e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

28 October 2018

FX weekly: HIA,SOMA & REBA-days

Martin Enlund | Andreas Steno Larsen

Next week, three dierent flow-factors suggest a solid USD-performance.Allow us to present HIA, SOMA and REBA-days. On the contrary China isexporting disinflationary impulses, which could prove to be an issue for theUSD down the road.

Table 1: Our current list of convictions

China exports disinflationary impulses

Before engaging in even more esoteric stu than usual, we would like to point your attention to a detailthat will have (and already has) global repercussions. USD/CNY is on the rise again, amidst the globalturmoil, while the 7 handle is yet to break. The current USD/CNY exchange rate roughly counters a 10%tari rate, as USD/CNY trades approximately 10% higher since 1st of May. What if the Chinese authoritieschose to battle a 25% tari-rate via the exchange rate? Then 7.91 is next up. We though don’t see long-termincentives for Xi Jinping and PBoC to allow a swift weakening. At least it wouldn’t really rhyme with theambitions of transforming CNY into a trustworthy reserve currency.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Chart 1: Current USD/CNY exchange rate counters a 10% tari rate. Will China battle a25% tari with the CNY as well?

A weaker CNY versus the USD though carries with it implications for the US inflation pressure already.Looking at the weighted Asian FX impulse versus US core inflation, we may have pinpointed the actualreason why US core inflation momentum has surprised negatively in recent months. It is merely aresult of weaker Asian currencies. China and Japan have exported disinflationary impulses to the USand hence the weaker core inflation momentum is a lagged result of weaker Asian currencies versusthe USD. According to our lead/lag studies this downwards pressure will persist over the next 3-4 months,leaving further downside risks for US core inflation. The question of the strong USD will be high on theagenda in Buenos Aires at the G20 summit (30 November – 1 December)

This China exported disinflationary impulse could turn into a problem for the USD in a month or twofrom now (at least if inflation elsewhere surprises positively), in particular due to the stretched long USDpositioning. The EUR inflationary impulse though will also to a certain extent be eected by the exact sameexported Asian disinflation, as the EUR is not weakening in trade-weighted-terms.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Chart 2: Asian countries are exporting a disinflationary impulse to the US

But more short-term, two (or even three) under-covered events are taking place in the market in the comingweek. First a T-2 day (HIA day) on Monday October 29, followed by a SOMA redemption day on WednesdayOctober 31 (combined with a REBA day). Both are usually highly USD positive.

Monday is a HIA day - good news for the dollar

Is the US tax reform is prompting US firms to repatriate cash on specific days? If a company wishes toconvert spot EUR into USD no before the end of October, it needs to do so no later than October 29 (T-2).We call these days “HIA days”, as the eect may stem from Trump’s tax reform, which in turn resembles theHomeland Investment Act of 2004.

While such days showed no pattern whatsoever in 2017, the dollar does show a strengtheningpattern on such days in 2018. For instance, EUR/USD has weakened by an average of 0.3% (on a close-to-close basis) and done so eight out of nine times this year (a hit ratio of 89%). Other G10 pairs also shownegative averages and hit rates of between 67% (JPY, AUD, NZD) and 89% (SEK). In short, if history repeats -or rhymes - the dollar will perform nicely on Monday October 29. See more here.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Table 1: G10 currencies (vs USD) on T-2 days / HIA-days

And there’s also another SOMA redemption day coming up!

The Fed has gradually been letting its balance sheet shrink at a quicker and quicker pace, with a maximumshrinkage of USD50bn/month reached this quarter (of which 30bn can be bonds and notes). As aconsequence of the maturities of bonds and notes bought by the Fed, liquidity shrinks a lot on some days.From the maturity profile of the Fed’s bond portfolio (the SOMA portfolio) we know when these daily,negative, liquidity impacts will occur.

Table 2: G10 currencies (vs USD) on SOMA days

The SOMA redemption day on October 31 will be a hefty one and will necessitate the second largestliquidity drain ever, after the one at the end of July. On the ten SOMA days since the end of February, EUR/

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

USD has always been lower at CET17:15 vs CET08:00, by an average of 0.25%, and odds are that the USDwill perform nicely on Wednesday too, unless oset by month-end rebalancing flows.

Chart 3: EUR/USD (always) drops between 14:30 and 17:15 on SOMA-days

Month-end rebalancing also USD-positive (REBA-days)

Month-end rebalancing flows will though also likely be relatively USD supportive, at least against theEUR and Scandis. In our month-end rebalancing model (based on monthly proxied market value changesof bonds and equities since 1989), the monthly negative market value change in USD assets is close to a 2standard-deviation event (for the first time in roughly ten years), while it is less extreme looking at the EUR-proxy, due to a positive mark to market from German bond markets.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Chart 4: Month-end rebalancing should support USD and JPY versus EUR and Scandis(The more negative z-score, the bigger a relative month-end buy signal)

Riksbank dashed hopes of a December signal

The Riksbank’s October meeting was largely a non-event. Some market participants had hoped the Riksbankwould more clearly signal its intentions on whether it plans a “lift-o” in December or in February. Thesehopes were dashed. This leaves the market free to try pricing it in.

This could leave the Riksbank in a tight spot in December as surprising the market is seldom a goal. What if itplans to lift rates by 25bp at a time it’s not well priced-in? To avoid surprising the market the Riksbank mightneed to guide markets ahead of the prospective hike. If the Riksbank Governor schedules a speech in earlyDecember at a time a hike is not well priced-in, then the mere presence of that speech could cause higherSEK rates and related SEK buying.

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Chart 5: EUR/SEK on average into the first hike in a Riksbank hike-cycle

The experience of EUR/SEK ahead of the past four hiking cycles implies a drop to 10.20-10.25 byDecember 20. We continue to advise caution though, as there are many headwinds for the SEK in thismarket. The market may become more illiquid as year-end approaches. A Riksbank hike is already wellpriced-in. The Riksbank is still expanding its balance sheet into February 2019. Year-end eects are likely todepress Stibor rates further. Swedish and global macro risks predominantly on the downside, and Swedenstill lacks a new government which means an expansionary budget is becoming less and less likely by theday. None of this seem concordant with significant underperformance of SGBs, which may be what’s need to“change the game” for the SEK.

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Chart 6: Swedish bond sell-o may be needed to change the SEK game

Moreover, recent dollar gains could suggest latent upside pressure on EUR/SEK as for instance localinstitutions might need to buy USD/SEK for hedge rebalancing reasons. Local interest to go against any SEKweakness may also be limited next week due to a week-long autumn break.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Chart 7: EUR/USD might be leading the way towards a higher EUR/SEK

On top of the risk of USD implied spill-over weakness in SEK, it is a local school holiday week in Sweden nextweek. Why is that interesting to point out?

We have noted throughout 2018 how the SEK tended to perform poorly, when the local Swedes wereo-desk. EUR/SEK is on average up by 0.2% per day on Swedish holidays with a 2 out of 3 hit ratio. Thisholds in particular if you only study the afternoon-trading patterns (14:30-17:30 CET).

With a strong USD and a Swedish holiday coming up, we opt to go long EUR/SEK.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Table 3: EUR/SEK and USD/SEK on Swedish holidays in 2018

Rest of G10 FX: How to trade short-term disinflationary impulses

We have been tactically short the AUD for a large part of 2018, as several of the factors that have causedthe aforementioned Asian export of disinflation can also be considered AUD negative factors. A Chineseslowdown with consequently weaker CNY and lower industrial metal prices are factors that speak in favourof weaker AUD. Hence, the disinflationary impulses from Asia tend to weaken AUD against the USD as theyunfold.

We don’t expect the AUD to reverse its trend; unless/before the disinflationary winds start to fade. We stilljudge that it is a story for 2019 and expect a weak November/December for the AUD.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Chart 8: It is still too early to buy into AUD again. It is a story for 2019. We keep a shortAUD bias

One of the things that have saved the AUD from being hammered in October is the already stretchedshort-positioning. Both NZD and AUD should have dropped 3-4% in October had usual patterns betweenglobal risk appetite and the antipodes prevailed. An already stretched short-positioning has prevented that.

We also keep the short AUD/NZD trade open as the short-positioning in NZD is even more stretchedthan in AUD. (NZD is the most hated currency in the world). Should a more pronounced wave of positionsquaring hit markets, we would concordantly also expect AUD/NZD to drop.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Chart 9: NZD is the most hated currency in the world

We are maybe grasping for straws here, but we sense a global hawkish reaction shift is underwaydespite the aforementioned disinflationary winds, as the G10 central banks almost in unison have startedto sound more upbeat on their models, now that the credit cycle has matured and the deflation panic is aclosed chapter. Everything is seemingly about to normalize and wage growth is on its way. The trust in thegood old Phillips curve is on the rise.

In UK, we look for another “hawkish twist” from a G10 central bank on Thursday (after a hawkish Fed, BoCetc), when the quarterly inflation report is out from Bank of England.

In an over-looked speech on “Pay Power”, BoE’s Andy Haldane sounded surprisingly wage-growth-hawkish saying that “With growth in money wages running at close to 3%, and with productivity growthrunning closer to zero, domestic cost growth in the UK is already running at, if not slightly above, ratesconsistent with the inflation target, even before any further (limited and gradual) build in wage pressures.”.In other words; Wage growth is already in “tightening-territory”, even before the Philips curve reallystarts to work. FX eects will though continue to put downwards pressure on UK inflation, but given theincreased confidence in the wage-growth component, also BoE might decide to look through a soft inflationpatch.

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

Chart 10: GBP inflation will also fade due to FX eects

Also remember Mario Draghi’s comments that “a vigorous inflation pressure is on its way in the Euroarea”. After all Mario Draghi refrained from being dovish last week, despite the whole string of obviousexcuses for him to have softened up the rhetoric markedly (weak PMIs, weak inflation, Italian budget woes &equity turmoil). The lack of dovishness could be seen as a slight hawkish reaction function shift in itself.

Should the increased confidence in wage growth models at some point also spill-over to the Australian andNew Zealand central banks, then a lot of people will be wrong-footed in AUD and NZD. Let’s see in 2019.

Previous FX weeklies:

·FX weekly: The debt ceiling is a USD ceiling (21 Oct)

·FX weekly: Volatility makes odd bedfellows (14 Oct)

·FX weekly: No Di-Maio'nnaise for your EURs (yet) (7 Oct)

·FX weekly: Along came year-end (30 Sep)

·FX weekly: Twin deficit scare #2 (23 Sep)

·FX weekly:  The Pope of Nope has spoken! (16 Sep)

·FX weekly: Who wants to impeach a +60 ISM president? (09 Sep)

·FX weekly: It is time to go long Scandis again (02 Sep)

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

·FX weekly: The Conte-Trump alliance (26 Aug)

·FX weekly: Fat-burning shorts (19 Aug)

·FX weekly: Time to call in Steven Seagal(12 Aug)

·FX weekly: Is the cyclical momentum over-priced? (05 Aug)

·FX weekly: How to trade a cease-fire? (29 Jul)

·FX weekly: What's that curve? (22 Jul)

·FX weekly: The China Factor (15 Jul)

·FX weekly: Take a short trade war breather (08 Jul)

·FX weekly: Trump will never #238 (01 Jul)

·FX weekly: The USD is the best carry currency in the world (24 Jun)

·FX weekly: Dollar to provide headwinds for earning estimates (17 Jun)

·FX weekly: Fire and fury risks for the USD (10 Jun)

·FX weekly:  It's not only Italy.. (03 Jun)

·FX weekly:  The Sumo SOMA days (27 May)

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

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

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

·FX weekly: Dragon Energy (29 Apr)

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

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

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

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

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

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

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

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

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

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

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

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

·FX weekly: Hawkish spectacles (04 Feb)

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

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

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

·FX weekly: The euphoria rises (07 Jan)

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

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

·FX weekly: A numbers game (17 Dec)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

e-markets.nordea.com/article/46526/fx-weekly-hia-soma-reba-days

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

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

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

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

· FX weekly:Flip-flop?(16 Jul)

· FX weekly:Consolidation time?(9 Jul)

· FX weekly:Hawks R Us(2 Jul)

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

· FX weekly:No Fed put?(18 Jun)

· FX weekly:A bouncy dollar?(11 Jun)

· FX weekly:Heating up(4 Jun)

· FX weekly:Summertime sadness(28 May)

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

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

· FX weekly:Inflation week…(7 May)

Martin EnlundChief AnalystMartin.Enlund@nordea.com

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

 

Nordea Bank Abp, Satamaradankatu 5, FI-00020 NORDEA, Finland http://www.nordea.com

 

   

 

 

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