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by Charalambos Pissouros

Markets Turn ‘Risk On’ Again, UK Parliament Votes on Brexit

Market sentiment improved overnight after the PBOC proceeded with the RRR cut announced on the 4th of January, while several Chinese officials noted that more stimulus measures are on the way. As for today, market participants are likely to turn their attention to the UK Parliament’s vote over the Brexit deal agreed by PM Theresa May and the EU. With the plan set to be voted down, the big question on everyone’s mind may be: What happens next?

Risk Appetite Rebounds as Chinese Officials Signal More Stimulus

The dollar was found lower against most of the other G10 currencies this morning. It gained only against JPY, while it traded nearly unchanged against EUR, CAD and SEK. The main winners were NZD, GBP and AUD.

USD performance G10 currencies

The Swedish Krona traded virtually unchanged against its US counterpart despite Sweden’s better-than-expected inflation data. Although the CPI rate remained unchanged as was anticipated, the CPIF rate rose to +2.2% yoy, exceeding estimates of +2.1%, while the core CPIF rate, which excludes energy, rebounded back to +1.5% yoy from 1.4%. SEK strengthened at the time of the release but was quick to give back all the inflation-related gains. In our view, SEK’s reaction suggests that the numbers were not strong enough for investors to raise bets that Riksbank officials may decide at one of their upcoming meetings to bring forth the timing of when they expect rates to rise again.  

The weakening of the safe-haven yen and the strengthening of the commodity-lined Aussie and Kiwi suggest that market sentiment switched back to “risk on” at some point, maybe overnight, during the Asian morning today. Indeed, although major EU and US bourses ended their Monday sessions in the red, most Asian indices traded in the green today, with Japan’s Nikkei 225 and China’s Shanghai Composite ending their trading 0.87% and 1.36% up respectively.

Yesterday, the day started with a risk-off flavor, following a disappointment in China’s trade data, which may have revived fears over a slowdown in the world’s second largest economy. Both imports and exports fell 7.6% yoy and 4.4% yoy respectively, while analysts had expected imports to accelerate to +5.0% yoy and exports to slow to +3.0% yoy. Another interesting point in the data was that China’s trade surplus with the US widened 17.2%. Remember that China’s large surplus with the US was one the main reasons this whole trade dispute started. Thus, such figures may allow the US to be even more aggressive in the next rounds of trade talks, taking advantage the willingness of Chinese officials to end the conflict that is taking a toll on their economy.

The data also raised questions as to whether China must proceed with more easing measures, something that was probably answered overnight by the PBOC, which proceeded with further RRR cuts as announced on the 4th of January, as well as remarks by several officials that more stimulus measures are on the way. These remarks and PBOC’s action may have been the trigger behind the 180-degree change in investors’ morale.

A few weeks ago, we noted that the fundamentals that weighed on market sentiment during 2018 have not disappeared yet. However, since then, US-China talks have been progressing positively, Chinese authorities appear willing to support their economy, and Fed officials have been signaling patience over future rate increases. This is a positive blend for risk sentiment, and barring any major changes, we would expect appetite stay supported for a while more. The only major theme around which uncertainty remains  extremely elevated is Brexit.

AUD/JPY – Technical Outlook

AUD/JPY slowly continues to climb higher and is now aiming for some of the levels last time being tested in the second half of December. AUD/JPY had also broken its short-term tentative downside resistance line, taken from the high of the 3rd of December, which adds a bit of a positive spin on the short-term outlook. For now, we will target slightly higher areas, but approach them with caution.

A strong move above the 78.70 barrier might interest more bulls to join the action, in order to drive AUD/JPY a bit higher. The pair could then target the 79.30 obstacle, which if broken, may clear the way to the next potential area of resistance at 79.85. This level was last time tested on the 20th of December, where it acted as an intraday swing high, from which AUD/JPY then rushed further down.

On the other hand, if negativity starts entering the market, the interest in the yen might rise, which could lead AUD/JPY to a drop. A break below the 77.52 hurdle, which is yesterday’s low, may raise concerns in the bull-bloc over the short-term upside potential and also place the pair back below the previously-mentioned downside line. In order to get more comfortable with lower levels though, we would need to see a drop below the 77.05 hurdle, marked by the low of the 10th of January. This way, we could then target the 76.20 obstacle, a break of which could increase the chances for the rate to travel to the 75.70 level, which was the intraday swing low of the 4th of January.

AUD/JPY 4-hour chart technical analysis

UK Parliament Votes on Theresa May’s Deal

Speaking about Brexit, the pound managed to gain for another day yesterday. On Friday, the currency capitalized on the back of headlines that the UK will seek to delay its departure from the EU and remained supported even after PM May’s spokeswoman denied the news. Yesterday, the currency drifted further north following a warning from May that a rejection of her plan could lead to the UK staying the EU, and a report that pro-Brexit conservatives will support the deal today. That said, the latter was subsequently denied.

As for today, investors are likely to lock their gaze on the UK Parliament’s vote, but with May facing opposition from all sides, her plan is set to be rejected. Thus, the big question on everyone’s mind may be: What happens next? Last week, the Parliament voted that the government should come up with an alternative plan within three working days if the existing deal is rejected. But, what if it doesn’t? In order to avoid a disorderly Brexit, the Parliament may seek to delay Brexit or revert Brexit altogether. With the government denying any headlines regarding the former front, and clearly saying that it won’t revoke its notice, the options left may be a second referendum or a no-confidence vote that could lead to general elections. After May’s remarks that a rejection could lead to no Brexit, we now see her resignation as possible outcome as well, but perhaps only if she loses by a large margin.

Brexit opinion polls

Having said that though, hardliners within the Parliament are unlikely to risk staying within the EU, especially with polls now suggesting that the Britons who believe that the UK’s decision to leave was wrong are more than those who believe it was right. After all, hardliners reject the existing plan because it keeps the UK closely tied to the EU. Thus, as the clock ticks towards the 29th of March, the official exit day, they may prefer to accept May’s accord in a second round of voting, if May is defeated by a tight margin on Tuesday.

As for the pound’s reaction, nothing is clear. We believe that the British currency will not react to the deal’s rejection per se, but to how tight or large the margin of the defeat is. A close call could prove supportive for the currency, as it could raise bets that May could get the deal through at a later vote, something that could alleviate a decent amount of uncertainty. On the other hand, a large defeat could drive Britain’s faith into unchartered territories. This would mean that the Parliament is unlikely to agree with any amendments the government may present as plan B, and the pound could slide. That said, the currency’s forthcoming path may be even more uncertain, as the possible outcomes would still range from a no-deal Brexit to no Brexit at all, even in case of a big-margin loss today.

GBP/CHF – Technical Outlook

After breaking its short-term tentative downside resistance line, drawn from the high of the 26th of November, GBP/CHF continues to form higher lows. This, of course, gives the bulls some confidence that the pair could be pushed further up. Certainly, with UK Parliament vote on its way, the uncertainty surrounding this pair’s forthcoming direction remains elevated. For now, taking into account the technical picture, we will remain cautiously bullish.

A push above the 1.2675 barrier may clear the path towards the next potential area of resistance at 1.2760, marked by the high of the 5th of December 2018. Of course, if the buying momentum doesn’t ease off, GBP/CHF may get dragged higher, towards the other good resistance zone at 1.2835, which held the rate from accelerating further on the 22nd and the 26th of November last year.

Alternatively, a drop below the important support area at 1.2570 could raise concerns over the potential up-move in the short run. But in order to start examining the downside again, we would need to see GBP/CHF dropping below the aforementioned downside resistance line and also breaking below the 1.2480 hurdle, which is the low of the 11th of January. This way, we might then target the 1.2415 obstacle, a break of which may lead the rate to the next potential area of support at 1.2365, marked by the low of the 3rd of January.

GBP/CHF 4-hour chart technical analysis

As for the Rest of Today’s Events

During the European day, we get Eurozone’s trade balance for November, and Germany’s annual GDP. The Euro area trade surplus is forecast to have narrowed slightly, while the annual German GDP is expected to have slowed to +1.5% from +2.2%.

Later, in the US, we have PPIs for December. Expectations are for the headline rate to have held steady at +2.5% yoy, while the core one is forecast to have risen to +2.9% yoy from 2.7%. We usually monitor producers’ prices as a gauge of where consumer prices may come in. But given that we already got the CPIs for December on Friday, we won’t pay the same attention as we used to on the PPIs, and we believe that they may pass unnoticed by the market as well. The US trade balance for November and the New York Empire State manufacturing index for January are also due out.

With regards to the energy market we have the API (American Petroleum Institute) weekly report on crude oil inventories, but as it is always the case, no forecast is available.

We also have four speakers on today’s agenda: ECB President Mario Draghi, Minneapolis Fed President Neel Kashkari, Kansas City Fed President Esther George and Dallas Fed President Robert Kaplan.

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