manufacturing PMI increased to 56.9. MBA mortgage applications increased by 1.5% in May. The trade deficit fell from $51.9 billion to $50.8 billion in April. On the labor market front, initial and continuing jobless claims rose to 218 thousand and 1.682 million, respectively DXY index fell by 0.8% this week. Chairman Powell gave the opening remarks at the FedListens conference organized by the Chicago Fed this Tuesday, during which he stated that the Fed is closely monitoring trade developments, and will act to sustain the expansion. This signals the potential for rate cuts in the coming monetary policy meetings. Report Links: President Trump And The Dollar - May 9, 2019 Take Out Some Insurance - May 3, 2019 Currency Complacency Amid A Global Dovish Shift - April 26, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been negative with inflation well below target: Markit manufacturing PMI in the euro area fell to 47.7 in May, as expected. Markit services and composite PMI increased to 52.9 and 51.8 respectively in May. Unemployment rate fell to 7.6% in April. Preliminary headline and core CPI both fell to 1.2% and 0.8% year-on-year respectively in May, dropping to the lowest levels in more than one year. Producer price inflation fell to 2.6% year-on-year in April. Retail sales growth fell to 1.5% year-on-year in April. Employment growth was unchanged at 1.3% year-on-year in Q1. EUR/USD increased by 0.8% this week. On Thursday, the ECB decided to leave interest rates unchanged. The Governing Council also expects the key rates to remain at current levels at least through the first half of 2020. Report Links: Take Out Some Insurance - May 3, 2019 Reading The Tea Leaves From China - April 12, 2019 Into A Transition Phase - March 8, 2019 Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: Housing starts fell by 5.7% year-on-year in April. Construction orders fell by 19.9% year-on-year in April. Consumer confidence fell to 39.4 in May. Nikkei manufacturing PMI increased to 49.8 in May, while Markit services PMI fell to 51.7 in May. Capital spending was positive in Q1, rising 6.1% year-on-year versus expectations of 2.6%. USD/JPY fell by 0.6% this week. Our “Heads I Win, Tails I Don’t Lose Too Much” bet on a short USD/JPY position is currently 1.3% in the money since entered last Friday.                                                                                        Report Links: Short USD/JPY: Heads I Win, Tails I Don’t Lose Too Much - May 31, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Tug OF War, With Gold As Umpire - March 29, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mixed: Nationwide house prices grew by only 0.6% year-on-year in April. Mortgage approvals increased to 66.3 thousand in April. Money supply (M4) increased by 3% year-on-year in April. Markit manufacturing PMI fell to 49.4 in May, the lowest since 2016. Construction PMI also fell to 48.6, while services PMI increased to 51. GBP/USD increased by 0.5% this week. During Trump’s visit to U.K. this week, he said that U.S. companies should have market access to every sector of the British economy as part of any deal. The pound is likely to trade higher until political uncertainty is reintroduced in July, ahead of elections for a new Conservative leader. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Take Out Some Insurance - May 3, 2019 Not Out Of The Woods Yet - April 5, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: Private sector credit increased by 3.7% year-on-year in April, slightly lower than expected. AiG performance of manufacturing index fell to 52.7 in May, while the services index increased to 52.5. The current account deficit narrowed to from A$6.3 billion to A$2.9 billion in Q1. Retail sales contracted by 0.1% month-on-month in April. GDP came in at 1.8% year-on-year in Q1, in line with expectations. Trade surplus fell to A$4.9 million in April. AUD/USD increased by 0.76% this week. The RBA cut interest rates by 25 bps to a record low of 1.25% on Tuesday, the first move since August 2016. Governor Philip Lowe emphasized that this decision is not due to deterioration in the Australian economy. Moreover, he believes that while the cut might reduce interest income for many, the effects will be fully passed to mortgage rates, thus lowering payments and boosting disposable income. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been mostly negative: Consumer confidence fell to 119.3 in May. Terms of trade increased by 1% in Q1. ANZ commodity price was unchanged in May. NZD/USD increased by 1.4% this week. The New Zealand dollar is benefitting from rising soft commodity prices, on the back of a poor U.S. planting season. However, we believe terms of trade over the longer term will be more favorable for Australia, compared to New Zealand. Hold strategic long AUD/NZD positions. Report Links: Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been mostly positive: Industrial product prices increased by 0.8% month-on-month in April. GDP growth increased by 1.4% year-on-year in Q1, above expectations.  Markit manufacturing PMI fell to 49.1 in May. Labor productivity increased by 0.3% quarter-on-quarter in Q1. The trade deficit narrowed to C$0.97 billion in April. Exports increased to C$50.7 billion, while imports fell to C$51.7 billion. USD/CAD fell by 1% this week. The latest downdraft in oil prices is likely to have a negative impact on the loonie. We remain short CAD/NOK as a play on better pricing for North Sea crude, versus WTI. Norway will also benefit more from a pickup in European growth.  Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Into A Transition Phase - March 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been neutral: Real retail sales fell by 0.7% year-on-year in April, versus the consensus of -0.8%. Headline inflation fell from 0.7% to 0.6% year-on-year in May. Manufacturing PMI increased to 48.6 in May. USD/CHF fell by 1.1% this week. The franc will benefit from rising volatility as penned in our Special Report three weeks ago. Moreover, the franc is still cheap relative to its fair value. Report Links: What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 There was little data out of Norway this week: Manufacturing PMI came in at 54.4 in May, from 54 in April. Current account surplus increased from NOK 47.3 billion to NOK 67.8 billion in Q1. USD/NOK fell by 0.6% this week. Our Commodity & Energy team continue to favor oil prices, but have revised down their forecasts from $77/bbl to $73/bbl for Brent this year and next. Despite the recent plunge in crude oil prices, rising inventories in the U.S. allow for OPEC production cuts, which will eventually be bullish. Report Links: Currency Complacency Amid A Global Dovish Shift - April 26, 2019 A Shifting Landscape For Petrocurrencies - March 22, 2019 Balance Of Payments Across The G10 - February 15, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive: Manufacturing PMI jumped to 53.1 in May, versus 50.9 in the previous month. Retail sales grew by 3.9% year-on-year in April. Industrial production increased by 3.3% year-on-year in April. Manufacturing new orders rose by 0.1% year-on-year in April.  Lastly, the current account surplus increased to SEK 63 billion in Q1.  USD/SEK fell by 0.6% this week. We like the Swedish krona as a potential reflation play and are going long SEK/NZD this week for a trade. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades