Risk Insight. The Central Bank Tightening Party: Who Will Be Next To Join? What are the chances... Volume 8, Issue th July 2017.

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1 Inside this issue Big Picture GBPUSD... 3 GBPEUR... 4 Risk Insight Volume 8, Issue th July 2017 EURUSD... 5 USDCAD... 6 Economic Data and Market Indicators... 7 Appendix... 8 The Central Bank Tightening Party: Who Will Be Next To Join? The Fed has been hosting the tightening party since December 2015, but has been very lonely. A couple of weeks ago, Stephen Poloz and the Bank of Canada showed up with their own 25bp hike. Other central banks seem to be thinking about joining the party as well. Meanwhile the Fed, after being alone for so long, is considering slowing the pace of rate hikes. While they haven t yet RSVP d, Sweden s Riksbank, the Bank of England, the Reserve Bank of Australia, and as of last week, the ECB, have all started signalling that they may join the party in the next year if not earlier. Bank of Canada The loonie has jumped 2.5% since the BoC hiked, and the market is expecting another hike before year end. While we think hindsight will show these hikes to have been a policy error (inflation well below target, housing bubble deflating if not bursting which will translate into a negative wealth effect and weight on consumer spending, extremely stretched household debt servicing costs jumping) the short term impact will be continued strength for CAD. CAD has strengthened 7% year-to-date. What are the chances.....that the Bank of Canada will hike interest rates in their next meeting? 19.6%..that EURUSD will be above 1.20 at the end of 2017? 30.0%..that GBPUSD will touch 1.35 within the next year? 71.1% ECB Whilst the ECB statement was quite dovish, the market jumped on the comment that a discussion on tapering will likely happen in the fall, which could be as early as September. The market is now pricing in 10 bps of hikes by September The FX markets jumped on this first indication of a discussion on tapering, as well as the fact that Draghi had ample opportunity to express concerns on the strength of the EUR (which he almost always does) but let the opportunity pass. EURUSD rallied 100 pips during the press conference. We are happy to announce that out of 80 contributors (including all major banks), Validus Risk Management has been the most accurate forecaster for GBPUSD in 2016 and for GBPEUR in Q1 2017, according to Bloomberg rankings. Validus Risk Management Ltd (FRN: is authorised and regulated by the UK Financial Conduct Authority). This newsletter is intended for Professional Clients only. +44 (0) info@validusrm.com

2 Bank of England The BoE s Monetary Policy Committee surprised the market last month when the minutes showed that 3 of the eight members had voted for a rate rise, even in the face of Brexit. The market is now expecting a hike at some point during the course of GBPUSD has rallied 3% since the June meeting, and almost 7% year to date. Reserve Bank of Australia The markets are now pricing in a 60% chance of a rate hike in the first half of 2018, after the RBA indicated that the neutral rate of interest is 3.5%, 2 full percentage points above where it is now. I m not sure they meant to have their statement interpreted as a signal that they intended to raise rates, but AUDUSD has jumped 3% since the June meeting, and 10% since the beginning of the year. Sweden s Riksbank The Swedish central bank has been referring to rate hikes in their statements since April, although pointing to a likely tightening in mid With inflation running above target, this schedule may be accelerated. While SEK has already appreciated vs USD by almost 11% year to date, the Riksbank may be quite happy to see that strengthen even further to act as a pseudo tightening of policy until they are ready to take action. US Federal Reserve Just when the party is getting into full swing, the Fed looks like it s having some second thoughts and is indicating that the pace of rate hikes might slow down somewhat. If that turns out to be the case, then expect the wide yield spreads to these other countries, which have for so long been USD supportive, to continue to narrow, which will point to a weaker USD going forward. It looks like just as the guests are arriving at the Central Bank Tightening Party, the hosts are going out for a walk. Author: John Glover

3 GBPUSD GBPUSD The pound fell last week as headline inflation figures missed expectations and prompted jitters in the market that the more hawkish stance that the BoE has taken on lately may be undone if the UK economy is not performing as well as first thought. Meanwhile, in the US, political concerns continue to build as President Trump s failure to pass the healthcare bill and override Obamacare triggered a dollar sell-off last week. However, this was partially offset by the weak sterling leading to GBPUSD falling marginally lower overall. Key events for this week are: 26 th July: UK Q2 GDP 26 th July: FOMC Minutes 27 th July: US Employment Data Horizon Primary Indicator Score Short-Term Momentum Bullish Mid-Term Carry Extremely Bearish Long-Term PPP Valuation Bullish Technical View 1 GBPUSD continued to test the grounds slightly above the previous range last week. 2 However, divergence beyond 1.31 has so far been capped and the pair currently trades slightly lower than last week around Support Resistance 3 In the longer term, we are bullish on GBPUSD but the pair will need to maintain these higher levels outside of the longstanding range in order to open up risks towards the next level of the shorter term. Level 1 Level 2 Level 1 Level FX Forecasts PPP Valuation Validus Bloomberg Poll Avg 2.2 Q (revised ) 1.28 Q (revised Q (revised ) 1.28 Q (revised ) 1.28 Hedging Cost* Tenor Today 1M Ago 12M Low 12M Avg 12M High 6M Y Y Y (*Annualised Basis Point impact to sell GBP Forward) Spot Blended Fair Value 20% Band According to Purchasing Power Parity, GBPUSD is currently 10.80% undervalued. 3

4 GBPEUR GBPEUR After the last few weeks of the ECB seemingly becoming more hawkish providing a brighter outlook for the euro, ECB President Mario Draghi made an effort to be more dovish last week during a news conference. That being said, Draghi also mentioned for the first time the potential for a discussion on tapering and the euro continued to soar higher. What s more, weak headline inflation figures in the UK last week prompted jitters in the market that the more hawkish stance that the BoE has taken on lately may be undone if the UK economy is not performing as well as first thought. Key events for this week are: 26 th July: UK Q2 GDP Horizon Primary Indicator Score Short-Term Momentum Extremely Bearish Mid-Term Carry Bullish Long-Term PPP Valuation Bullish Technical View 1 Once again the 20-day moving average for GBPEUR has held strong last week. After briefly testing a break higher, the pair has again fallen back to be firmly capped by this moving average. 2 What s more, the support previously encountered at 1.13 has been overridden by the 20-day moving average, further cementing this as a key level to watch for GBPEUR. Support Resistance 3 Risks back towards October 16 lows around 1.10 would only be opened up should GBPEUR manage to sustain a break below 1.13 but in the longer term, our bias is bullish on GBPEUR. Level 1 Level 2 Level 1 Level FX Forecasts Validus Bloomberg Poll Avg Q (revised ) 1.14 Q (revised ) 1.12 Q (revised ) 1.12 Q (revised ) 1.12 Hedging Cost* Tenor Today 1M Ago 12M Low 12M Avg 12M High 6M Y Y Y (*Annualised Basis Point impact to sell GBP Forward) PPP Valuation Spot Blended Fair Value 20% Band According to Purchasing Power Parity, GBPEUR is currently 7.22% undervalued. 4

5 EURUSD EURUSD After the last few weeks of the ECB seemingly taking on a hawkish stance, ECB President Mario Draghi made an effort to be more dovish during a news conference last week. That being said, Draghi also mentioned for the first time the potential for a discussion on tapering and the euro continued to soar higher, reaching its highest point against the dollar since August The rally in EURUSD was further fuelled by a weak dollar which was triggered by President Trump s failure to pass the healthcare bill, adding to the mounting political concerns in the US. Key events for this week are: 26 th July: FOMC Minutes 27 th July: US Employment Data Horizon Primary Indicator Score Short-Term Momentum Extremely Bullish Mid-Term Carry Extremely Bearish Long-Term PPP Valuation Bullish Technical View 1 EURUSD has broken above the range which has held the pair for the last two years, soaring beyond 1.15 to a high of last week. 2 The pair has tested these grounds previously during this period, reaching a high of in August 2015 before falling back into the range, so we must be cautious of becoming too bullish at this stage. Support Resistance 3 That being said, our overall bias is for EURUSD to continue rising to around 1.18 by the end of the year. Level 1 Level 2 Level 1 Level FX Forecasts Validus Bloomberg Poll Avg Q (revised ) 1.13 Q (revised ) 1.14 Q (revised ) 1.14 Q (revised ) 1.14 Hedging Cost* Tenor Today 1M Ago 12M Low 12M Avg 12M High 6M Y Y Y (*Annualised Basis Point impact to sell EUR Forward) PPP Valuation Spot Blended Fair Value 20% Band According to Purchasing Power Parity, EURUSD is currently 5.67% undervalued. 5

6 USDCAD USDCAD The Canadian dollar continued it s rally last week despite weak inflation figures which showed a fall in prices in June for the first time this year. The rally was fuelled further by a weak dollar which was triggered by President Trump s failure to pass the healthcare bill, adding to the mounting political concerns in the US. Key events for this week are: 26 th July: FOMC Minutes 27 th July: US Employment Data 28 th July: Canadian GDP Horizon Primary Indicator Score Short-Term Momentum Extremely Bearish Mid-Term Carry Neutral Long-Term PPP Valuation Neutral Technical View 1 Once again, USDCAD has continued to diverge from the previous trend highlighted in blue in the chart, reaching a 14-month low last week. 2 The pair will likely encounter support next at the 2016 low at around However, in the longer term, our bias remains skewed for a reversion back towards 1.37 by H Support Resistance Level 1 Level 2 Level 1 Level FX Forecasts Validus Bloomberg Poll Avg Q (revised ) 1.30 Q (revised ) 1.30 Q (revised ) 1.31 Q (revised ) 1.31 Hedging Cost* Tenor Today 1M Ago 12M Low 12M Avg 12M High 6M Y Y Y (*Annualised Basis Point impact to sell CAD Forward) PPP Valuation Spot Blended Fair Value 20% Band According to Purchasing Power Parity, USDCAD is currently 1.48% overvalued. 6

7 Economic Data & Market Indicators Economic Matrix GDP CPI Unemployment Industrial Production Retail Sales Current Account % GDP Budget Balance % GDP 10 Year Yield US 1.40% 1.60% 4.40% 1.97% 2.80% -2.36% -3.40% 2.24% EUR 1.90% 1.30% 9.30% 4.00% 2.60% 3.46% -1.32% 0.50% UK 2.00% 2.60% 4.50% -0.20% 0.90% -3.86% -2.36% 1.19% CAN 3.71% 1.00% 6.50% 4.85% 7.30% -3.08% 0.10% 1.90% Central Bank Bias Current Rate Last Change Date of Change Next Meeting Likely Outcome UK 0.25% -0.25% 4 th August 16 3 rd August 17 Unchanged US 1.00% % +0.25% 14 th June th July 17 Unchanged CAN 0.75% +0.25% 12 th July 16 6 th September 17 Unchanged EUR 0.00% -0.05% 10 th March 16 7 th September 17 Unchanged 7

8 Appendix - Primary Indicator Methodology 1. Momentum The momentum indicator is based on four metrics - 1 week change, 1 month change, 8/15 day moving average and 10/25 day moving average of the spot rate. We look at the direction of movement of each metric in the previous week (increase or decrease) and then assign a final score. For example, if all metrics moved up, we assign an Extremely Bullish score. Movement in metrics Score Extremely Bullish Bullish Neutral Bearish Extremely Bearish 2. Carry We calculate carry based on the difference between interest rates in two respective countries for each currency pair. See below for score assignment: Carry Score > 1% Extremely Bullish < 1% and > 0.5% Bullish < 0.5% and > -0.5% Neutral < -0.5% and > -1% Bearish < -1% Extremely Bearish 3. PPP Valuation In order to determine whether a currency pair is over or undervalued, we use CPI, PPI, OECD, Goldman Sachs and IMF fair values, calculate their average, and compare it with the spot price. Depending on the magnitude of divergence of the spot from the fair value, we assign a specific risk score (see table below): Valuation Score > 15% Extremely Bearish < 15% and > 5% Bearish < 5% and > -5% Neutral < -5% and > -15% Bullish < -15% Extremely Bullish Disclaimer: The Information is not intended to be a complete statement or summary of securities, markets or developments referred to in the document. Validus does not undertake to update or keep current the Information. Any opinions expressed in this document may change without notice and may differ or be contrary to opinions expressed by other business individuals or groups of Validus. Any statements contained in this report attributed to a third party represent Validus's interpretation of the data, information and/or opinions provided by that third party either publicly or through a subscription service, and such use and interpretation have not been reviewed by the third party. Nothing in this document constitutes a representation that any investment strategy or recommendation is suitable or appropriate to an investor s individual circumstances or otherwise constitutes a recomendation. For advice, trade execution or other enquiries, clients should contact their representative. 8