US Dollar

Highlights When it comes to a beauty contest among currencies, the US dollar is a winner right now. Significant dollar moves tend to occur in very long cycles. When – and only when – the crisis ends will the dollar begin to surrender to significant headwinds. The transition from a stronger to weaker dollar is likely to occur in fits and starts. Watch the gold-to-bond ratio and USD/CNY exchange rate as key arbiters in timing this shift. Feature The world economy has clearly been nudged into a very deep recession. But as with other pandemics, the global economy is likely to survive this one too. As currency markets continue to fight a tug-of-war between deteriorating global growth and very easy financial conditions, it is instructive to start placing bets on the likely winners (and losers) that will emerge from this battle. Throughout the past few decades, the most powerful driver of currencies has been the relative rate of return between any two economies. After all, an exchange rate is simply a measure of relative prices between any two concerns. And as equilibrating mechanisms by definition, currencies will fluctuate to equalize rates of returns across borders. Therefore, placing bets with higher odds of success critically requires answering two questions. Which markets and/or asset classes have the highest potential rate of return? What are the key mechanisms/signals through which this value will be unlocked? The Source Of US Dollar Beauty When it comes to a beauty contest among currencies, the US dollar is clearly the fairest. In fact, the most recent Treasury International Capital (TIC) data show that inflows into US assets have been reaccelerating (Chart I-1). Remarkably, the momentum of these purchases has been driven by equities (bottom panel), as US stocks have outperformed their international peers. Even the 2017 change in the US tax code to allow for favorable capital repatriation still continues to benefit the dollar. On a rolling 12-month basis, the US has repatriated about $192 billion in net assets, or close to 1% of GDP. Chart I-11. Inflows Into US Assets Are Picking Up 1. Inflows Into US Assets Are Picking Up 1. Inflows Into US Assets Are Picking Up Supercharging this trend has been a global shortage of dollars, which has increased the international appeal of US paper. This was triggered by the Federal Reserve’s tapering of asset purchases. The Fed’s balance sheet peaked a nudge above US$4.5 trillion in early 2015 and, until recently, had been falling. This triggered a severe contraction in the U.S. monetary base (Chart I-2), and curtailing commercial banks’ excess reserves. Chart I-2A Liquidity Flush 2. A Liquidity Flush 2. A Liquidity Flush Despite the Fed’s massive liquidity injections and significant uptake of its swap program (Chart I-3), the greenback could remain well bid in the near term. We will not revisit the analysis here, but encourage clients to read our issue from last week in case they missed it.1 What we can add is that the dollar tends to thrive in uncertainty, and even with ample dollar liquidity, non-banks are still facing dollar shortages. For example, there remains a gap between the rate on the Fed’s US dollar swap lines and various measures of offshore dollar funding. Meanwhile, cross-currency basis swaps are still wide for some developed and emerging market currencies (Chart I-4).2 Chart I-3Foreign Central Banks Tap Into USD Swaps Foreign Central Banks Tap Into USD Swaps Foreign Central Banks Tap Into USD Swaps Chart I-4The Funding Crisis Has Eased The Funding Crisis Has Eased The Funding Crisis Has Eased Bottom Line: As a countercyclical currency, the greenback remains well bid in the near term. Historically, the dollar has tended to move in long cycles, usually 10 years, suggesting the current bull market might be nearing an end (please see Chart I-8 in the next section). This also suggests there is no need to rush into building USD shorts, should the next cycle in the dollar last a decade.  Regime Shift? When, and only when the crisis ends will the dollar begin to surrender to significant headwinds. The good news is that these headwinds continue to mount, and will eventually exert a powerful deflationary force on the greenback.  When, and only when the crisis ends will the dollar begin to surrender to significant headwinds. Starting with equity markets, expected relative returns are extremely unfavorable for US stocks. Chart I-5A – Chart I-5R shows that the equity valuation starting point is important for local-currency returns over the long term. The chart shows 10-year annualized equity relative returns, superimposed on our composite valuation indicator.3 So, in the case of the US versus Japan, the left-hand side scale shows that US equities are trading 1.5 standard deviations above their mean valuation relative to Japanese equities. The right-hand side scale shows what to expect in terms of relative returns over the next 10 years by overweighting Japanese equities relative to the US. Chart I-5A Cycles And The US Dollar Cycles And The US Dollar Chart I-5B Cycles And The US Dollar Cycles And The US Dollar Chart I-5C Cycles And The US Dollar Cycles And The US Dollar Chart I-5D Cycles And The US Dollar Cycles And The US Dollar Chart I-5E Cycles And The US Dollar Cycles And The US Dollar Chart I-5F Cycles And The US Dollar Cycles And The US Dollar Chart I-5G Cycles And The US Dollar Cycles And The US Dollar Chart I-5H Cycles And The US Dollar Cycles And The US Dollar Chart I-5I Cycles And The US Dollar Cycles And The US Dollar Chart I-5J Cycles And The US Dollar Cycles And The US Dollar Chart I-5K Cycles And The US Dollar Cycles And The US Dollar Chart I-5L Cycles And The US Dollar Cycles And The US Dollar Chart I-5M Cycles And The US Dollar Cycles And The US Dollar Chart I-5N Cycles And The US Dollar Cycles And The US Dollar Chart I-5O Cycles And The US Dollar Cycles And The US Dollar Chart I-5P Cycles And The US Dollar Cycles And The US Dollar Chart I-5Q Cycles And The US Dollar Cycles And The US Dollar Chart I-5R Cycles And The US Dollar Cycles And The US Dollar Cycles And The US Dollar Cycles And The US Dollar The forward P/E on MSCI US and Japan is 19.7x and 13.4x, respectively. The skew towards the US is because market participants expect US profits to keep outperforming, the greenback to keep appreciating, or a combination of the two. While this might be plausible in the short term as the fascination with FAANG stocks continues to capture investors’ imaginations, the empirical evidence is that current US valuations have more than fully capitalized future earning streams. Based on historical correlations, expected 10-year annualized returns for the MSCI US relative to Japan is -10%. Importantly, our composite valuation indicator adjusts for sector weights, so that there is no over representation of any sector in any country. So even if technology and healthcare are winners over the next decade, capital can still gravitate from the US towards other markets where these sectors are cheaper. Capital outflows will lead to a selloff in an overvalued US dollar. In fact, across our sample of 18 developed and emerging market currencies, the message remains that long-term equity capital will dry up for US assets due to expensive valuations. Therefore, the latest inflows into US equities are at risk of a Minsky moment. Such capitulation could well be the beginning of a 10-year cycle of dollar weakness. Cross-currency basis swaps are still wide for some developed and emerging market currencies. Second, the US has lost its interest rate advantage. Against an aggregate of G10 currencies, the dollar currently yields almost nil in real terms (Chart I-6). This has historically led to a softer dollar. Remarkably, even for a Japanese or German investor, negative domestic rates might no longer be a catalyst to invest in US paper, should domestic inflation continue blasting downward. The catalyst for outflows could be if the US 10-year Treasury yield hits zero, amidst the Fed adopting negative rates. Chart I-6The US Interest Rate Gap Has Vanished The US Interest Rate Gap Has Vanished The US Interest Rate Gap Has Vanished Chart I-710-Year Cycle Outlook For The Dollar 10-Year Cycle Outlook For The Dollar 10-Year Cycle Outlook For The Dollar Once that happens, new bond investors face the prospect of real losses from either higher yields and/or currency depreciation as the Fed continues to dilute existing Treasury shareholders (Chart I-7). If the Fed is set to anchor the price of money near zero for the foreseeable future, currency depreciation is the only mechanism to entice foreign investors to keep funding the US twin deficits. The US dollar does have an exorbitant privilege in that as a reserve currency, the trade deficit is settled in dollars. However, that privilege does require that the rise in foreign exchange reserves from other central banks are reinvested back into Treasurys. This allows the current account deficit (or capital account surplus) to finance the budget deficit. The bad news is that official flows into US paper have plateaued, with the likes of Beijing and other central banks continuing to destock their holdings of Treasurys (Chart I-8). Global allocation of foreign exchange reserves paints a similar picture – allocations toward the US dollar recently peaked at about 65% and have been in a downtrend since, with the void being filled by other currencies, notably gold, the British pound, the Swiss franc, and the yen. Chart I-8Diversification Away From Dollars Accelerates Diversification Away From Dollars Accelerates Diversification Away From Dollars Accelerates The key point is that for one reason or another, foreign central banks are diversifying out of dollars. Our bias is that China has been doing so to make room for the internationalization of the RMB, as well as for geopolitical reasons, similar to other countries such as Russia. This trend will be supercharged as private investors start to focus on the real prospect of very dire returns over the coming cycle. Bottom Line: Expensive valuations and low interest rates make prospective returns for US equities and fixed income unattractive. This will force private capital to require a much lower exchange rate to fund US liabilities. The RMB And Gold As Umpires Chart I-9Will TLT Outperform GLD Next Decade? Will TLT Outperform GLD Next Decade? Will TLT Outperform GLD Next Decade? The transition from a stronger to weaker dollar is likely to occur in fits and starts. For one, the dollar is a countercyclical currency and will remain strong as uncertainty continues to dominate the macro landscape. We are watching two key indicators (among many others) as signposts for when the shift is occurring: Gold-To-Bond Ratio: One of our favorite indicators for gauging ultimate downside in the dollar is the gold-to-bond ratio. Ever since the breakdown of the Bretton Woods system, gold has stood as a viable threat to dollar liabilities, capturing the ebb and flows of investor confidence in the greenback tick-for-tick. Any sign that the balance of forces are moving away from the US dollar will favor a breakout in the gold-to-bond ratio. The TLT ETF relative to the GLD ETF broke above parity earlier this year, and has since been consolidating those gains (Chart I-9). This has brought it back within the trading range in place since early 2017. A decisive move below 0.95 will be a bearish development for the greenback. RMB Exchange Rate: As the RMB continues to gain international recognition, Chinese government bonds should outperform Treasurys. It is remarkable that from 2011 up until the Fed turned dovish in 2018, Chinese government bond performance was much better than Treasurys, even as the dollar was soaring (Chart I-10). Going forward, the USD/CNY rate should continue to act a key anchor for the direction of cyclical/emerging market currencies, as we highlighted last week. A break above last year’s highs will be bearish, while it will be encouraging if the 7.0 level is breached on the downside. Chart I-10Will Treasurys Outperform RMB Bonds Next Decade? Will Treasurys Outperform RMB Bonds Next Decade? Will Treasurys Outperform RMB Bonds Next Decade? Bottom Line: Watch the bond-to-gold ratio and Chinese RMB exchange rate as key signals for the direction of the US dollar. A breakdown in the US dollar will be a key mechanism to unlock value in foreign assets.  Housekeeping Chart I-11Target 1.10 On AUD/NZD Target 1.10 On AUD/NZD Target 1.10 On AUD/NZD The Reserve Bank of New Zealand decided to keep rates on hold, but reinforced forward guidance by almost doubling the size of its asset purchases to NZ$60 billion, while keeping open the possibility of negative rates. This has driven the divergence between Aussie and Kiwi 10-year yields to the highest level since 2008 (Chart I-11). In a world where rates continue to fall to very low levels, the policy of yield curve control implemented by the Reserve Bank of Australia does not pack the same punch as negative interest rates. Fundamentally, three factors will support the AUD/NZD cross: First, terms-of-trade dynamics are more favorable for Australia, which is lifting the nation’s basic balance to a substantial surplus. While infrastructure investment growth in China is likely to slow from historical levels, liquefied natural gas imports should remain in a structural uptrend. China’s switch from coal to natural gas electricity generation will continue to buffet Australian export volumes. On the kiwi side of things, as food security becomes more and more important in a post COVID-19 world, agricultural exports will not enjoy the same volume boost. Stay long AUD/NZD. Second, a substantial lift to New Zealand’s labor dividend has come from immigration (Chart I-12). The recent surge in net migrant numbers is due to exit restrictions for recent entrants. Yet even as things return to normal, that labor dividend will remain low as many people rethink international travel for work. This will restrain some supply-side parts of the economy, prompting the RBNZ to keep rates lower for longer. Chart I-12Loss Of A Meaningful Tailwind For Employment Loss Of A Meaningful Tailwind For Employment Loss Of A Meaningful Tailwind For Employment Finally, the cross offers a lot of relative value – not just from an interest rate standpoint, but also on a real effective exchange rate basis.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Please see Foreign Exchange Strategy Weekly Report, titled “Line In The Sand,” dated May 08, 2020, available at fes.bcaresearch.com. 2 Egemen Eren, Andreas Schrimpf, and Vladyslav Sushko, “US Dollar Funding Markets During The Covid-19 Crisis – The International Dimension,” BIS Bulletin (May 12, 2020). 3 Composite indicator comprised of price-to-earnings, forward price-to-earnings, price-to-cash flow, dividend yield, price-to-book, price-to-sales, Tobin's Q, and market capitalization-to-GDP. Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been negative: Nonfarm payrolls fell by 20.5 million in April. The unemployment rate soared to 14.7% from 4.4%. The labor force participation rate declined to 60.2%. However, average hourly earnings increased by 7.9% year-on-year, since most job losses were in lower-income quartiles. Headline inflation fell from 1.5% to 0.3% year-on-year in April. Core inflation declined from 2.1% to 1.4% year-on-year in April. The NFIB business optimism index fell from 96.4 to 90.9 in April. Initial jobless claims kept increasing by 22.9 million last week. The DXY index appreciated by 1.2% this week. On Tuesday, House Democrats unveiled a $3 trillion stimulus package to further aid the economy, including nearly $1 trillion for state and local governments, $200 billion fund for essential worker hazard pay, and an additional $75 billion for COVID-19 testing. Report Links: Capitulation? - April 3, 2020 The Dollar Funding Crisis - March 19, 2020 Are Competitive Devaluations Next? - March 6, 2020 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been negative: Industrial production plunged by 13% year-on-year in March. The unemployment rate in France declined from 8.1% to 7.8% in Q1. The euro depreciated by 0.5% against the US dollar this week. The ECB Economic Bulletin released this Thursday highlighted that euro area GDP could fall by between 5% and 12% this year, highlighting uncertainty around the ultimate extent of the economic fallout. More importantly, the ECB Governing Council is fully prepared to increase the size of the PEPP by as much as necessary. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been negative: The coincident index fell from 95.4 to 90.5 in March. The leading economic index fell from 91.9 to 83.8 in March. The trade surplus narrowed from ¥1.4 trillion to ¥1.03 trillion in March. The current account surplus shrank by nearly 40% to ¥1.97 trillion. Bank lending increased by 3% year-on-year in April, up from 2% the previous month. Machine tool orders kept contracting by 48.3% year-on-year in April.  The Japanese yen fell by 0.7% against the US dollar this week. The Economy Watchers’ Survey released this week showed that the current situation index plunged from 14.2 to 7.9 in April. The outlook index also declined from 18.8 to 16.6. It also implied that the situation is likely to deteriorate further, due to the severe challenges posed by COVID-19. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been negative: GDP contracted by 1.6% year-on-year in Q1, compared with a 1.1% increase the previous quarter. Retail sales increased by 5.7% year-on-year in April, up from a 3.5% decline in March. The total trade deficit widened notably from £1.5 billion to £6.7 billion in March. Industrial production fell further by 8.2% year-on-year in March. Manufacturing production fell by 9.7% year-on-year in March. The British pound fell by 1.6% against the US dollar this week, alongside the weak Q1 GDP data. Moreover, the National Institute of Economic and Social Research (NIESR) estimates that GDP will plunge by about 25-to-30%quarterly in Q2. They also pointed out that while some activities will resume with the reopening, there is a significant risk of a second wave which could trigger a further setback in the economy. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mixed:  The NAB business confidence improved from -65 to -46 in April, while the business conditions index fell from -22 to -34 in April. Westpac consumer confidence ticked up from -17.7 to 16.4 in May. Employment decreased by 594K in April, down from a 5.9K increase the previous month. The unemployment rate increased from 5.2% to 6.2%, however this is well below the expected rise to 8.3%. The wage price index increased by 2.1% year-on-year in Q1. The Australian dollar fell by 1.9% against the US dollar this week. The labour force survey showed that the number of people looking for work declined significantly during the shutdown, which has been one of the main reasons why the unemployment rate did not fall as much as expected. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mixed: ANZ business confidence improved from -66.6 to -45.6 in May. Net migration increased by 4,941 in March, compared with a 4,339 increase the previous month. The New Zealand dollar fell by 2% against the US dollar this week. On Tuesday, the RBNZ kept the interest rate unchanged at 0.25%, while increasing its asset purchase programme by up to NZ$60 billion. Moreover, it implied that negative interest rates could be possible as the COVID-19 pandemic continues to disrupt the economy. We recommend holding on to long AUD/NZD positions. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been negative: Housing starts declined from 195.4K to 171.3K in April. Building permits plunged by 13.2% month-on-month in March. The unemployment rate soared to 13% from 7.8% in April. The participation rate declined to 59.8% from 63.5%. Employment decreased by 1993.8K in April, better than the expected 4000K drop, while average hourly wages increased by 10.5% year-on-year. The Canadian dollar depreciated by 0.9% against the US dollar this week. The employment loss is led by Quebec, which saw the increase of unemployment to 18.7%. Moreover, while the number of self-employed workers was little changed, there has been a large drop in total hours worked. In addition, the loss of employment was concentrated in accommodation, food services and construction. Report Links: More On Competitive Devaluations, The CAD And The SEK - May 1, 2020 A New Paradigm For Petrocurrencies - April 10, 2020 The Loonie: Upside Versus The Dollar, But Downside At The Crosses Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been negative: Producer and import prices kept declining by 4% year-on-year in April, following a 2.7% decrease in March. Sight deposit increased from CHF 663.8 billion to CHF 669.1 billion for the week ended May 8. The Swiss franc fell by 0.3% against the US dollar this week. Switzerland has entered its second phase of reopening. Schools, businesses, museums and restaurants can reopen as long as they take precautionary measures. However, as a small open economy, Switzerland is heavily dependent on exports and imports, which are curtailed in a global economic recession. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been negative: Manufacturing output fell by 3% month-on-month in March. PPI plunged by 16.1% year-on-year in April. Headline inflation increased from 0 to 0.4% in April, while core inflation soared from 2.1% to 2.8% year-on-year, led by higher food prices especially imported fruits and vegetables. The Norwegian krone initially rebounded by 2.8% against the US dollar, then gradually fell amid broad dollar strength, returning flat this week. The Norges Bank Executive Board has decided to exclude a list of Canadian oil companies from its government pension fund due to pollution concerns. Report Links: A New Paradigm For Petrocurrencies - April 10, 2020 Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been negative: Headline consumer prices contracted by 0.4% year-on-year in April. The Swedish krona has been flat against the US dollar this week. The Minutes of the Monetary Policy Meeting released this week showed that the Riksbank is ready to scale up its bond purchases if conditions warrant. Last week, all bank members continued to support asset purchases of up to SEK 300 billion until this September. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The Federal Reserve’s temporary FIMA repo facility will go a long way in helping ease dollar-funding stress outside the US. However, with the duration of the lockdown highly uncertain, a liquidity crisis could rapidly evolve into a solvency one. If the containment measures prove successful by summer, then the global economy will be awash with much stimulus, which will be fertile ground for pro-cyclical currencies. However, in the event that we receive indications of a more malignant outcome, we could retest and break above the recent highs in the DXY. We assign a one-third probability to this outcome. For now, a barbell strategy is warranted. Hold a basket of the cheapest currencies, along with some safe-havens. Crude oil has approached capitulation lows, but conditions are not yet in place for a durable bottom. Stand aside on petrocurrencies for now. Feature Chart I-1The Fed's Liquidity Injections Are Working The Fed's Liquidity Injections Are Working The Fed's Liquidity Injections Are Working The DXY index has once again broken above the psychological 100 level. This has occurred alongside the backdrop of very generous swap lines offered by the Federal Reserve to foreign central banks, as well as a temporary repo facility for foreign and international monetary authorities (FIMA). In fact, the euro-dollar cross-currency basis swap is now in positive territory, suggesting that a key funnel for offshore dollar liquidity has now significantly widened (Chart I-1). Why then has the dollar continued to strengthen, despite a concerted effort by the Fed to flood the global system with dollars? We offer and explore three reasons: The Fed’s actions are still insufficient. The dollar crisis is evolving from a liquidity one to a solvency one. The liquidity-to-growth transmission mechanism needs time. The Fed’s Actions Are Still Insufficient The Fed’s actions so far to ease the offshore dollar funding stress have been to: Offer unlimited funding through swap lines to five major central banks at the overnight index swap + 25 basis points.1  This was effective the week of March 16. Extend the swap lines to nine more central banks, with a cap of US$60 billion and a maturity of 84 days.2 This was announced March 19. Allow FIMA account holders to temporarily exchange their Treasury securities held with the Fed for US dollars. This was announced on Tuesday. Have these actions been sufficient? For most developed market currencies, yes. Chart I-2 shows that the currencies that have been most hit in the first quarter were of the countries initially excluded from the swap agreement such as Australia, Norway and New Zealand. Since the March 19 agreement, these currencies have staged significant rallies. Chart I-2Very Few Winners In Q1 Capitulation? Capitulation? However, there are three reasons why the Fed’s actions are still insufficient. First, they are limited to only 14 central banks, and need to be expanded further. While currencies such as the Brazilian real and Mexican peso have stabilized, others like the Turkish lira or South African rand continue their freefall. In short, many emerging market central banks do not have swap agreements with the US. These are countries with huge dollar liabilities that could continue to see their currencies fall, pushing up the  aggregate dollar index. Developed market commodity currencies tend to be highly correlated to emerging market currencies (Chart I-3). There is a huge pool within the financial architecture unable to access funding through central bank swap lines.  The second reason is that the pool of Treasury securities available to swap for US dollars has shrunk significantly. This has been on the back of slowing global trade, which sapped the current account surpluses of many countries, dampening their foreign exchange reserves. Thus, while the Fed’s latest actions may prevent an international dumping of US Treasurys, it may be insufficient to completely assuage funding stresses (Chart I-4). Chart I-3Commodity Currencies Still At Risk Commodity Currencies Still At Risk Commodity Currencies Still At Risk Chart I-4A Smaller Pool Of Treasurys To Sell A Smaller Pool Of Treasurys To Sell A Smaller Pool Of Treasurys To Sell Finally, a recent report by the Bank of International Settlements3 showed that of the US$86 trillion in outstanding foreign exchange swaps/forwards, about 60% is among non-bank financial and other institutions. This suggests there is a huge pool within the financial architecture unable to access funding through central bank swap lines. Given that hedge funds are included in this group, this category entails a lot more credit risk than any central bank will be willing to bear (Chart I-5). Chart I-5Can The Fed Bail Out Non-Banks? Capitulation? Capitulation? Bottom Line: While the Fed’s injection of dollar liquidity has been massive and significant, access to these funds may be limited to entities that have significant credit risk. There is not much the Fed can do about this. But at the same time, it also suggests the Fed’s actions have been insufficient to quench the global thirst for dollar liquidity. From A Liquidity To A Solvency Crisis If the containment measures prove successful by summer, then the global economy will be awash with much stimulus, which will be fertile ground for pro-cyclical currencies. As a counter-cyclical currency, the dollar will buckle, lighting a fire under our favorites such as the Norwegian krone and the Swedish krona. The euro will be the most liquid beneficiary of this move. However, the DXY index has effortlessly broken above the psychological 100 level, suggesting we could catapult to new highs. When massive amounts of stimulus are injected into markets but prices keep falling (and the dollar keeps rallying), this portends a liquidity crisis morphing into a solvency one. What ensues is a liquidation phase where the only guiding signposts are technical indicators and valuation extremes. There are a few indications we could be stepping into this phase: During recessions, the dollar rally has tended to occur in two phases. The first phase prompts the US authorities to act, usually by dropping interest rates, which dampens the rally. The next phase epitomizes indiscriminate liquidation by financial markets (Chart I-6). Enter 2008. The US first introduced swap lines with a few central banks in December 2007. But from March to October 2008, the dollar soared by about 25%. This prompted the Fed to expand its swap lines to include even some emerging markets. Despite the knee-jerk fall in the dollar of 11%, we eventually made new highs by rallying 15%. While the Fed’s injection of dollar liquidity has been massive and significant, access to these funds may be limited. As the dollar rises, it takes time for economies to implode due to strong monetary and fiscal frameworks. The implosion of the euro area economy only surfaced well after the 2008 crisis. Specifically, there has been an epic rise in global nonfinancial corporate debt. As a result, credit default swaps across many countries are surging (Chart I-7). High-yield spreads are blowing out. Our bond strategists believe that even though there is value in investment-grade debt, high-yield paper remains at risk.4  Historically, whenever the default rate has breached 4% (as is the case now), a self-reinforcing feedback loop of higher refinancing rates and defaults ensues (Chart I-8). With a recovery rate that is going to be much lower than historical standards due to bloated balance sheets, this is worrisome. Chart I-6The Dollar Rally Occurs In Two Phases The Dollar Rally Occurs In Two Phases The Dollar Rally Occurs In Two Phases Chart I-7CDS Spreads Are Widening Significantly CDS Spreads Are Widening Significantly CDS Spreads Are Widening Significantly Chart I-8Large Defaults Are Ahead Large Defaults Are Ahead Large Defaults Are Ahead It is difficult to pinpoint where the epicenter of the potential default wave will be. The energy sector looks like a prime candidate, putting many commodity currencies at risk. Bottom Line: There is a non-negligible risk that the liquidity crisis evolves into a solvency one. Though this is not our base case, we assign a one-third probability to this outcome. Liquidity To Growth Transmission Channel Monetary stimulus only affects the economy with a lag, and fiscal stimulus is so far unlikely to completely plug the hole from economic disruption. This leaves currency technicals and valuation as among the only few guiding signposts towards a peak in the DXY. There is usually a significant lag between easing in offshore dollar funding costs and a respective bottom in the domestic currency (Chart I-1). The AUD/JPY cross has broken below the key support zone of 70-72. This defensive line held notably during the European debt crisis, China’s industrial recession and, more recently, the global trade war. This pins the next level of support in the 55-57 zone, on par with the recessions of 2001 and 2008. The USD/JPY is weakening again and will likely hit 100. A rising yen is usually accompanied by a dollar rally against other procyclical currencies. Outside of the Fukushima crisis, this has been a key indicator that the investment environment is becoming precarious (Chart I-9). Chart I-9The Yen Could Touch 100 The Yen Could Touch 100 The Yen Could Touch 100 Some high-beta currencies such as the USD/TRY, USD/ZAR, and USD/IDR are still in freefall. These currencies are usually good at sniffing out a change in the investment landscape, specifically one becoming perilous for carry trades. Similarly, the USD/CNY has tested and has failed to break above 7.12. This will be a key level to watch since a break above will send Asian currencies into the abyss. “Doctor” copper has failed to stage a meaningful rebound. In fact, the copper-to-gold and oil-to-gold ratios continue to head lower from oversold levels.  Whenever cyclical sectors are underperforming defensives at the same time as non-US markets underperforming US ones, this has signaled that the marginal dollar is rotating towards the US. This is usually dollar bullish (Chart I-10A and Chart I-10B). “Doctor” copper has failed to stage a meaningful rebound. In fact, the copper-to-gold and oil-to-gold ratios continue to head lower from oversold levels. This signifies impairment in the liquidity-to-growth transmission mechanism (Chart I-11). Earnings revisions continue to head lower across all markets. Chart I-10ACyclical Markets Are Not Confirming A Dollar Top Cyclical Markets Are Not Confirming A Dollar Top Cyclical Markets Are Not Confirming A Dollar Top Chart I-10BCyclical Markets Are Not Confirming A Dollar Top Cyclical Markets Are Not Confirming A Dollar Top Cyclical Markets Are Not Confirming A Dollar Top   Chart I-11Dr Copper Is Sick Dr Copper Is Sick Dr Copper Is Sick Bottom Line: Historically, signs of capitulation can usually be observed by paying close attention to market internals and currency technicals. While we have had some marginal improvement, we are not out of the woods yet. Portfolio Strategy Chart I-12Go Short CAD/NOK Go Short CAD/NOK Go Short CAD/NOK We recommend maintaining a barbell strategy – a basket of the cheapest currencies, along with some safe-havens such as the yen and Swiss franc. Overall, investors should maintain a small upward bias in the dollar in the near term. Meanwhile, short USD/JPY positions make sense. Oil plays are becoming attractive, but conditions for a durable bottom are not yet in place. The strong rebound in the NOK/SEK cross is just an unwinding of the flash crash. If the dollar and oil have been at the epicenter of these moves, then the cross is still at risk of relapsing in the near term. We were stopped out of a long position in this cross, and will discuss oil and petrocurrencies next week. That said, a short CAD/NOK position is a much safer way to express a longer-term bearish view on the dollar (Chart I-12). We are going short this cross today with a stop-loss at 7.5. Finally, the pound remains extremely cheap versus the dollar, but the rally in recent days has eroded the potential for tactical upside. We will await better opportunities to own sterling.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 These include the Bank Of Canada, Bank Of Japan, Bank Of England, European Central Bank, and the Swiss National Bank. 2 These include the Reserve Bank of Australia, the Banco Central do Brasil, the Danmarks Nationalbank (Denmark), the Bank of Korea, the Banco de Mexico, the Norges Bank, the Reserve Bank of New Zealand, the Monetary Authority of Singapore, and the Sveriges Riksbank. 3  Stefan Avdjiev, Egemen Eren and Patrick McGuire, “Dollar Funding Costs during the Covid-19 Crisis through the Lens of the FX Swap Market,” BIS Bulletin, dated April 1, 2020. 4 Please see US Bond Strategy and Global Fixed Income Strategy Joint Special Report, “Trading The US Corporate Bond Market In A Time Of Crisis,” dated March 31, 2020, available at usbs.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been negative: The University of Michigan's consumer sentiment index plunged to 89.1 in March from 101 the previous month, the fourth largest monthly decline over the past half a century. ADP employment recorded a loss of 27K jobs in total nonfarm private sector, including a 90K decrease in small businesses payroll which was offset by the 48K increase in healthcare. Initial jobless claims surged to 6.6 million for the week ended March 27. The ISM manufacturing index came in at a relatively benign 49.1, but this was boosted by supplier deliveries. The DXY index appreciated by 1.1% this week amid growing concerns over COVID-19 and disappointing data releases. Shortly after the $2 trillion coronavirus rescue package last week, President Trump is now calling for another "very big and bold" $2 trillion "Phase 4" package on infrastructure spending. Report Links: The Dollar Funding Crisis - March 19, 2020 Are Competitive Devaluations Next? - March 6, 2020 The Near-Term Bull Case For The Dollar - February 28, 2020 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been negative: The business climate indicator dropped to -0.28 from -0.06 in March, as the COVID-19 crisis deepens. The March consumer price inflation fell across the euro area: headline inflation fell from 1.2% to 0.7% year-on-year and core inflation decreased from 1.2% to 1%.  EUR/USD depreciated by 1.1% this week. Euro zone countries have until April 9 to design another stimulus package to support the economy which might consist of financial loans and a short-term work scheme. The biggest challenge being faced is that while some member countries (including France, Italy and Spain) are calling for joint debt issuance, others (including Germany and Austria) are fiercely against it. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been negative: The jobs-to-applicants ratio dropped from 1.49 to 1.45 in February. Industrial production contracted by 4.7% year-on-year in February, down from -2.3% the previous month. Housing starts fell by 12.3% year-on-year in February.  The Japanese yen appreciated by 1.6% against the US dollar this week, supported by growing concerns over COVID-19 and a global recession. The quarterly Tankan Survey shows that the sentiment index fell to a 7-year low of -8 in Q1 among large manufacturers, and dived to 8 from 20 among non-manufacturers. Besides, the survey points to a further deterioration of confidence over the next three months. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been negative, despite some positive releases for Q4: Consumer confidence dropped from -7 to -9 in March. Markit manufacturing PMI slipped from 48 to 47.8 in March. The current account deficit narrowed from £15.9 billion to £5.6 billion in Q4. Annualized GDP growth was unchanged at 1.1% year-on-year in Q4. The British pound soared by 2% against the US dollar this week. To preserve cash during the pandemic, the BoE's Prudential Regulation Authority (PRA) suggested commercial banks to suspend dividends and buybacks until the end of this year in addition to cancelling outstanding 2019 dividends. Moreover, the PRA also expects banks not to pay any cash bonuses to senior staff. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mixed: Consumer confidence dropped from 72.2 to 65.3 in March. Manufacturing PMI slipped from 50.1 to 49.7 in March. New home sales increased by 6.2% month-on-month in February, up from 5.7% the previous month. Building permits grew by 20% month-on-month in February. However, we expect housing activities to slow down in March. The Australian dollar fell further by 0.4% against the US dollar this week. In the minutes released this Wednesday, the RBA warned that a "very material contraction" in economic activity was ahead. While the RBA said it was not possible to provide an update of the macro forecast given the "fluidity of the situation", it also expressed concerns that the contraction might linger beyond the June quarter. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been negative: Building permits grew by 4.7% month-on-month in February. However, business confidence plunged from -19.4 to -63.5 in March. The activity outlook index also dived from 12 to -26.7 in March. The New Zealand dollar fell by 0.8% against the US dollar this week. Similar to the BoE, the RBNZ is now restricting all locally-incorporated banks from paying dividends on ordinary shares until the economy has sufficiently recovered in order to preserve cash and support the stability of the financial system. The RBNZ is also taking measures to help support banks to lend to businesses. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been negative: Bloomberg Nanos confidence dropped from 51.3 to 46.9 for the week ended March 27. Markit manufacturing PMI fell below 50 for the first time since last September to 46.1 in March. The Canadian dollar fell by 1.2% against the US dollar this week, weighed down by the sharp decline in oil prices. The BoC lowered the overnight target rate by another 50 bps in an emergency meeting last Friday. It also joined the QE club by launching the Commercial Paper Purchase Program (CPPP) which aims to ease short-term funding stress. Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been negative: KOF leading indicator dropped from 100.9 to 92.9 in March. Total sight deposits increased from CHF 609 billion to CHF 621 billion for the week ended March 27. The manufacturing PMI plunged from 49.5 to 43.7 in March. Headline consumer prices fell by 0.5% year-on-year in March, further down from the 0.1% decline in February. The Swiss franc fell by 1.5% against the US dollar this week. The SNB is not only battling a weaker economic backdrop, but also strong demand for safe-haven currencies. While the SNB has less room to further lower interest rates, it is taking part in easing funding stress from the pandemic. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been negative: Retail sales increased by 2% month-on-month in February, up from 0.5% the previous month. Manufacturing PMI fell to 41.9 from 51.6 in March, the lowest since the Great Financial Crisis. The new orders, production and employment components all plunged below 40, while suppliers' delivery index soared to 74. The Norwegian krone rebounded by 2% against the US dollar this week, following the brutal selloff in recent weeks weighed by the sharp decline in oil prices. The Norges Bank is stepping up in currency intervention to reduce volatility including buying the krone in exchange for the US dollar. We believe there is now tremendous value in the krone once oil prices stabilize. Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been negative: Retail sales grew by 2.8% year-on-year in February. Manufacturing PMI crashed to 43.2 in March from 52.7. The Swedish krona fell by 0.5% against the US dollar this week. In the Swedish Economy Report released on Wednesday, the NIER (Swedish National Institute of Economic Research) estimates that Sweden's GDP will fall by just over 6% in the second quarter. While the NIER believes that the current central bank measures are appropriate in supporting the economy in a wave of bankruptcies and mass unemployment, Sweden has more room to act with relatively lower government debt to its advantage. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Dear clients, In addition to this short weekly report, you will also receive a Special Report penned by my colleague Jonathan LaBerge on Sweden, with implications for the SEK. I hope you will find the report both useful and insightful. In the interim, I wish safety for you and your families. Best Regards, Chester Ntonifor Highlights The lack of dollar liquidity had been a tailwind behind the dollar bull market. However, an expansion in the Federal Reserve’s balance sheet should help stem the global shortage of dollars. Ditto if there is an expansion of swap lines beyond the five major central banks. The risk is that the shortage of dollars has already begun to trigger negative feedback loops in a few countries. Until tentative signs emerge that the global economy is on better footing, expect spikes in the dollar. The caveat is that a big fiscal spending package in the US should lead to a deterioration in the current account. This will improve the offshore dollar liquidity situation. Feature The latest flare-up in risk aversion has also rotated to the offshore dollar funding market. Across G10 countries, US dollar cross-currency basis swaps - a measure of the costs to obtain greenbacks domestically - have been rising at an alarming pace. During the Federal Reserve’s emergency meeting on Sunday, swap lines were extended to five major central banks. The terms were very generous, with costs at the overnight index swap rate + 25 basis points, as well as a maturity of 84 days. However, the following day, the dollar continued its fervent rally, with the euro-US cross-currency basis swap touching -120 points (Chart 1). Chart 1A Broad-Based Funding Crisis A Broad-Based Funding Crisis A Broad-Based Funding Crisis The lack of follow through from the Fed’s liquidity injection highlights a fundamental risk to our sanguine view that the dollar should top out sooner rather than later. While we maintain this view, it has been discouraging that the DXY has broken above 100. We had anticipated a move higher on February 21, prompting us to close our long DXY position for a loss. Today, we suggest waiting for better signposts to short the greenback outright.1 US Dollar Flows The dollar remains the reserve currency of today, with the Fed at the center of the global financial architecture. The process behind dollar shortages is a simple one: Chart 2Global FX Reserve Growth Was Anemic Global FX Reserve Growth Was Anemic Global FX Reserve Growth Was Anemic Countries that are experiencing falling trade balances (because of a trade slowdown or trade war) will see a fall in their foreign exchange reserves. This naturally means that their supply of dollars is declining (Chart 2). Wary of seeing local dollar interest rates rise (leading to a higher dollar, and some companies going bust), central banks could sell dollars to the private sector in exchange for local currency. As a reserve currency, the US trade deficit is also settled in dollars. This naturally leads to a flow of greenbacks outside US borders. However, it also means that the current account deficit finances the budget deficit. Therefore, a falling trade surplus in exporting countries naturally means a falling deficit in the US. In order to stimulate the US economy, the authorities pursue macroeconomic policies that tend to weaken the dollar, such as lowering rates and/or running a wider fiscal deficit. The central bank helps finance this fiscal deficit via expanding the monetary base (Seigniorage). The drop in rates causes the yield curve to steepen. This incentivizes banks to lend, which in turn boosts US money supply. As the economy recovers and demand for imports (machinery, commodities, consumer goods) rises, the current account deficit widens. This leads to a renewed outflow of dollars. It is easy to see where the process can get short-circuited, especially via an external shock. If you accept the premise that the sum of the Fed’s custody holdings together with the US monetary base constitutes the root of global dollar liquidity, then it is not yet accelerating fast enough.2 Like in the past, the Fed has been quick to correct the situation: Recently, it has instituted swap lines. However, they remain inadequate for three key reasons: The swap lines should be extended from the five central banks to many countries, because Covid-19 is now a global pandemic. Not even China (along with other emerging markets) was  included in the swap agreements. The swap lines usually have terms/limits/amounts, which means that even if the domestic central bank decided to be the lender of last resort, it could still run short of dollars. Widespread fiscal measures have been announced, but this has been mostly geared towards sustaining income. Until governments unilaterally backstop airlines, shipping firms, restaurants, or any other company afflicted by the virus from going bankrupt, a negative self-reinforcing feedback loop will remain. Chart 3The Dollar As An Arbiter Of Growth The Dollar As An Arbiter Of Growth The Dollar As An Arbiter Of Growth We continue to recommend standing aside on the dollar until the dust has settled. Longer-term fundamentals suggest a dollar-bearish view, but until the world gets a sense that global growth is bottoming soon, the dollar uptrend remains intact (Chart 3). We continue to use internals and market fundamentals as a guide for when to time a top.3  Finally, we have been stopped out of a few trades and are tightening stops on a few. Please see this week’s trade table for a few recommendations.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com     Footnotes 1    Please see Foreign Exchange Strategy Weekly Report,  “The Near-Term Bull Case For The Dollar”, dated February 28, 2020, available at fes.bcaresearch.com. 2   Please see Foreign Exchange Strategy Weekly Report,  “Is The World Short Of Dollars?”, dated September 13, 2019, available at fes.bcaresearch.com. 3   Please see Foreign Exchange Strategy Weekly Report,  “Currency Technicals And Market Internals”, dated March 13, 2020, available at fes.bcaresearch.com. Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The near-term path for the DXY remains up. Uncertainty about the trajectory of global growth is a potent tailwind. Central bank ammunition will eventually put a floor under global growth, but it remains a powerless weapon until animal spirits are revived. The signal on when to sell the DXY will originate from the internal dynamics of financial markets. We elaborate on a few key indicators in this report. Long-yen bets remain cheap insurance against a rise in FX volatility. Remain short USD/JPY and CHF/JPY. Until recently, the CAD had proved resilient amid the recent market turmoil. With close ties to the US, the safe-haven umbrella had sheltered the CAD from the vicious downdraft in other commodity currencies. The forces of mean reversion will pressure the CAD at the crosses. We were stopped out of our long AUD/USD trade with a loss of 2.9%. The important lesson is to stand aside when markets start to deviate from fundamentals. Feature Chart I-1Mixed Messages From Bond And Currency Markets Mixed Messages From Bond And Currency Markets Mixed Messages From Bond And Currency Markets Various market participants will look at the recent market action through different lenses. Long equity investors could easily consider this to be a healthy correction necessary to sustain the bull market in stocks. After all, the S&P 500 remains 29% above its 2018 lows, making the 10% peak-to-trough decline essential to flush out stale longs. Bond investors could see the decline in yields through two lenses: 1) a goldilocks scenario where growth eventually rebounds but central banks remain accommodative or 2) a malignant scenario where the cascading resurgence of the virus outside of Wuhan, China tethers the global economy to recession. The inversion of the yield curve in the US certainly supports  scenario 2. As for currency markets, it is becoming more and more evident that pro-cyclical pairs are pricing in an Armageddon scenario (Chart I-1). It is implausible to accurately discern the collective data being discounted in financial markets, especially when the turnover of information is as fluid and rapid as today. That said, there have been a few key market signals that have been sending a consistent message that one can pay heed to. The collective assessment is to stand aside on the dollar (and risk assets) for now. The Message From Financial Markets As a countercyclical currency, the message from high frequency growth/liquidity indicators is that the path of least resistance for the DXY remains up over the next few weeks. Chart I-2Mixed Messages From Stocks And Currencies Mixed Messages From Stocks And Currencies Mixed Messages From Stocks And Currencies Chart I-2 shows that the rise in global stocks was already discounting an improvement in global manufacturing in an order of magnitude similar to the 2012 and 2016 episodes. However, currency markets had been discounting a much more subdued recovery (bottom panel). What has become evident in recent days in that the stock market got the story wrong, at least in terms of timing. Currently, stocks are still pricing a continued cyclical bounce in global manufacturing activity (albeit less impressive), while currency markets are pricing in outright deterioration. So directionally, both markets are sending the same message, but they disagree in terms of magnitude.  What is remarkable is that over the past few days, currency markets that were already poised for a malignant growth outcome are still selling off indiscriminately, with our favorite greed/fear barometers making fresh lows. If we had a strong certainty that global growth was on a path toward a V-shaped recovery, then currency performance could be interpreted as a sign of capitulation. But given the uncertainty now tainted around the nascent recovery we witnessed early this year it also warns against bottom-fishing at current levels. For example, peak-to-trough, the AUD/JPY, a key barometer of greed versus fear in currency markets, is down 28% and on the verge of breaking below the key 70-72 support zone. The performances of even more high-octane currency pairs such as the RUB/JPY, the ZAR/JPY or even the BRL/JPY have been dismal. As these pairs break through key support zones, it could trigger a flurry of sell orders that would reinforce the downtrend. Europe, Asia and emerging markets have a much higher concentration of cyclical stocks in their bourses compared to the US. Thus, whenever cyclical sectors are underperforming defensives at the same time that non-US markets are underperforming US ones, it is a clear sign that the marginal dollar is rotating towards the US. In a nutshell, the performance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. This applies to both emerging and developed market currencies (Chart I-3). So far, this has not been the case. The backdrop could be extremely attractive valuations, but the catalyst will have to be capitulation from current sellers of cyclical stocks. The performance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. Chart I-3ACapital Keeps Flowing Out Of Cyclical Markets Capital Keeps Flowing Out Of Cyclical Markets Capital Keeps Flowing Out Of Cyclical Markets Chart I-3BCapital Keeps Flowing Out Of Cyclical Markets Capital Keeps Flowing Out Of Cyclical Markets Capital Keeps Flowing Out Of Cyclical Markets The 2015-2016 roadmap was instructive on when such a capitulation might occur. Even as the market was selling off, certain cyclical sectors such as industrials started to outperform defensives ones (Chart I-4). This was a clear sign that selling pressure in cyclical sectors had been exhausted. The overall market bottomed eight months later, along with a peak in the dollar. The signal from bond yields is that non-US currencies should be outperforming. This is reflected by the fact that the drop in bond yields has been much more pronounced in the US across the curve spectrum. Currencies tend to rise with relative yields for the simple reason that markets need to make an investor indifferent between buying the currency today or in the future. If yields are higher today, the forward rate will be lower, discounting expected depreciation in the higher-yielding currency. Since the financial crisis, it has been rare that this correlation breaks down (Chart I-5). The only way one can square falling US rates with a rising dollar today is that Federal Reserve rate cuts will be most potent on the US domestic sector, helping the US consumer charge the eventual rebound in global growth. My colleague Mathieu Savary argues that this could indeed be the backdrop for the dollar over the next two-to-three years. Chart I-4Pay Heed To Subtle Divergences Pay Heed To Subtle Divergences Pay Heed To Subtle Divergences Chart I-5Interest Rates And The Dollar Interest Rates And The Dollar Interest Rates And The Dollar As for the near term, what is clear is that US growth continues to outperform, which is supportive of the dollar. The sharp drop in the economic surprise index for the G10 relative to the US supports this view (Chart 6). In commodity markets, the copper-to-gold and oil-to-gold ratios are breaking down along with government bond yields. This clearly signifies that the liquidity-to-growth transmission mechanism is impaired (Chart I-7). “Force majeures” are rare, so the fact that China has already issued more than 1,600 certificates covering copper, liquefied natural gas, and coal imports reveals an inherent belief that the slowdown will be genuine and meaningful. Chart I-6The US Still Has Positive Growth ##br##Surprises The US Still Has Positive Growth Surprises The US Still Has Positive Growth Surprises Chart I-7Commodity Markets Are Sending A Distress Signal Commodity Markets Are Sending A Distress Signal Commodity Markets Are Sending A Distress Signal Earnings revisions are heading lower across a swathe of geographies. Bottom-up analysts are usually less certain about the level of earnings but spot on about the direction (Chart I-8). Not surprisingly, the downgrades have been driven by emerging markets, meaning that return on capital will be best sought in less-cyclical bourses such as the US. Momentum-wise, being long the US dollar is becoming a captivating trade. 75% of currencies are currently falling versus the dollar. The history of this indicator is that it has usually required a move into overbought conditions before a bet on a playable reversal can be justified (Chart I-9). Chart I-8Earnings Revisions In EM Have Fallen Off A Cliff Earnings Revisions In EM Have Fallen Off A Cliff Earnings Revisions In EM Have Fallen Off A Cliff Chart I-9A Growing Consensus Of Short Dollar ##br##Trades A Growing Consensus Of Short Dollar Trades A Growing Consensus Of Short Dollar Trades On a cyclical horizon (over the next year), we remain dollar bears given our inherent belief that the shock from the virus will soon dissipate, and green shoots from global growth will reemerge. However, for more tactical investors, momentum currently favors the greenback. In addition to the indicators above, we are also monitoring global growth economic barometers on when to time a shift away from the DXY. On Volatility And Safe Havens The dollar is expensive across most measures of purchasing power, but less so when other fundamental factors such as interest-rate differentials and productivity trends are taken into consideration. The risk is that, as a reserve currency, the dollar rally continues unimpeded by valuation and sentiment concerns for the time being (Chart I-10). This is not our base case, but the probability of such a scenario is not zero. More importantly, currency volatility remains near record lows as the latest dollar rally simply supercharges a trend in place over the past decade (Chart I-11). Every seasoned investor does and should pay attention to low volatility. Over the last three episodes where volatility dropped to these levels, the dollar soared and pro-cyclical currencies suffered severe losses. Everyone remembers 1997-1998, 2007-2008, and 2014-2015. So far, the risk is that this time will be the same. Chart I-10The Dollar Is Expensive, But Not Excessively So The Dollar Is Expensive, But Not Excessively So The Dollar Is Expensive, But Not Excessively So Chart I-11Currency Volatility Remains ##br##Depressed Currency Volatility Remains Depressed Currency Volatility Remains Depressed Most clients acknowledge that recent US dollar purchases have been on an unhedged basis. This means as long as nominal US yields remain above those in the rest of the world, this trend can continue. That said, the prospect for real capital losses should the consensus long-dollar trade be wrong is non-negligible. The dollar has been in a bull market since 2011, but the shift in valuations has simply unwound the undervaluation gap. The dollar tends to run in long cycles, and a decisive move into much overvalued territory is possible (though again, not our base case). US Treasurys have started to outperform gold, suggesting the US dollar is becoming, at the margin, the currency of preference for safety (Chart I-12).   The gap between the USD/JPY and real rates has opened up a rare arbitrage opportunity. The yen provides valuable portfolio insurance at this economic crossroads. One of the most potent moves in rate markets has been the +135-basis-point move in favor of Japanese yields (Chart I-13). More importantly, the gap between the USD/JPY and real rates has opened up a rare arbitrage opportunity. Should a selloff in global risk assets materialize, the yen will strengthen. On the other hand, if global growth does eventually accelerate, the yen will surely weaken on its crosses but could still strengthen vis-à-vis the dollar. Chart I-12The Signal From Bonds Versus Gold The Signal From Bonds Versus Gold The Signal From Bonds Versus Gold Chart I-13JGBs Are Becoming Attractive JGBs Are Becoming Attractive JGBs Are Becoming Attractive This win-win situation for the yen hinges on three key pivotal developments: For most of the past five years, the Bank of Japan was one of the most aggressive central banks in terms of asset purchases. This was a huge catalyst for a downturn in the trade-weighted yen (Chart I-14). With renewed expansion of the Fed’s balance sheet, monetary policy is tightening on a relative basis in Japan. Movements in the yen are as influenced by external conditions as what is happening domestically, given Japan’s huge export sector. For example, the yen reacts very potently to moves in the VIX (Chart I-15). The yen is a very cheap currency, and the latest selloff has all but assured further depreciation into undervalued territory. As we will illustrate in an upcoming report, it pays to be contrarian when it comes to currency valuations, albeit over the longer term (Chart I-16). Chart I-14The BoJ And QE: No More Bullets The BoJ And QE: No More Bullets The BoJ And QE: No More Bullets Chart I-15The Yen Is Still A Risk Off Currency The Yen Is Still A Risk Off Currency The Yen Is Still A Risk Off Currency Chart I-16A Win-Win Dynamic For Long Yen Positions A Win-Win Dynamic For Long Yen Positions A Win-Win Dynamic For Long Yen Positions In a situation where global growth does improve, the yen will tend to weaken, given that it is usually used to fund carry trades. That said, our contention is that the yen will surely weaken at the crosses but could still strengthen versus the dollar. This is because the USD/JPY and the DXY tend to have a positive correlation, since the dollar drives the yen most of the time. More conservative investors can remain short CHF/JPY. The authorities at the Swiss National Bank must be pacing up and down over the impact of a strong currency in a deflationary world. Given that Swiss interest rates are the lowest in the G10, the CHF becomes the only tool of adjustment to inflate domestic prices. Selling the franc and loading up on US and international stocks as they correct is a foolproof way cushion the business cycle in Switzerland. Meanwhile, inflation differentials with the US have been lower in Japan compared to Switzerland, but the franc has been stronger. This suggests that, as a safe haven, the franc is incrementally more expensive than the yen. Bottom Line: The yen is the most attractive safe-haven currency at the moment. Remain short USD/JPY and CHF/JPY. We are widening our stops on both trades to account for the rise in market volatility.    Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies US Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been mostly positive: The Markit preliminary manufacturing PMI decreased to 50.8 from 51.9 in February. New home sales jumped by 7.9% month-on-month in January.  Consumer confidence increased slightly to 130.7 from 130.4 in February. Durable goods orders slipped 0.2% month-on-month while nondefense capital goods orders excluding aircraft grew 1.1% month-on-month in January. The DXY index depreciated by 1.2% this week. Markets sold off dramatically on the back of renewed fears about Covid-19. While markets are pricing in 71 basis points of easing over the next 12 months, Fed Vice Chair Clarida emphasized a wait-and-see approach. Fed inaction places a near-term bid on the dollar, though longer term, we remain bearish. Avoid outright dollar bets for now.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020   The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been positive: The Markit manufacturing PMI improved to 49.1 from 47.9 while the services PMI increased to 52.8 from 52.5 in January. This nudged the composite PMI further into expansion territory at 51.6. Core CPI came in at 1.4% year-on-year in January. Sentiment improved in the euro area this week. In February, the economic sentiment indicator increased to 103.5 from 102.6, the business climate indicator improved to -0.04 from -0.19, and the industrial confidence moved up to -6.1 from -7.    In Germany, the closely watched IFO survey bounced to 96.1, driven by the expectations component. So far, the V-shaped recovery in European manufacturing expectations appears un-derailed. The euro appreciated by 1.4% against the US dollar this week. Following the powerful upward momentum that we saw in the DXY index over the last few days, some specter of mean reversion is not a surprise. This week, President Lagarde reiterated the need for fiscal measures to combat climate change, which will also be euro-bullish beyond Covid-19.    Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 The Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been mostly negative: The national CPI grew by 0.7% in January, decreasing slightly from 0.8% the previous month. More instructive will be the Tokyo CPI print released as we go to press. The Jibun Bank manufacturing PMI declined to 47.6 from 48.8 in February. The coincident index decreased to 94.1 while the leading economic index increased to 91.6 in December. The Japanese yen appreciated by 2% against the US dollar this week. As we go to press, Japan is temporarily closing all schools to temper the spread of the coronavirus. Domestically, data were weak already with the PMI weighed down by new orders and output prices. Tourism, a key source of domestic demand, has also been hit hard. As a safe-haven currency, a risk-off scenario will only trigger repatriation flows benefitting the yen.   Report Links: Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2   Recent data in the UK have been positive: The Markit manufacturing PMI increased to 51.9 from 50 while the services PMI decreased to 53.3 from 53.9 in February. That still underpinned a solid composite PMI at 53.3. The BRC shop price index declined by 0.6% year-on-year in January.   The British pound was flat against the US dollar this week. BoE deputy governor Cunliffe took a somewhat hawkish tone, stating that “there is not much monetary policy can do” in the case of a supply shock from Covid-19. Uncertainty over monetary policy, Brexit and Covid-19 are now compounding influences on pound volatility.  Our bias is a trading range for GBP-USD between 1.28-1.32 until a clear catalyst emerges.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mixed: The value of construction work done in Q4 2019 contracted by 3% quarter-on-quarter, improving from a contraction of 7.4% the previous quarter. Private capital expenditure contracted by 2.8% quarter-on-quarter in Q4 2019, worsening from a contraction of 0.4% the previous quarter. The Australian dollar depreciated by 0.6% against the US dollar this week. Australia is more exposed to negative developments regarding Covid-19, given strong ties to China. Weak data on investment and consumption have also suppressed the Australian dollar recently. Notwithstanding, AUD/USD, now at post-crisis lows, looks deeply oversold. We were stopped out of our long AUD/USD trade for a loss of 2.9%. For risk management purposes, we are standing aside.   Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019   New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mixed: Exports decreased to NZD 4.7 billion from NZD 5.5 billion while imports were flat at NZD 5.1billion in January. The monthly trade balance was in a deficit of NZD 340 million in January.   The ANZ business confidence indicator worsened to -19.4 from -13.2 in January. Retail sales grew by 0.7% quarter-on-quarter in Q4 2019, declining from a 1.7% expansion in Q3 2019. The New Zealand dollar depreciated by 0.1% against the US dollar this week. Like its antipodean partner, New Zealand is highly exposed to the slowdown in the Chinese economy. In the short-term, tourism will be hit hard, as will other service industries. This environment will not be favorable for long NZD trades.      Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019   Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been mixed: Retail sales growth remained flat month-on-month at 0.5% in December, slowing significantly from growth of 1.1% the previous month. Wholesale sales grew by 0.9% month-on-month in December, improving from a contraction of 1.1% the previous month. The current account deficit narrowed to CAD 8.76 billion from CAD 10.86 billion in Q4 2019. We get GDP data this Friday morning, and we anticipate a nascent recovery put at risk from Covid-19.  The Canadian dollar depreciated by 0.7% against the US dollar this week. In addition to global risk-off flows, the Canadian dollar was hurt by the sharp decline in oil prices, which are now close to 2019 lows. Uncertainty has led markets to price in 52 basis points of further easing from the BoC. This will support our long EUR/CAD trade going forward.   Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies- November 8, 2019   Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 There is scant data out of Switzerland this week: The expectations component of the ZEW survey declined to 7.7 from 8.3 while the current situation component declined to 15.4 from 29.2 in February. The Swiss franc appreciated by 1.5% against the US dollar this week. This must be sending shock waves along SNB corridors. Domestic data remain weak but, as with the Japanese yen, the franc was propped up by safe-haven flows. In the near-term, expect the franc to trade more on global sentiment rather than economic fundamentals. EUR/CHF strengthened slightly over the past few days but remains close to historic lows. The SNB will be watching carefully for signs of sustained strength in the franc and will act as needed to prevent rampant appreciation.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020   Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been positive: The unemployment rate decreased to 3.9% from 4% in December.  Retail sales grew by 0.5% month-on-month in January, improving from a contraction of 2% in the previous month. The Norwegian krone depreciated by 0.7% against the US dollar this week. The petrocurrency was hurt by falling oil prices which triggered a 9.7% decline in the Oslo Bors All-Share Index this week. At 1.5%, the Norway’s policy rate is among the highest in developed markets. If the economy remains weak and there is another global easing cycle, the Norges Bank will feel the pressure. We remain short USD/NOK but acknowledge that this trade could continue to underperform in the next few days.    Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019   Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been positive: Consumer confidence improved to 98.5 from 92.6 in February. The producer price index contracted by 0.4% year-on-year in January. The trade balance moved into a surplus of SEK 9.9 billion from a deficit of 2.3 billion. Retail sales grew by 2.7% year-on-year in January, slowing slightly from 2.8% the previous month. Capacity utilization decreased to -2.1% in Q4 2019 from 0.5% the previous quarter. The Swedish krona appreciated by 1.3% against the US dollar this week. Usually, when a currency is cheap, the undervaluation starts to show up in external balances as was the case with Sweden trade data. The key concern for the Riksbank at the moment will be the impact of the negative oil price shock on its inflation forecast as well as the impact of Covid-19 on external demand.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019   Footnotes Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights The breakout in the DXY indicates the investment universe could become precarious. The euro could fall to 1.04 on such an outcome. The yen and Swiss franc should outperform in this environment, barring recent weakness in the Japanese currency. This will catalyze the Swiss National Bank to start weaponizing its currency. EUR/CHF could first undershoot 1.06 but will then become very attractive. We were stopped out of long AUD/CAD for a loss of 3%. Weighing In On Recent Market Developments The rally in the dollar has been broad-based, with the DXY index threatening to break above 100. What is peculiar about this rally is that it is not driven by relative fundamentals, but rather by sentiment. For example, interest rate differentials across much of the developed world have risen versus the dollar, in stark contrast  with the drop in their exchange rates (Chart I-1). The risk is that as a momentum currency, the surge in the dollar triggers a negative feedback loop that tightens financial conditions in emerging markets, curtailing a key source of global demand (Chart I-2). Chart I-1Dollar Up, Rate Differentials Down Dollar Up, Rate Differentials Down Dollar Up, Rate Differentials Down Chart I-2A Strong Dollar Could Lead To Debt Deflation A Strong Dollar Will Lead To Debt Deflation A Strong Dollar Will Lead To Debt Deflation The most recent TIC data from the US Treasury confirmed that inflows into domestic bonds have surged, especially driven by private concerns. These inflows have been huge enough to alter the structural downtrend of outflows (Chart I-3). Given that hedged yields are currently unattractive for non-US investors, these flows are also a bet on an appreciating dollar. This fits anecdotal evidence that today’s sharp drop in the yen was driven by private investors, stampeding out of the local market, into the safety of US Treasurys and other assets. Chart I-3Positive Momentum Into US Treasurys Positive Momentum Into US Treasurys Positive Momentum Into US Treasurys We have elaborated in numerous reports why the risks to the dollar are to the downside, including expensive valuation and lopsided positioning. However, these obstacles fall to the wayside in a risk-off environment. As such, for risk management purposes, we are closing our short DXY position today for a loss of 2.5%. Bottom Line: The breakout in the dollar is at risk of becoming self-reinforcing in the near term. Stand aside on the DXY for now. Thought Experiment On A Few Scenarios Different market participants have taken different views on the durability and potential impact of the COVID-19 outbreak. Equity market indices in general are looking through a potential blip in the Q1 data on the assumption that the Q2 recovery will be V-shaped and powerful. The peak in momentum of new cases outside of Hubei province as well as a less-alarming death rate compared with the SARS episode certainly supports this view (Chart I-4). Chart I-4ACases Outside The Epicenter Have Peaked For Now Cases Outside The Epicenter Have Peaked For Now Cases Outside The Epicenter Have Peaked For Now Chart I-4BCases Outside The Epicenter Have Peaked For Now Cases Outside The Epicenter Have Peaked For Now Cases Outside The Epicenter Have Peaked For Now The disconnect has been in the dismal performance of procyclical currencies. SEK/JPY, a key barometer of greed versus fear in financial markets, is near capitulation lows, despite secular highs for the stock-to-bond ratio (Chart I-5). Meanwhile, the EUR/USD has once again begun to inflect lower, continuing a trend in place since the beginning of 2018. Chart I-5Pro-Cyclical Crosses Are Pricing A Malignant Outcome Pro-Cyclical Crosses Are Pricing A Malignant Outcome Pro-Cyclical Crosses Are Pricing A Malignant Outcome This suggests one of three outcomes: Equity markets are correct to price in a benign scenario, with an eventual synchronized growth recovery led by the US (Chart I-6A). This is dollar bullish. Currency markets are right to be pricing in a catastrophic fallout in growth, with anything linked to China/global growth getting slaughtered. This is also dollar bullish. The bond markets are spot on in pricing in a goldilocks scenario, where rates stay low and non-US markets lead an eventual recovery (Chart I-6B). This is dollar bearish. Chart I-6AEquity Markets Are Pricing A Benign Outcome Equity Markets Are Pricing A Benign Outcome Equity Markets Are Pricing A Benign Outcome Chart I-6BEquity Markets Are Pricing A Benign Outcome Equity Markets Are Pricing A Benign Outcome Equity Markets Are Pricing A Benign Outcome Bottom Line: Two of three scenarios lead to a higher US dollar. For most developed market participants, the adjustment towards a higher dollar would have to occur through a lower euro, given its weight in the DXY index. How Low Could The EUR/USD Fall? The possibility of either a synchronized recovery led by the US or a catastrophic fallout to growth is certainly valid for the euro area. Chart I-7 plots relative GDP growth between the two regions. The conclusion is very evident: The collapse in the euro since the financial crisis has been driven by falling growth differentials between the Eurozone and the US. Based on higher-frequency indicators, this remains the case as of January – the ZEW survey showed that the expectations component for euro area activity slowed markedly, while that of the US improved. In the absence of a synchronized pickup in global growth, a weaker exchange rate helps.  One way to arrest the rising growth divergence between the euro area and the US is to lower the cost of capital in the entire Eurozone, such that it makes sense even for the less-productive peripheral countries to borrow and invest. This will boost productivity, lifting the neutral rate. This has certainly been the case. Bond yields in peripheral Europe are collapsing relative to those in Germany. And, as expected, investment spending in the periphery is also picking up, which should close the productivity gap with the core countries (Chart I-8). Unfortunately, for the small, open countries that characterize the euro area, external demand is also needed to transform those productivity gains into profits Chart I-7Weak Growth Will Pressure ##br##The Euro Weak Growth Will Pressure The Euro Weak Growth Will Pressure The Euro Chart I-8Investment Spending Was Strong Going Into The Crisis Investment Spending Was Strong Going Into The Crisis Investment Spending Was Strong Going Into The Crisis In the absence of a synchronized pickup in global growth, a weaker exchange rate helps. Our intermediate-term timing model, which has been back-tested as a tool for profitably hedging portfolios, suggests the euro is cheap, but not excessively so. Medium-term bottoms have usually occurred when the euro is around 5% cheaper than current levels, or around 1.03-1.04 (Chart I-9). Since the peak in global trade in 2011, one of the few ways for countries to expand their trade pie has been via a “beggar thy neighbor” policy. This is even more important for the euro area, if the Phase One trade deal between the US and China results in less purchases of European machinery, cars, and aircraft. Coupled with a hiccup in Chinese growth in Q1, the euro will have to be the mechanism of adjustment. The European Central Bank has one powerful tool to ensure this occurs: quantitative easing. By crowding out locals from the domestic fixed-income market, investors will have to flock to either equities or foreign securities. This will weigh on the euro. This is especially the case since quantitative easing from the ECB is open-ended, while that from the Federal Reserve (not-QE) is not. Eventually, investors might begin to front-run the relative expansion in the ECB’s balance sheet. Since the peak in global trade in 2011, one of the few ways for countries to expand their trade pie has been via a “beggar thy neighbor” policy.  Chart I-10 shows that a rising basic balance in the euro area has been a key mechanism in preventing a further drop in the euro. This will change in the case of a catastrophic fallout to growth. Chart I-9The Euro Is Cheap, But Not A ##br##Screaming Buy The Euro Is Cheap, But Not A Screaming Buy The Euro Is Cheap, But Not A Screaming Buy Chart I-10A Positive Basic Balance Has Prevented A Much Lower Adjustment A Positive Basic Balance Has Prevented A Much Lower Adjustment A Positive Basic Balance Has Prevented A Much Lower Adjustment Eventually, all trends reverse, and there will be a pickup in growth, led by more growth-sensitive economies. Given both the internal and exchange rate adjustments in the euro area, the common-currency zone will be primed to benefit. The euro tends to be largely driven by pro-cyclical flows, and European equities, especially those in the periphery, are already trading at some of the cheapest cyclically adjusted price-to-earnings multiples in the developed world. Watch earnings revisions for euro zone equities versus the US. They tend to firmly lead the euro by about 9-to-12 months (Chart I-11). Chart I-11Watch Earnings Revisions For The Next EUR/USD Move Watch Earnings Revisions For The Next EUR/USD Move Watch Earnings Revisions For The Next EUR/USD Move Bottom Line: There is near-term downside to the EUR/USD towards 1.03. The SNB And The Franc The franc has been in a bull market against pretty much every European currency since the onset of the global growth slowdown, with the latest developments only supercharging that trend. The worst-case scenario for Switzerland is a global growth fallout, since the valuation starting point for the franc is expensive, not only vis-à-vis the euro (Chart I-12), but even more so against the Swedish krona and  Norwegian krone. So, the key question for the franc is the pain threshold for the SNB to step up intervention. Chart I-12The Franc Is Getting Incrementally Expensive The Franc Is Getting Incrementally Expensive The Franc Is Getting Incrementally Expensive The first mandate of the Swiss National Bank is price stability, consistent with inflation at 2%. On this front, it has clearly underdelivered. The central bank expects inflation to gradually pick up to 1.2% by 2023, but the backdrop for prices in Switzerland has been sub-1% for much of the post-crisis period (Chart I-13). Meanwhile, as a small, open economy, tradeable goods prices are important for domestic inflation, and import prices are deflating by over 1.9% year-on-year, in part driven by a strong currency (Chart I-14). If left unchecked, this could begin to un-anchor inflation expectations, leading to a negative feedback loop that the SNB will likely find very difficult to lean against. Chart I-13SNB Forecasts May Not Be Realized Soon SNB Forecasts May Not Be Realized Soon SNB Forecasts May Not Be Realized Soon Chart I-14The Risk From A Strong Franc Is Deflation The Risk From A Strong Franc Is Deflation The Risk From A Strong Franc Is Deflation Domestically, the Swiss economy was holding up well, but it is now an open question as to how much longer it can continue to defy the pull of a slowing external sector. As a highly export-driven country, the manufacturing sector usually dictates trends in the overall Swiss economy (Chart I-15). Sentiment indicators such as the ZEW expectations component were perking up ahead of the onset of COVID-19. It is now a sure bet that these will relapse in the coming months. More importantly, the impact on Switzerland might be bigger relative to its trading competitors, given the expensive franc. It is now an open question as to how much longer Switzerland can continue to defy the pull of a slowing external sector.  A key barometer for the SNB will be exports. Export volumes are already deflating (Chart I-16), yet the trade balance is still benefiting from the large share of precious metals exports, which are currently experiencing a terms-of-trade boost. This will not last forever, given the falling market share of precious metals in the Swiss trade balance Chart I-15How Long Can Employment Defy Gravity How Long Can Employment Defy Gravity? How Long Can Employment Defy Gravity? Chart I-16A Lower Franc Will Support Export Volumes A Lower Franc Will Support Export Volumes A Lower Franc Will Support Export Volumes There is a new twist for “operation weak franc.” The US Treasury department has put Switzerland on the currency-manipulator watch list. In general, the SNB is reticent on the issue of currency intervention, stating only that it intervenes to counteract negative effects on inflation and exports from an overly expensive franc. But it is encouraging that sight deposits at local banks started to accelerate at USD/CHF 0.96 (Chart I-17) and the SNB is also likely to act if EUR/CHF meaningfully breaks below 1.06. Economically, the SNB has to walk a fine line between a predominantly deflationary backdrop in Switzerland and a rising debt-to-GDP ratio that pins it among the highest in the G10. The good news is that a lot of the imbalances resulting from excess liquidity in recent years are being addressed. The housing market is a case in point. Growth in rental housing units, which usually constitute the bulk of investment homes, is deflating, which contrasts favorably with growth in owner-occupied homes (Chart I-18). Macro prudential measures such as a cap on second homes as well as stricter lending standards have helped. Meanwhile, a slowdown in the working-age population in Switzerland has neutered a meaningful source of demand. Chart I-17The SNB Is Stepping Up Intervention The SNB Is Stepping Up Intervention The SNB Is Stepping Up Intervention Chart I-18A Healthy Housing Adjustment A Healthy Housing Adjustment A Healthy Housing Adjustment     Bottom Line: We are lowering our limit-buy on EUR/CHF to 1.05 to account for a potential undershoot. Housekeeping We were stopped out of our long AUD/CAD trade for a loss of 3.0%. As highlighted above, currency markets are beginning to price in a malignant scenario for global growth, where anything non-US gets decimated. In such an environment, the best policy is to stand aside.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been mostly positive: Retail Sales excluding autos grew by 0.3% month-on-month compared to 0.2% in January. Industrial production contracted further by 0.3% month-on-month in January. The Michigan consumer sentiment index increased to 100.9 from 99.8 in February. The core producer price index grew by 1.7% in January, from 1.1% in December. Housing starts decreased to 1.57 million from 1.63 million, while building permits increased to 1.55 million from 1.42 million in December. The DXY index appreciated by 0.8% this week. As a momentum currency, the rise could become self-reinforcing. Stand aside on DXY. Report Links: Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been negative: The trade balance increased to EUR 22.2 billion, on a seasonally adjusted basis, from EUR 19.1 billion in December. GDP grew by 0.9% year-on-year in Q4 2019, slowing from 1.2% the previous quarter. ZEW economic sentiment declined to 10.4 from 25.6 in February. The current account surplus decreased to EUR 32.6 billion from 35.2 billion in December. Construction output contracted by 3.7% year-on-year in December, from growth of 1.4% the previous month. The euro depreciated by 0.5% against the US dollar this week. The disappointing ZEW numbers for the Eurozone and Germany and concerns about persistently low growth were a major headwind for the euro this week. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been negative: GDP contracted by 1.6% quarter-on-quarter in Q4 2019, compared to growth of 0.4% the previous quarter. Industrial production contracted by 3.1% year-on-year in December. Capacity utilization decreased to -0.4% in December. The merchandise trade balance fell to a deficit of JPY 224.1 billion in January. Machinery orders contracted by 3.5% year-on-year in December. Imports contracted by 3.6% and exports contracted by 2.6% year-on-year in January. The Japanese yen depreciated by 1.9% against the US dollar this week. Domestic data was very disappointing, with GDP contracting more than expected. Meanwhile technical factors such as portfolio flows were also responsible. That said, short USD/JPY remains cheap insurance. Report Links: Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been mixed: The Rightmove house price index grew by 2.9% year-on-year in February. The ILO unemployment rate remained flat at 3.8% in December. The growth in average earnings including bonuses slowed to 2.9% from 3.8% in December. The CPI grew by 1.8% while the retail price index grew by 2.7% year-on-year in January. Retail sales grew by 0.8% year-on-year in January. The British pound depreciated by 1.3% against the US dollar this week. The key worry for incoming BoE governor Andrew Bailey is a stagflationary environment, with increases in inflation driven by weak business investment and productivity growth. Stand aside on GBP for now. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been negative: The six month annualized growth rate in the Westpac leading index fell to -0.46% from -0.28% in January. The wage price index grew by 2.2% year-on-year in Q4, staying flat from the previous quarter. The unemployment rate increased to 5.3% from 5.1% in January. The Australian Dollar depreciated by 1.4% against the US dollar this week. Much of the decline was driven by the perceived dovish tone of the minutes from the Reserve Bank of Australia (RBA) February meeting. The RBA’s primary concerns were slow consumption growth and the effects of the bushfires on growth in the near-term.  However, the housing market, led by Sydney and Melbourne, is picking up quickly. We remain positive AUD/USD but will stand aside if it breaches 60 cents. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mixed: Visitor arrivals declined by 0.2% year-on-year in December. The ANZ monthly inflation gauge remained flat at 3.2% year-on-year in January, The REINZ house price index grew by 0.3% month-on-month in January. The Global Dairy Trade price index declined 2.9% in February. The New Zealand dollar depreciated by 1.6% against the US dollar this week. Dairy trade was hampered by weak demand from China and Prime Minister Jacinda Ardern warned of a negative impact on GDP growth in the first half of 2020 from Covid-19.  Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been mixed: Manufacturing sales contracted by 0.7% month-on-month in December. Headline CPI grew by 2.4%, while the BoC core measure grew 1.8% year-on-year in January. The Canadian dollar appreciated by 0.1% against the US dollar this week. The rally was driven by the surge in oil prices over the past two weeks coinciding with a decline in the number of new Covid-19 cases. While acknowledging the negative demand shock from China, our Commodity and Energy strategists currently believe that Chinese policy stimulus will help shore up oil demand going into the second half of this year. This will be bullish CAD. Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been mixed: Import prices contracted by 1.9% year-on-year in January, compared to a contraction of 3.2% the previous month.  The trade balance increased to CHF 4,788 million in January from CHF 1,975 million the previous month. Industrial production grew by 1.6% year-on-year in Q4 2019, slowing from 7.9% the previous quarter. The CHF depreciated 0.4% against the US dollar this week. The SNB has repeatedly emphasized that it stands ready to prevent rampant appreciation in the Swiss franc which could hurt exports. Report Links: Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 There was scant data out of Norway this week: The trade balance decreased to NOK 21.2 billion in January from NOK 25.6 billion the previous month. The Norwegian krone depreciated by 0.7% against the US dollar this week. The past two weeks saw a remarkable rally in oil prices, which should help the petrocurrency, but a strong dollar has weighed on NOK/USD. However, our NOK/EUR position, a part of our long petrocurrencies basket trade, has benefitted from the oil rally and weakness in the euro. In an annual speech this week, Governor Olsen of the Norges Bank stressed the need for Norway to decrease reliance on the sovereign wealth fund and transition to a less oil-dependent economy. In the long run, this could mean krona leaving behind the “petrocurrency” moniker. Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been negative. The unemployment rate increased to 7.5% in January from 6% the previous month. The CPI grew by 1.3% year-on-year in January, compared to 1.8% the previous month. The Swedish krona depreciated by 1.9% against the US dollar this week. In the February monetary policy report released last week, the Riksbank revised down inflation forecasts due to lower energy prices in 2020. However, they expect this to be a transitory shock and see inflation moving closer to 2% once it subsides. Although the krona depreciated on the unemployment and inflation data this week, it looks unlikely to be enough for the Riksbank to change its policy stance. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Remain short the DXY index. The key risk to this view is a US-led rebound in global growth, or a pickup in US inflation that tilts the Federal Reserve to a relatively more hawkish bias. Stay long a petrocurrency basket. The latest flare-up in US-Iran tensions is just a call option to an already bullish oil backdrop. Watch the performance of cyclicals versus defensives and non-US markets versus the S&P 500 as important barometers for maintaining a pro-cyclical stance. Feature The consensus view is rapidly converging to the fact that the dollar is on the precipice of a decline, and cyclical currencies are bound to outperform. This is good news for our forecast but bad news for strategy. The fact that speculators are now aggressively reducing long dollar positions, one of our favorite contrarian indicators, is disconcerting (Chart I-1). The dollar tends to be a momentum currency, so our inclination is to stay the course on short dollar positions (Chart I-2). That said, we are not dogmatic. In FX, momentum investors eventually get vilified, while contrarians get vindicated. This suggests revisiting the core risks to our view, especially in light of recent market developments. Chart I-1A Consensus Trade? A Consensus Trade? A Consensus Trade? Chart I-2The Dollar Is A Momentum Currency The Dollar Is A Momentum Currency The Dollar Is A Momentum Currency An Oil Spike: US Dollar Bullish Or Bearish? The latest story on the global macro front is the possibility of an oil spike, driven by escalation in US-Iran tensions. Our geopolitical strategists believe that while Middle East tensions are likely to remain elevated for years to come, a full-scale war is not imminent.1 This view is fomented by a few key factors. First, the Iranian response to the assassination of Qasem Soleimani was relatively muted, given no US lives were claimed. This was also reinforced by the Iranian foreign minister’s claim that the actions were concluded. As we go to press, the Kyiv-bound Ukrainian aircraft that crashed in Tehran is being characterised as an “act of God” so far. In a nutshell, this suggests de-escalation. Second, sanctions against Iran have been causing real economic pain, given rampant youth unemployment and falling government revenues. This means that Tehran will have to be strategic in any confrontation with the US, since the risks domestically are asymmetrically negative. Renegotiating a new nuclear deal seems like a better bargaining chip than an all-out war. The dollar tends to be a momentum currency, so our inclination is to stay the course on short dollar positions. The biggest risk for oil prices is the possibility of a more marked drop in Iranian production, or possibly the closure of the Strait of Hormuz, though this is a low-probability event for the moment (Chart I-3). Our commodity strategists posit that while a closure of the strait could catapult prices to $100/bbl, there are some near-term offsetting factors.2 These include strategic petroleum reserves in both China and the US, as well as OPEC spare capacity that could benefit from the newly expanded pipeline to the port of Yanbu. This suggests that a flare up in US-Iran tensions remains a call option rather than a catalyst on an already bullish oil demand/supply backdrop. Chart I-3The Risk From Iran The Risk From Iran The Risk From Iran Risks to oil demand remain firmly tilted to the upside. Oil demand tends to follow the ebb and flow of the business cycle. Transport constitutes the largest share of global petroleum demand. Ergo the trade slowdown brought a lot of freighters, bulk ships, large crude carriers, and heavy trucks to a halt (Chart I-4). Any increase in oil demand will be on the back of two positive supply-side developments. First, OPEC spare capacity remains a buffer but is very low, meaning any rebound in oil demand in the order of 1.5%-2% (our base case), will seriously begin to bump up against supply-side constraints. Not to mention, unplanned outages typically wipe out 1.5%-2% of global oil supply. Any such occurrence in 2020 will nudge the oil market dangerously close to a negative supply shock (Chart I-5). Chart I-4Oil Demand And Global Growth Oil Demand And Global Growth Oil Demand And Global Growth Chart I-5Opec Spare Capacity Is Low On Oil, Growth And The Dollar On Oil, Growth And The Dollar Traditionally, a pick-up in oil prices has tended to be bearish for the US dollar. In theory, rising oil prices allow for increased government spending in oil-producing countries, making room for the resident central bank to tighten monetary policy. This is usually bullish for the currency. An increase in oil prices also implies rising terms of trade, which further increases the fair value of the exchange rate. Balance-of-payment dynamics also tend to improve during oil bull markets. Altogether, these forces combine to become powerful undercurrents for petrocurrencies. That said, it is important to distinguish between malignant and benign oil price increases. There have been many recessions preceded by an oil price spike, and rising prices on the back of escalating tensions are not a recipe for being bullish petrocurrencies. That said, absent any escalating tensions or a marked pickup in global demand, which is not our base case, the rise in oil prices should be of the benign variety – pinning Brent towards $75/bbl. OPEC spare capacity remains a buffer but is very low, meaning any rebound in oil demand in the order of 1.5%-2% (our base case), will seriously begin to bump up against supply-side constraints. In terms of country implications, rising oil prices will go a long way towards improving Canada’s and Norway’s trade balances. In the case of Norway, net trade fell in 2019 due to lower exports of oil and natural gas, but still stands at 5.1% of GDP. The trade balance is the primary driver of the current account balance, and the latter now stands at 4.4% of GDP. On the other hand, the Canadian trade deficit has been hovering near -1% of GDP over the past few years. Further improvement in energy product sales will require an improvement in pipeline capacity and a smaller gap between Western Canadian Select (WCS) and Brent crude oil prices (Chart I-6). We are bullish both the loonie and Norwegian krone, but have a short CAD/NOK trade as high-conviction bet on diverging economic fundamentals. Chart I-6NOK Will Outperform CAD NOK Will Outperform CAD NOK Will Outperform CAD Shifting Correlation Even though rising oil prices tend to be bullish for petrocurrencies, being long versus the US dollar requires an appropriate timing signal for a downleg in the greenback. With the US shale revolution grabbing production market share from both OPEC and non-OPEC producing countries, there has been a divergence between the price of oil and the performance of petrocurrencies. In short, as the now-largest oil producer in the world, the US dollar is itself becoming a petrocurrency (Chart I-7).  Chart I-7Shifting Landscape For Petrocurrencies Shifting Landscape For Petrocurrencies Shifting Landscape For Petrocurrencies This is especially pivotal as the US inches towards becoming a net exporter of oil. Put another way, rising oil prices benefit the US industrial base much more than in the past, while the benefits for countries like Canada and Mexico are slowly fading. The strategy going forward will be twofold. First, buying a petrocurrency basket versus the dollar will require perfect timing in the dollar down-leg. Another strategy is to be long a basket of oil producers versus oil consumers. We are long an oil currency basket versus the euro as a dollar neutral way of benefitting from rising oil prices. Chart I-8 shows that a currency basket of oil producers versus consumers has both had a strong positive correlation with the oil price and has outperformed a traditional petrocurrency basket. Chart I-8Buy Oil Producers Versus Oil Consumers Buy Oil Producers Versus Oil Consumers Buy Oil Producers Versus Oil Consumers Risks To The View Above all, the dollar remains a counter-cyclical currency. As such, when global growth rebounds, more cyclical economies benefit most from this growth dividend, and capital tends to gravitate to their respective economies. This holds true for global oil and gas sectors that tend to have a higher concentration outside of US bourses. As such, one key risk is that if the S&P 500 keeps outperforming oil, as has been the case over the past decade, the dollar is unlikely to weaken meaningfully (Chart I-9). We understand this is a call on sectors (US tech especially), rather than relative growth profiles, but what matters for currencies is the impulse of capital flows. That said, improving global growth should allow EM energy consumption (a key driver of oil prices), to pick up. Chart I-9Oil Prices And The Stock Market Oil Prices And The Stock Market Oil Prices And The Stock Market The second risk is a pickup in US inflation expectations that tilts the Fed towards a relatively more hawkish bias. The economic linkage between US inflation and oil is weak, but financial markets assign a strong correlation to the link (Chart I-10). In our view, given that higher gasoline prices tend to hurt US retail sales, and the consumer is the most important driver of the US economy, higher oil prices can only be inflationary if the overall US economy is also robust (Chart I-11). This combination is unlikely to occur if rising oil prices are being driven by a flare-up in geopolitical tensions.   Chart I-10A Rise In Oil Prices Will Help Inflation Expectations A Rise In Oil Prices Will Help Inflation Expectations A Rise In Oil Prices Will Help Inflation Expectations Chart I-11Gasoline Prices And US Consumption Gasoline Prices And US Consumption Gasoline Prices And US Consumption A US inflation spike in 2020 is a low-probability event. There have been two powerful disinflationary forces in the US. The first is the lagged effect from the Fed’s tightening policies in 2018. This is especially important given that the fed funds rate was eerily close to the neutral rate of interest, providing little incentive for firms to borrow and invest. This was further exacerbated by the trade war. Inflation is a lagging indicator, and it will take a sustained rise in economic vigor to lift US inflation expectations. This will not be a story for 2020 (Chart I-12). Meanwhile, the recent rise in the dollar and fall in commodity prices are likely to continue to anchor US inflation expectations downward, which should keep the Fed on the sidelines. Chart I-12Velocity Of Money Versus Inflation Velocity Of Money Versus Inflation Velocity Of Money Versus Inflation The gaping wedge between the US Markit and ISM PMIs remains a cause for concern. Given sampling differences, where the Markit PMI surveys more domestically-oriented firms, it is fair to assume it is also a barometer of US domestic growth relative to global output. Put another way, whenever the US services PMI is outperforming its manufacturing component, the dollar tends to appreciate (Chart I-13). Looking across global PMIs, there has been a notable pickup in Asia, specifically in Korea, Taiwan and Singapore, though weakness in Japan and Europe has persisted. This warrants close monitoring. Chart I-13The Risk To A Bearish Dollar View The Risk To A Bearish Dollar View The Risk To A Bearish Dollar View We continue to view further deceleration in the global manufacturing sector as a tail risk rather than our base case. Trade tensions have receded, global central banks remain very dovish, and Brexit uncertainty has diminished. This should allow global CEOs to begin deploying capital, on the back of pent-up investment spending. More importantly, the slowdown in the global economy has been driven by the manufacturing sector, so it is fair to assume that this is the part of the economy that is ripe for mean reversion. On the political spectrum, it has been historically rare for the Fed to raise interest rates a few months ahead of an election cycle, which should allow a weaker dollar to help grease the global growth supply chain. Any pickup in global manufacturing activity will allow the Riksbank to adopt a more hawkish bias, narrowing interest rate differentials between Norway and Sweden.  Bottom Line: The key risk to a bearish dollar view is a US-led global growth rebound, allowing the Fed to adopt a much more hawkish stance relative to other central banks. This would be an environment in which US inflation would also surprise to the upside. So far, this remains a tail risk. Housekeeping We will soon be taking profits on our long NOK/SEK position. Reduce the target to 1.09 and tighten the stop to 1.06. Any pickup in global manufacturing activity will allow the Riksbank to adopt a more hawkish bias, narrowing interest rate differentials between Norway and Sweden. Most importantly, the cross will approach a profitable technical level in the coming weeks, on the back of our call a few weeks ago to rebuy the pair (Chart I-14). 2020 will be a year of much more tactical calls. Stay tuned. Chart I-14Take Profits On NOK/SEK Soon Take Profits On NOK/SEK Soon Take Profits On NOK/SEK Soon   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1  Please see Geopolitical Strategy Special Alert "A Reprieve Amid The Bull Market In Iran Tensions," dated January 8, 2020, available at gps.bcaresearch.com 2 Please see Commodity & Energy Strategy Weekly Report "Iran Responds To US Strike; Oil Markets Remain Taut," dated January 9, 2020, available at uses.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been robust: ISM manufacturing PMI fell to 47.2 from 48.1 in December. However, Markit and ISM services PMIs both increased to 52.8 and 55, respectively.  The trade deficit narrowed by $3.8 billion to $43.1 billion in November. ADP recorded an increase of 202K workers in December, the largest increase since April. Initial jobless claims fell from 223K to 214K, better than expected. MBA mortgage applications soared by 13.5% for the week ended December 27th. The DXY index recovered by 0.7% this week from its recent decline. Trump's speech has eased tensions between the US and Iran, making an escalation towards a full-scale war unlikely. Moreover, recent data point to a continued expansion in the US through 2020. That being said, we believe that the global growth will outpace the US, which is bearish for the dollar, but this is an important risk to monitor. Tomorrow’s payroll report will be an important barometer. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been positive: Markit services PMI increased to 52.8 from 52.4 in December. Headline inflation jumped to 1.3% year-on-year from 1% in December, while core inflation was unchanged at 1.3%.  Retail sales accelerated by 2.2% year-on-year in November, from 1.7% the previous month. The Sentix investor confidence soared to 7.6 from 0.7 in January. The expectations versus the current situation component continues to point to an improving PMI over the next six months. EUR/USD fell by 0.7% this week. Recent data from the euro area have been consistent with our base case view that the euro area economy is rebounding, and is likely to accelerate in 2020. We remain long the euro, especially against the CAD. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been disappointing: The manufacturing PMI fell slightly to 48.4 from 48.8 in December; the services PMI also fell to 49.4 from 50.3 in December. Labor cash earnings fell by 0.2% year-on-year in November. Consumer confidence increased to 39.1 from 38.7 in December. USD/JPY increased by 1.2% this week. The Japanese yen initially surged on the back of US-Iran headlines, then fell as tensions faded after Trump's speech. While we don't expect a full-scale war between the US and Iran for the moment, geopolitical risks will likely persist before the elections later this year. We continue to recommend the Japanese yen as a safe-haven hedge, though our long position is currently out of the money. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 A Few Trade Ideas - Sept. 27, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been positive: Nationwide housing prices increased by 1.4% year-on-year in December. Halifax house prices also grew by 4% year-on-year in December. Markit services PMI surged to 50 from 49 in December. The British pound fell by 0.4% against the US dollar this week. On Thursday, BoE Governor Mark Carney said in a speech that “with the relatively limited space to cut the Bank Rate, if evidence builds that the weakness in activity could persist, risk management considerations would favor a relatively prompt response.” This has been viewed by the market as dovish and the pound fell on the message. In the long term, we like the pound as Brexit risk fades. In other news, the BoE has announced Andrew Bailey as the successor to Mark Carney, scheduled to take over in March 2020. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdon: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been positive: The Commonwealth bank services PMI increased to 49.8 from 49.5 in December. Moreover, the AiG manufacturing index slightly increased to 48.3 from 48.1. Building permits fell by 3.8% year-on-year in November. On a monthly basis however, it increased by 11.8%. Exports increased by 2% month-on-month in November, while imports fell by 3%. The trade surplus widened to A$5.8 billion. The Australian dollar plunged by 1.5% against the US dollar amid broad US dollar strength this week. The Aussie is the weakest currency so far this year.  This is especially the case given demand destruction from the ongoing severe bushfires in Australia. On the positive side, a weaker Australian dollar could support exports and the current account as international trade picks up in 2020. The extent of fiscal stimulus will be an important wildcard for both the RBA and the AUD. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mostly positive: House prices increased by 4% year-on-year in December.  The ANZ commodity price index fell by 2.8% in December. The New Zealand dollar fell by 1% against the US dollar this week. On January 1st, China's central bank announced that it would inject additional liquidity into the economy. This is bullish for global growth along with a "Phase I" trade deal. As a small open economy, New Zealand is one of the countries that will benefit the most from a global growth recovery. We will be monitoring whether the scope for improvement in agricultural commodity prices is bigger than that for bulks, which underscores our long AUD/NZD position. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been negative: Exports fell slightly by C$0.7 million in November. Imports also fell by C$1.2 million, which led to a narrower trade deficit of C$1.1 billion. Ivey PMI dropped sharply to 51.9 from 60 in December. Housing starts fell to 197K from 204K in December. Building permits also fell by 2.4% month-on-month in November. The Canadian dollar fell by 0.5% against the US dollar along with the decline in energy prices this week, erasing the gains earlier this year. While we expect the Canadian dollar to outperform the US dollar from a cyclical perspective, the CAD is likely to underperform against other cyclical currencies as global growth picks up steam through 2020. Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been positive: The manufacturing PMI rose to 50.2 from 48.8 in December, the first expansion since March 2019, mainly driven by increases in both production and new orders. Headline inflation shifted back to positive territory at 0.2% year-on-year in December, following negative prints for the past two consecutive months.  Real retail sales were unchanged in November on a year-on-year basis. The Swiss franc was little changed against the US dollar this week, while it rose against other major currencies including the euro on the back of positive PMI and inflation data. More importantly, recent Middle East tensions have reignited safe-haven demand, increasing bids for the Swiss franc. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been positive: The unemployment rate fell further to 3.8% from 3.9% in October. The Norwegian krone has been fluctuating with the ebb and flow of US-Iran tensions and oil prices. This week it fell by 0.8% against the US dollar after Trump implied that both the US and Iran are backing off from an escalation into war. Moreover, the bearish oil inventory data from EIA managed to pull down oil prices even further. Despite the recent fluctuation in oil prices, we maintain an overweight stance on a cyclical basis based on a global growth recovery in 2020.  Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 A Few Trade Ideas - Sept. 27, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 There has been scant data from Sweden this week:  Retail sales increased by 1.3% year-on-year in November. On a month-on-month basis however, it fell by 0.4% compared with October. The Swedish krona fell by 0.8% against the US dollar this week amid broad dollar strength. Despite rising geopolitical tensions, we remain optimistic and expect the global economy to recover this year given the US-China trade détente and increasing stimulus from China. The Swedish krona is poised to rise with global growth and a stronger manufacturing sector. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Feature The purpose of this Special Report is to identify and provoke a healthy debate on the prevailing investment themes for the 2020s and to speculate on what the key US sector beneficiaries and likely losers may be. Every decade a dominant theme captures investors’ imaginations and morphs into a bubble. Massive speculation typically propels the relevant asset class into the stratosphere as investors extrapolate the good times far into the future and go on a buying frenzy. Chart 1 shows previous manic markets starting with the Nifty Fifty, gold bullion, the Nikkei 225, the NASDAQ 100, crude oil and most recently the FAANGs. Chart 1Manias: An Historical Roadmap Manias: An Historical Roadmap Manias: An Historical Roadmap What will be the dominant themes of the next decade? How should investors capitalize on some of these big trends? The purpose of this Special Report is to identify and provoke a healthy debate on the prevailing investment themes for the 2020s and to speculate on what the key US sector beneficiaries and likely losers may be. Theme #1: De-Globalization Picks Up Steam The first investment theme for the upcoming decade is the “apex of globalization” or “de-globalization”. We have written about this theme extensively at BCA Research and it is the mega-theme of our sister Geopolitical Strategy (GPS) service. Odds are high that countries will continue looking inward as the US adopts a more aggressive trade policy, China’s trend growth slows, and US-China strategic tensions intensify. The three pillars of globalization are the free movement of goods, capital, and people across national borders. We expect to see marginally less of each in the future. Chart 2 shows that we are at the conclusion of a period of tranquility. Pax Americana underpinned globalization as much as Pax Britannica before it. The US is in a relative decline after decades of geopolitical stability allowed countries like China to rise to “great power” status and rivals like Russia to recover from the chaos of the 1990s. Chart 2De-globalization Has Commenced De-globalization Has Commenced De-globalization Has Commenced De-globalization has become the consensus since the election of Donald Trump. But Trump is not the prophet of de-globalization; he is its acolyte. Globalization is ending because of structural factors, not cyclical ones. And its decline was pre-written into its “source code.” Three factors stand at the center of this assessment, outlined in our 2014 Special Report, “The Apex Of Globalization – All Downhill From Here”: multipolarity, populism and protectionism. Events have since confirmed this view. The three pillars of globalization are the free movement of goods, capital, and people across national borders. We expect to see marginally less of each in the future. Investment Implication #1: Profit Margin Peak The most profound and provocative investment implication from de-globalization is that SPX profit margins have peaked and will likely come under intense pressure, especially for US conglomerates that – on a relative basis to international peers – most enthusiastically embraced globalization. Reconstructed S&P 500 profits and sales data date back to the late-1920s. Historically, corporate profit margins and globalization (depicted as global trade as a percentage of GDP) have been positively correlated (Chart 3). Chart 3Profit Margin Trouble Profit Margin Trouble Profit Margin Trouble As countries are more outward looking, trade flourishes and openness to trade allows the free flow of capital to take advantage of profit-maximizing projects. Following the Great Recession and similar to the Great Depression, trade has suffered and trade barriers have risen. The Sino-American trade war has accelerated the inward movement of countries, including Korea and Japan, and has had negative knock-on effects on trade as evidenced by the now two-year old global growth deceleration. China’s response to President Trump’s election was to redouble its pursuit of economic self-sufficiency, which meant a crackdown on corporate debt and a fiscal boost to household consumption. Trump’s tariffs then damaged sentiment and trade between the two countries. Any deal reached prior to the 2020 US election will remain in doubt among global investors. The longer the trade war remains unresolved, the deeper the cracks will be in the foundations of the global trading system. Such a backdrop is negative for profit margins, as inward looking countries prevent capital from being allocated most efficiently. Moreover, the uprooting of supply chains due to the trade war hurts margins and the redeployment of equipment in different jurisdictions will do the same at a time when final demand is suffering a setback. In addition, rising profit margins are synonymous with wealth accruing to the top 1% of US families and vice versa. This relationship dates back to the late-1920s, as far back as our dataset goes. Using Piketty and Saez data, which exclude capital gains, it is clear that profit margin expansion exacerbates income inequality (top panel, Chart 4). Chart 4Heightened Risk Of Wealth Re-distribution Heightened Risk Of Wealth Re-distribution Heightened Risk Of Wealth Re-distribution Expanding margins lead to higher profits. Because families at the top of the income distribution are more often than not business owners, income disparities are the widest when margins are in overshoot territory. Eventually this income chasm comes to a head and generates political discontent. Populism has emerged on both the right and left wings of the US political spectrum – and since the rise of Trump, even Republicans complain about inequality and the excesses of “corporate welfare” and laissez-faire capitalism. Because inequality is extreme – relative to America’s developed peers – and political forces are mobilizing against it, the probability of wealth re-distribution is rising in the coming decades (middle panel, Chart 4). Labor’s share of national income has nowhere to go but higher in coming years and that is negative for profit margins, ceteris paribus (bottom panel, Chart 4). Drilling beneath the surface, the three secular US equity sector/factor implications of the apex of globalization paradigm shift are: prefer small caps over large caps prefer value over growth overweight the pure-play BCA Defense Index Investment Implication #2: Small Is Beautiful While a small cap bias is contrary to the cyclical US Equity Strategy view of preferring large caps to small caps, the issue is timing: the small cap preference is a secular view with a time horizon that spans the next decade. The small versus large cap share price ratio’s ebbs and flows persist over long cycles. Small caps outshined large caps uninterruptedly from 1999 to 2010. Since then large caps have had the upper hand (Chart 5). Were the apex of globalization theme to gain traction in the 2020s, small caps should reclaim the lead from large caps, especially in the wake of the next US recession. Similar to the death of the global banking model, companies with global footprints will suffer the most, especially compared with domestically focused outfits. One way to explore this theme is via domestic versus global sector preference. But a more investable way to position for this sea change, is to buy small caps (or microcaps) at the expense of large caps (or mega caps). Small caps are traditionally domestically geared compared with large caps that have significantly more foreign sales exposure. Chart 5It’s A Small World After All It’s A Small World After All It’s A Small World After All The closest ETF ticker symbols resembling this trade is long IWM:US/short SPY:US. Investment Implication #3: Buy Value At The Expense Of Growth Similar to the size bias, the style bias also moves in secular ways. Value outperformed growth from the dot com bust until the GFC. Since then growth has crushed value, even temporarily breaking below the year 2000 relative trough. This breakneck pace of appreciation for growth stocks is clearly unsustainable and offers long-term oriented investors a compelling entry point near two standard deviations below the historical mean (Chart 6). Chart 6Value Has The Upper Hand Versus Growth Value Has The Upper Hand Versus Growth Value Has The Upper Hand Versus Growth Financials populate value indexes, a similarity with small cap outfits. Traditionally, financials are a domestically focused sector with export exposure registering at half of the S&P’s average 40% level of internationally sourced revenues. On the flip side, tech stocks sit atop the growth table and they garner 60% of their revenue from abroad. This value over growth style preference will pay handsome dividends if the de-globalization theme becomes more main stream as countries become more hawkish on trade and the Sino-American war continues to erect barriers to trade that took decades to lift. The caveat? If President Trump strikes a short-term deal with China ahead of the 2020 election, the de-globalization theme will suffer a setback. But our geopolitical strategists expect a ceasefire at best, not a durable deal, and also expect the trade war to resume in some way, shape or form in 2021-22, regardless of the outcome of the US election. The closest ETF ticker symbols resembling this trade is long IVE:US/short IVW:US.  Investment Implication #4: Defense Fortress One final long-term playable investment idea from the apex of globalization is a structural bull market in defense stocks (Chart 7). Our October 2016 “Brothers In Arms” Special Report drew parallels with the late nineteenth century period of European rearmament, and the American and Soviet arms race of the 1960s. These movements were greatly beneficial to the aerospace and defense industry. Currently, the move by several countries to adopt more independent foreign policies, i.e. to move away from collaboration and cooperation toward isolationism and self-sufficiency, entails an accompanying arms race. Chart 7Stick With Pure-play Defense Stocks Stick With Pure-play Defense Stocks Stick With Pure-play Defense Stocks Table 1 Top US Sector Investment Ideas For The Next Decade Top US Sector Investment Ideas For The Next Decade China’s challenge to the regional political status quo motivates a boost to defense spending globally. In fact SIPRI data on global military spending by 2030 (Table 1) increases our conviction that this trade will succeed on a five-to-ten year horizon. Beyond the global arms race, two additional forces are at work underpinning pure-play defense contractors. A global space race with China, India and the US wanting to have manned missions to the moon, and the rise of global cybersecurity breaches. Defense companies are levered to both of these secular forces and should be prime sales and profit beneficiaries to rising space budgets and increasing cybersecurity combat budgets. The ticker symbols for the stocks in the pure-play BCA defense index are: LMT, RTN, NOC, GD, HII, AJRD, BWXT, CW, MRCY. Theme #2: Tech Sector Regulation, US Enacts Privacy Laws The second long-term geopolitical theme that we are exploring is the regulatory or “stroke of pen” risk that is rising on FAANG stocks – Facebook, Apple, Amazon, Netflix, and Google. These companies were this decade’s undisputed stock market winners. The US anti-trust regulatory framework was designed to curb broad anti-competitive actions of trusts. As Lina Khan discusses in her seminal article, these actions “include not only cost but also product quality, variety, and innovation.” However, through subsequent regulatory evolution, the Chicago School has focused the US anti-trust process on consumer welfare and prices. If President Reagan and the courts could change how anti-trust laws were administered in the 1980s, so too can future administrations and courts. Today the US Congress, on both sides of the aisle, is looking into regulatory tightening, while the judicial system will take longer to change its approach. Moreover, the impetus for tougher anti-trust policy is here. It comes from a long period of slow growth, income inequality, and economic volatility – such as in the 1870s-80s. This was certainly the case for Standard Oil in 1911, which became a nation-wide boogeyman despite most of its transgressions occurring in the farm belt states. Today, income inequality is a prominent political theme and source of consumer discontent. A narrative is emerging – which will be super-charged during the next recession – that growth has been unequally distributed between the old economy and the twenty-first century technology leaders. With regard to privacy, the news is equally grim for large tech outfits. The EU General Data Protection Regulation (GDPR), which came into force on May 2018, imposes compliance burdens on any company handling user data. In the US, California has signed its own version of the law – the Consumer Privacy Act – which will go into effect in January 2020. These laws give consumers the right to know what information companies are collecting about them and what companies that data is being shared with. They also allow consumers to ask technology companies to delete their data or not to sell it. While tech companies are likely to fight the new California law, and the US court system is a source of uncertainty, we believe the writing is on the wall. The EU is by some measures the largest consumer market on the planet. California is certainly the largest US market of the states. It is unlikely that the momentum behind consumer protection will change, especially with the EU and California taking the lead. The odds of a federal privacy law, following in the footsteps of the Consumer Privacy Act, are also rising. Investment Implication #5: Shun Interactive Media & Services Stocks These risks introduce a severe overhang for FAANG stocks. We are especially worried for the S&P interactive media & services index that includes GOOGL and FB. Tack on the threat of federal regulation and this represents another major headwind for profits and net profit margins that are extremely elevated for these near monopolies. Given that advertising revenue is crucial to the business model of social media companies (GOOGL and FB included), a significant uptick in privacy regulation will likely hurt their bottom line. With regard to profit margins, tech stocks in general command a profit margin twice as high as the SPX. Specifically, FB and GOOGL enjoy margins that are 500 basis points higher than the broad tech sector (Chart 8)! This is unsustainable and will likely serve as easy prey for policymakers. Our view does not necessarily call for breaking up these monopolies. The US will have to weigh the economic consequences of anti-trust policy in a context of multipolarity in which China’s national tech champions are emerging to compete with American companies for global market share. Nevertheless increased regulation is inevitable and some forced sales of crown jewel assets may take place. Moreover, the threat of a breakup will lurk in the background, creating uncertainty until key legislative and judicial battles have already been fought. That will take years. Finally, we doubt the tech sector will be left alone to “self-regulate” its incumbents and negotiate a price on consumers’ privacy. More likely, a new privacy law will loom overhead, serving as a negative catalyst for profit growth. Uncertainty will weigh on the S&P interactive media & services relative performance. Chart 8Regulation Will Squeeze Tech Margins Regulation Will Squeeze Tech Margins Regulation Will Squeeze Tech Margins The ticker symbols to short/underweight the S&P interactive media & services index are an equally weighted basket of GOOGL and FB (they command a 98% market cap weight in the index). Theme #3: SaaS, Artificial Intelligence, Augmented Reality And Autonomous Driving Are Not Fads The third big theme that will even outlive the upcoming decade is the proliferation of software as a service (SaaS). The move to cloud computing and SaaS, the wider adoption of artificial intelligence, machine learning, autonomous driving and augmented reality are not fads, but enjoy a secular growth profile. In the grander scheme of things today’s world is surrounded by software. Millions of lines of code go even into gasoline powered automobiles, let alone electric vehicles. Autonomous driving is synonymous with software, the Internet of Things (IoT) needs software, the space race depends on software, modern manufacturing and software are closely intertwined, phone calls for quite some time have been a software solution, and the list goes on and on. This tidal effect is hard to reverse and is already embedded in workflows across industries. Opportunities to penetrate health care and financial services more deeply remain unexplored and it is difficult to envision another competing industry unseating “king software”. These secular trends are not only productivity enhancing, but will also most likely prove recession-proof. When growth is scarce investors flock to any source of growth they can come by and we are foreseeing that when the next recession arrives, investors will likely seek shelter in pure play SaaS firms. Investment Implication #6: Software Is Eating The World Buying software stocks for the long haul seems like a bulletproof investment idea. But the recent stellar performance of software stocks that has moved valuations to overshoot territory. Our recommended strategy is to buy or add software stock exposure on any weakness with a 10-year investment time horizon. All of these secular trends have pushed capital outlays on software into a structural uptrend. Software related capex is not only garnering a larger slice of the tech spending budgets but also of the overall capex pie. If it were not for software capex, the contraction in non-residential investment in recent quarters would have been more severe (Chart 9). Private sector software capex is near all-time highs as a share of total outlays. Government investment in software is also reaccelerating at the fastest pace since the tech bubble. When productivity gains are anemic, both the business and government sectors resort to software upgrades in order to boost productivity. Cyber security is another more recent source of software related demand as governments around the globe are taking such risks extremely seriously (bottom panel, Chart 9). Given this upbeat demand backdrop and ongoing equity retirement, software stocks are primed to grow into their pricey valuations. Chart 9Software Is Eating The World Software Is Eating The World Software Is Eating The World Finally, this long-term trade will also serve as a hedge to the short/underweight position we recommend in the S&P interactive media & services index. The closest ETF ticker symbol resembling the S&P software index is IGV:US. Theme #4: Millennials Already Are The Largest Cohort And Will Dominate Spending The fourth long-term theme we anticipate will gain traction in the 2020s is the demographic rise of the Millennial generation. Much has been made of preparing for the arrival of the Millennial generation, accompanied by well-worn stereotypes of general "failure to launch" as they reach adulthood. However, "arrival" is a misnomer as this age cohort is already the largest and "failure" is simply untrue. According to the U.S. Census Bureau, Millennials are the US’s largest living generation. Millennials (or Echo Boomers) defined as people aged 18 to 37 (born 1982 to 2000), now number more than 80mn and represent more than one quarter of the US’s population. Baby Boomers (born 1946 to 1964) number about 75mn. Stealthily becoming the largest age group in the US over the last few years, Millennials per-year-birth-rate peaked at 4.3mn in 1990. Surprisingly, the pace matched that of the post-war Baby Boom peak-per-year-birth-rate in 1957 - the per-year average over the period was higher for the Baby Boomers (Chart 10). Chart 10Millennials Are The Largest Cohort Millennials Are The Largest Cohort Millennials Are The Largest Cohort This gap is now set to grow rapidly as the death rate of Baby Boomers accelerates. What is more, the largest one-year age cohort is only 25 years old, thus, Millennials will be the dominant generation for many years. It is unclear how these “kids” will impact the market as they become the most important consumers, borrowers and investors, but make no mistake: this is a seismic shift in economic power and it is here to stay. The Echo Boom is a big, generational demographic wave. A difficult and painful delay has not tempered its looming importance. Finally, this wave of echo-boomers is educated, relatively unburdened by debt (please see BOX in the June 11, 2018 Special Report on demystifying the student debt load as it pertains to Millennials), and as they inevitably “grow up”, form new households and have kids. They will borrow, spend, earn, but not necessarily save and invest to the same extent as the Boomers. And this will be an important long-term theme going forward. Near term we might already be seeing signs of their arrival and firms have begun to pivot accordingly. Investment Implication #7: Buy The BCA Millennials Equity Basket Millennials will boost consumption spending in a number of different ways. The relatively unburdened Millennial cohort will be entering prime home acquisition age soon and this should underpin the long-term prospects of the US housing market and derivative industries. Further, Millennials consume differently from their parents; social media, online shopping and smart phones are not the consumption categories of the Baby Boomers. With this in mind, we have created a basket of ten stocks that we think will be driven over the long term by the demographic rise of the Millennial. We note that these stocks are heavily weighted to the technology and consumer discretionary sectors, which is logical as Millennial consumption habits tend to be discretionary focused and technology-based. Beginning with consumer discretionary, we are highlighting AMZN, NFLX and SPOT as core holdings in our Millennials basket. AMZN’s heft dwarfs consumer discretionary indexes but it could fall in several categories; the acquisition of Whole Foods makes it a Millennials-focused consumer staples retailer and its cloud computing web services segment is a tech leader. NFLX and SPOT represent the means by which Millennials consume media, by streaming movies and music over the internet. The idea of owning physical media is rapidly becoming an anachronism. The home ownership themes noted in the report above lead us to add HD and LEN to the basket. Millennials are “doers” and are set to be the dominant DIYers in the next few years, making HD a logical choice. LEN, as the nation’s largest home builder, should benefit from the Millennials coming of age into home buyers. We are also adding TSLA to our basket as a lone clean tech-oriented equity. TSLA capitalizes on the increasing shift to clean energy of Millennials (the key reason why no traditional energy companies have a spot in our basket). The technology stocks in our Millennials basket are AAPL, UBER (which replaces FB as of today) and MSFT, together representing more than 9% of the total value of the S&P 500. AAPL’s inclusion in the list is predictable as the leading domestic purveyor of devices on which Millennials consume media content. FB is a predictable holding, with more than half of all Americans being monthly active users, dominated by the Millennial cohort. It has served our basket well since inception, but today we are compelled to remove it and replace it with UBER. UBER is a Millennial favorite and the epitome of the sharing economy. In reality UBER is a logistics company and while it is losing money it is eerily reminiscent of AMZN in its early days. Maybe UBER will dominate all means of transportation and its ease of use will propel it to a mega cap in the coming decade. Our inclusion of MSFT is based on its leadership in cloud computing, a rapidly growing industry. We expect the connectivity and mobile computing demands of Millennials will accelerate. The last stock we are adding to our basket is also the only financial services equity. Though avid consumers, Millennials have shown an aversion to cash, preferring card payment systems, including both debit and credit-based. Accordingly, we are adding the leader in both of these, V, to our Millennials basket (Chart 11). Chart 11Buy BCA’s Millennial Equity Basket Buy BCA’s Millennial Equity Basket Buy BCA’s Millennial Equity Basket Investors seeking long term exposure to stocks lifted by the supremacy of the Millennial generation should own our Millennial basket (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). We would not hesitate to add other sharing economy stocks, including Airbnb, to this basket should they become investable in the near future. Theme #5: ESG Becomes Mainstream Investors are increasingly looking at allocating assets based on environmental, social, and governance (ESG) considerations, and this mini-theme has the potential to become a big trend in the 2020s. There are a number of factors that underpin ESG investing. First, Millennials are climate conscious and given that they already are the largest cohort in the US they will not only dominate spending, but also influence election results. Moreover, via social media Millennials can sway public opinion and participate in the ESG conversation. Second, ECB President Christine Lagarde recent speech to the Economic and Monetary Affairs Committee of the European Parliament is a must read.1 If the ECB were to explicitly focus on climate change policy as part of its monetary policy operations then this is a game changer. Green investment financing including “green bonds” could become mainstream. Keep in mind the as reported in the FT “the European Parliament has declared a climate emergency; the new European Commission (EC) has taken office on a promise of an imminent “green new deal”, and Commission president Ursula von der Leyen has vowed to accelerate emissions cuts.” Last Wednesday, the EC released “The European Green Deal” with a pretty aggressive time table. The EC president said “The green deal is Europe’s man on the moon moment” and presented 50 policies slated to get rolled by 2022 to meet revamped climate goals. The implication is that once ESG takes center stage at a number of these institutions it will be easier to become mainstream and propagate the world over. Third, large institutional investors are starting to adopt an ESG mindset, especially pension plans. These investors with trillions of dollars at their disposal can not only disfavor fossil fuel investment, but also undertake investments in “green projects” via private and public equity markets. Banks are also moving in the “greening of finance” direction and given that they are the pipelines of the global plumbing system, swift adoption will go a long way in taking ESG mainstream. Finally, the electric vehicle (EV) proliferation is another key driver on how the ESG theme will play out in the 2020s. As a reminder, in the US 50% of all energy consumption is gasoline related linked to automobiles. While battery technology still has limitations, EV is no longer a fad as the German and Japanese automakers are starting to make inroads on TSLA. These car manufacturers do not want to be left out, especially if this shift toward EV becomes mainstream in the 2020s. The Chinese are not far behind on the EV manufacturing front, however government policy can really become a game changer. If a number of countries and/or California mandate a large share of all new vehicles sold be EV, then the investment implications will be massive. Investment Implication #8: Avoid Fossil Fuels, Gambling, Alcohol And Tobacco… While there are a few ESG related ETFs, we would rather explore this theme’s investment implications of sectors to avoid in the coming decade. We are believers that ESG criteria will continue to gain in importance in institutional investment management decisions. Accordingly, we would tend to avoid ‘sin stocks’, including gambling, tobacco and alcohol; demand for their services is unlikely to decline but investment weightings should mean that share prices will underperform. Further, we think a clean energy shift will mean energy stocks will likely continue to be long-term underperformers (Chart 12). Chart 12Areas To Avoid As ESG Becomes Mainstream Areas To Avoid As ESG Becomes Mainstream Areas To Avoid As ESG Becomes Mainstream Final Thoughts On The US Dollar In this report, we tried to focus on the upcoming decade’s big themes that we deem will play out, and centered recommendations on US equities/sectors. We do not want to neglect some macroeconomic variables that tend to mean revert over time. Specifically, the US dollar, interest rates and most importantly US indebtedness, will also be key drivers of investment theses in the 2020s. Currently, debt is rising faster than nominal GDP growth with the government and non-financial business debt-to-GDP profiles on an unsustainable path (second panel, Chart 13). Granted, the saving grace has been generationally low interest rates as the debt service ratios have fallen (top panel, Chart 13). However, if the four decade bull market in Treasury bonds is over, or may end definitively with the next US recession sometime in the early 2020s, then rising interest rates are the only mechanism to concentrate CEOs’ and politicians’ minds. On the dollar front, Chart 14 highlights the ebbs and flows of the trade-weighted US dollar since it floated in the early-1970s. The DXY index has moved in six-to-ten year bull and bear markets. The most recent trough was during the depths of the Great Recession, while the (tentative?) peak was in late-2016. If history repeats, eventually the dollar will mean revert lower in the 2020s, especially given the fiscal profligacy of the current administration that may continue into 2024, assuming President Trump gets re-elected next November. Chart 13Unsustainable Debt Profiles Unsustainable Debt Profiles Unsustainable Debt Profiles Chart 14Greenback’s Historical Ebbs And Flows Greenback’s Historical Ebbs And Flows Greenback’s Historical Ebbs And Flows The US dollar remains the reserve currency of the world today, but that exorbitant privilege is clearly fraying on the edges as the balance-of-payments dynamics are heading in the wrong direction. Over the next five years, the US Congressional Budget Office (CBO) estimates that the US budget deficit will swell to 4.8% of GDP. Assuming the current account deficit widens a bit then stabilizes (usually happens when global growth improves), this will pin the twin deficits at 8% of GDP. This assumes no recession, which would have the potential to swell the deficit even further. The US saw its twin deficits swell to almost 13% of GDP following the financial crisis, but the difference then was that in the wake of the commodity boom the dollar was cheap (and commodity currencies overvalued). The subsequent shale revolution also greatly cushioned the US trade deficit. Shale productivity remains robust and US output will continue to rise, but the low-hanging fruit has already been plucked.   Another dollar-negative force is its expensiveness. By rising 35% since its trough, the USD has sapped the competitiveness of the US manufacturing sector, which is accentuating the American trade deficit outside of the commodity sector (Chart 14). If the ESG trend ends up hurting oil prices, the US current account will follow the widening deficit in manufactured products. Moreover, the US is lagging Europe on the green revolution. Either the US will have to import green technologies, or the US government will have to provide more subsidies to the private sector. Either way, both of these dynamics will hurt the US current account deficit further. Historically, the currency market is the main vehicle to correct such imbalances. Chart 15Twin Deficits Will Weigh On The US Dollar Twin Deficits Will Weigh On The US Dollar Twin Deficits Will Weigh On The US Dollar The apex of globalization will also hurt the greenback. In a world where all the markets are integrated, borrowers in EM nations often use the reserve currency to issue liabilities at a lower cost. This boosts the demand by EM central banks for US dollar reserves to protect domestic banking systems funded in USD. Moreover, some countries like China implement pegs (both official and unofficial) to the US dollar in order to maintain their competitiveness and export their production surpluses to the US. To do so they buy US assets. If the global economy becomes more fragmented and the Sino-US relationship continues to deteriorate structurally as we expect, then these sources of demand for the dollar will recede. Overlay the widening US current account deficit, and you have the perfect recipe for a depreciating trade-weighted US dollar. Finally, the US is likely to experience more inflation than the rest of the world following the next recession. The US economy has a smaller capital stock as a share of GDP than Europe or Japan, and American demographics are much more robust. This means that the neutral rate of interest is higher in the US than in other advanced economies. As a result, the Fed will have an easier time generating inflation by cutting real rates than both the ECB and the BoJ. Higher inflation will ultimately erode the purchasing power of the dollar and prove to be a structurally negative force for the USD.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com Matt Gertken Geopolitical Strategist mattg@bcaresearch.com Marko Papic Chief Strategist, Clocktower Group marko@clocktowergroup.com Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Mathieu Savary The Bank Credit Analyst mathieu@bcaresearch.com   References Please click on the links below to view reports: Peak Margins - October 7, 2019 The Polybius Solution - July 5, 2019 War! What Is It Good For? Global Defense Stocks! - October 31, 2018 The Dollar: Will The U.S. Invoke A "Nuclear" Option? - August 30, 2018 Is The Stock Rally Long In The FAANG? - August 1, 2018 Millennials Are Not Coming Of Age; They Are Already Here - June 11, 2018 Brothers In Arms - October 31, 2016 The End Of The Anglo-Saxon Economy?  - April 13, 2016 Apex of Globalization  - November 12, 2014 Footnotes 1           https://www.imf.org/en/News/Articles/2019/09/04/sp090419-Opening-Statement-by-Christine-Lagarde-to-ECON-Committee-of-European-Parliament

Highlights The key risk to a dollar bearish view is a US-led rebound in global growth. This would allow the Federal Reserve to tighten monetary conditions much faster than other central banks, supporting the dollar in the process. Watch the performance of cyclicals versus defensives and non-US markets versus the S&P 500 as important barometers for this risk. Feature We were on the road last week, visiting clients in South Africa. The biggest preoccupation was what could put a dollar bearish view offside, especially vis-à-vis the rand. Many understand that the dollar is a countercyclical currency and tends to depreciate when global growth is rebounding. Yet there was still a good amount of trepidation on the totality of this argument. The dollar has been in a bull market since 2011, but there have been a couple of growth cycles during that period. One of our last meetings was in the beautiful city of Stellenbosch, a university town lined with majestic landscapes and rooted deep in South African history. A multi-asset fund manager had just met with two FX strategists before meeting with us. One of them was a dollar bull, and the other a bear. We could sense from his demeanor that indecisiveness was not part his ‘modus operandi,’ and he definitely wanted some clarity from our meeting. What transpired was an honest conversation on currencies, especially vis-à-vis our bearish dollar view. The conversation embodied the sentiment we had been getting from most other fund managers, which is that the view on the dollar is highly polarized. As we went through a swathe of charts, I noted his insightful questions, many of which drilled to the core of where the view could go wrong. Is The Dollar That Countercyclical? The observation that the dollar is a countercyclical currency rests on two pillars. The first is that the US economy is driven more by services than manufacturing. As such, when global growth is rebounding, more cyclical economies benefit most from this growth dividend, and as such, capital tends to gravitate to their respective economies. This is aptly illustrated by the fact that whenever global cyclical sectors (higher concentration outside the US) are outperforming defensive ones, the dollar is in a bear market (Chart I-1). In the US, a wider fiscal deficit tends to be partly financed by new money creation.  More importantly, the Fed tends to be the lender of last resort to the global economy, not least because the US dollar remains a reserve currency. In times of crises, the authorities pursue macroeconomic policies that tend to weaken the dollar, such as lowering rates and/or running a wider fiscal deficit. In the US, a wider fiscal deficit tends to be partly financed by new money creation. Part of the feedback loop in this mechanism is that it leads to a flow of greenbacks outside US borders. This eases offshore rates while greasing the international money supply chain (Chart I-2). Chart I-1The Dollar Tends To Weaken When Cyclicals Are Outperforming The Dollar Tends To Weaken When Cyclicals Are Outperforming The Dollar Tends To Weaken When Cyclicals Are Outperforming Chart I-2An Increasing Supply##br## Of Dollars An Increasing Supply Of Dollars An Increasing Supply Of Dollars Where can this view go wrong? If the Fed’s mandate is vis-à-vis the domestic US economy rather than maintaining international financial stability, then the biggest risk to a bearish dollar view is one in which global growth rebounds (or decelerates), but the US economy holds up well, allowing the Fed to pursue a relatively tighter monetary stance. This week, we got the US Markit and ISM PMIs, and the gaping wedge between the two is the highest since the 2015 manufacturing recession. Given sampling differences, where the Markit PMI surveys more domestically oriented firms, it is fair to assume it is also a barometer of US domestic growth relative to global output. Put another way, whenever the US services PMI is outperforming its manufacturing component, the dollar tends to appreciate (Chart I-3). If global growth rebounds but the US is leading the rebound (the Fed has been one of the most dovish central banks after all), the dollar can continue to rally. Our view is that this remains a tail risk. The slowdown in the global economy has been driven by the manufacturing sector, so it is fair to assume that this is the part of the economy that is ripe for mean reversion. Not to mention, cyclical swings in most economies tend to be driven by manufacturing and exports rather than services. Meanwhile, on the services front, the US economy appears to be rolling over relative to global. Even relative to China, the US appears to remain victim to the repercussions of the trade war (Chart I-4). This divergence is likely to keep the Fed on the sidelines, at least relative to other central banks. Meanwhile, on the political spectrum, our geopolitical strategists  observe that historically, it has been extremely rare for the Fed to raise interest rates a few months ahead of an election cycle. Chart I-3The Risk To A Bearish Dollar View The Risk To A Bearish Dollar View The Risk To A Bearish Dollar View Chart I-4Conflicting Messages Conflicting Messages Conflicting Messages A source of support for this view arises from the German bund versus US Treasury spread. In short, it is a battle of manufacturing versus services. Ever since the European debt crisis, the velocity of money in the euro area has collapsed relative to that of the US. In the financial world, relative long bond yields have followed suit in tight correlation (Chart I-5). If this reverses, it will be a key sign that the neutral rate of interest in the Eurozone is rising relative to that of the US, albeit from a low starting point. The message from bond markets is that such a shift is already taking place. Chart I-5R-Star For The Euro Area Could Move Higher R-Star For The Euro Area Could Move Higher R-Star For The Euro Area Could Move Higher There have been two powerful disinflationary forces for the velocity of money in the US. The first is the lagged effect from the Fed’s tightening policies in 2018. This is especially important given that the fed funds rate was eerily close to the neutral rate of interest, providing little incentive for firms to borrow and invest. Inflation is a lagging indicator, and it will take a sustained rise in economic vigor to lift US inflation expectations. This will not be a story for 2020 (Chart I-6A). Second, the recent rise in the dollar and fall in commodity prices is likely to continue to anchor US inflation expectations downward (Chart I-6B). This should keep the Fed on the sidelines. Chart I-6AVelocity Of Money Versus Inflation Velocity Of Money Versus Inflation Velocity Of Money Versus Inflation Chart I-6BVelocity Of Money Versus Inflation Velocity Of Money Versus Inflation Velocity Of Money Versus Inflation Bottom Line: The key risk to a bearish dollar view is a US-led global growth rebound, allowing the Fed to adopt a much more hawkish stance relative to other central banks. This would be an environment in which US inflation would also surprise to the upside. So far, the move in bond markets suggests this remains a tail risk (Chart I-7). Chart I-7Stalemate Stalemate Stalemate Equity (And Bond) Capital Flows The nascent upturn in a few growth indicators is also coinciding with a positive signal from financial variables. Global cyclical stocks have started to outperform defensives, and the traditional negative correlation with the dollar appears to be holding (previously referenced Chart I-1). Correspondingly, flows into more cyclical ETF markets are accelerating. These are usually a small portion of overall FX flows, but the information coefficient is directionally quite good. The key risk to a bearish dollar view is a US-led global growth rebound, allowing the Fed to adopt a much more hawkish stance relative to other central banks. The S&P 500 has been the best performing market for a few years now, so a crucial part of the dollar call lies in international equity markets outperforming the US. Markets such as the Swedish OMX, the Swiss Market Index and the TSX, among others, have broken out – indices with large international exposure and which are very much tied to the global cycle. Such market breakouts also tend to correspond with a weaker dollar, especially when the return on capital appears marginally higher outside the US. In a nutshell, the performance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. This applies to both the South African rand and other emerging and developed market currencies (Chart I-8A and Chart I-8B). The catalyst will have to be rising relative returns on the capital outside the US, but the starting point is also extremely attractive valuations. Chart I-8ACapital Flows And Exchange Rates Capital Flows And Exchange Rates Capital Flows And Exchange Rates Chart I-8BCapital Flows And Exchange Rates Capital Flows And Exchange Rates Capital Flows And Exchange Rates Over a shorter horizon, sentiment might drive stock market performance, but valuations matter a lot for the longer term. Chart I-9A shows the composite valuation indicator for the US relative to other developed markets. The message is quite clear: Any investor deploying fresh capital into the US today is doing so with the prospect of much lower longer-term returns, at least compared to the euro area and Japan. With inflows into US assets having rolled over, this will likely remain a source of concern for longer-term investors. This is compounded by the fact that expectations for the US technology sector going forward are likely to be hampered by regulatory concerns and lofty valuations. For South African investors, structural reforms will be needed for much more juicy long-term equity returns, beyond a terms-of-trade benefit (Chart I-9B). Chart I-9AReturns To US Equities Look Dire Returns To US Equities Look Dire Returns To US Equities Look Dire Chart I-9BReturns To US Equities Look Dire Returns To US Equities Look Dire Returns To US Equities Look Dire On the fixed-income front, international investors may still find US bond markets attractive in an absolute sense due to higher interest rate spreads. However, the currency risk is just too big a potential blindside to bear. Markets with the potential for currency appreciation such as Australia, Canada, Norway or even Sweden might be better bets. Flow data also highlight just how precarious it is to be long US dollars. As of September, overall flows into the US Treasury market have been negative, which may have contributed to the bottom in bond yields. Net foreign purchases by private investors are still positive, but the momentum in these flows is clearly rolling over. This is more than offset by official net outflows that are running at $350 billion (Chart I-10). As interest rate differentials have started moving against the US, so has foreign investor appetite for Treasury bonds. Chart I-10A Growing Dearth Of Treasury Buyers A Growing Dearth Of Treasury Buyers A Growing Dearth Of Treasury Buyers Bottom Line: Flows into US assets are rapidly dwindling. This may be partly because as the S&P 500 makes new highs amid lofty valuations, long-term investors are slowly realizing that future expected returns will pale in historical comparison. Given that being long Treasurys and the dollar remains a consensus trade, international investors run the risk of being potentially blindsided by a sharp drop in the dollar. Rebuy NOK/SEK We were stopped out of our long NOK/SEK position last week. We are reinstating this trade as relative fundamentals, especially from an interest rate perspective, still favor the cross. We are reinstating long NOK/SEK as relative fundamentals, especially from an interest rate perspective, still favor the cross. We remain oil bulls on the back of a pickup in global demand and OPEC production discipline. This should lead to the outperformance of energy stocks, benefiting inflows into Norway (Chart I-11). Chart I-11No Near-Term Replacement For Oil No Near-Term Replacement For Oil No Near-Term Replacement For Oil Chart I-12Interest Rates Favor NOK/SEK Interest Rates Favor NOK/SEK Interest Rates Favor NOK/SEK Interest rate differentials continue to favor NOK over SEK. The Riksbank will probably – at the margin – be more hawkish than the Norges Bank in an attempt to exit negative interest rates, but the carry will remain wide (Chart I-12). Meanwhile, Norway mainland GDP growth continues to outpace that of Sweden (Chart I-13). Finally, the cross has approached an important technical level, with our intermediate-term indicator signaling oversold conditions. Should the NOK/SEK pattern of higher lows and higher highs in place since the 2015 bottom persist, we should be on the cusp of a powerful rally (Chart I-14). Chart I-13Growth Favors NOK/SEK Growth Favors NOK/SEK Growth Favors NOK/SEK Chart I-14Rebuy NOK/SEK Rebuy NOK/SEK Rebuy NOK/SEK   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been positive: The ISM and Markit data are sending conflicting signals: the Markit manufacturing PMI edged up to 52.6, while the ISM number dipped towards 48.1 in November. On the services front, the Markit PMI was unchanged at 51.6, while the ISM PMI fell to 53.9. ADP employment recorded an increase of 67K jobs in November, well below expectations. The jobs report on Friday will be especially important. The trade deficit narrowed by $4 billion to $47.2 billion in October. The DXY index fell by 0.9% this week. Incoming data have been consistent with our base case view that global growth has bottomed and will rebound in 2020. Along with a manufacturing sector recovery, pro-cyclical, or higher-beta currencies are poised to outperform the US dollar. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 201 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area signal a tentative recovery: Preliminary headline and core inflation both rebounded to 1% and 1.3% year-on-year, respectively in November. The Markit manufacturing PMI increased to 46.9 in November. The Services PMI also edged up to 51.9. Retail sales grew by 1.4% year-on-year in October, lower than the 2.7% yearly growth from the previous month. GDP growth was unchanged at 1.2% year-on-year in Q3. EUR/USD appreciated by 0.6% this week. The recent rebound in both inflation and PMI has brightened the outlook for the euro area and boosted investor confidence. Our Global Investment Strategy upgraded euro area equities to overweight recently. We continue to remain positive on the euro against the US dollar. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Japanese Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been positive: Construction orders soared by 6.4% year-on-year in October. Manufacturing PMI increased to 48.9 from 48.6 in November. Consistently, the services PMI also increased to 50.3. Vehicle sales fell by 14.6% year-on-year in November. This series is extremely volatile, especially given the front-loading of purchases ahead of the consumption tax hike. USD/JPY fell by 0.8% this week. Sluggish growth in Asia, together with the consumption tax hike have weighed on the Japanese economy through 2019. However, the Japanese yen remained resilient due to its safe-haven nature. The Abe government has revealed a sizeable fiscal stimulus, but the potential impact on the economy is still being digested. At the margin, fiscal stimulus reduces the scope for the BoJ to adopt more experimental monetary policies, which is bullish the yen. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 A Few Trade Ideas - Sept. 27, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been upbeat: On the PMI front, both Markit manufacturing and services PMIs increased to 48.9 and 49.3, respectively in November. The construction PMI also rebounded to 45.3 from 44.2. Consumer credit increased by £1.3 billion in October. The British pound has appreciated by nearly 2% against the US dollar this week, making it the best performing G10 currency over the past few weeks. Our Geopolitical strategists believe that the UK election will not reintroduce a no-deal Brexit risk, either in the short-term or long-term. This is positive for the UK economy overall, and bullish for the British pound especially given it is still trading well below its long-term real effective exchange rate. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdon: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been robust: GDP growth soared to 1.7% from 1.4% year-on-year in Q3. On the PMI front, both AiG manufacturing and services PMIs fell to 48.1 and 53.7, respectively in November. The Commonwealth manufacturing PMI was little changed at 49.9, while the services PMI increased to 49.7.   The current account balance increased to 7.9 billion from 4.7 billion in Q3. AUD/USD increased by 0.8% this week. On Monday, the RBA kept interest rates unchanged at 0.75%. Governor Lowe implied that after 3 rate cuts this year, the current low cash rate is already boosting Australian asset prices and household spending. Combined with government spending and a growing population, this should help underpin the Australian economy and the Aussie dollar in the long run. We remain overweight the Aussie dollar. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 There was scant data from New Zealand this week: Terms-of-trade increased by 1.9% quarter-on-quarter in Q3. NZD/USD increased by 1.7% this week. As a small open economy, New Zealand should benefit once global growth stabilizes. Moreover, rising terms-of-trade, mainly in dairy and meat prices, are lifting New Zealand exports and the trade balance this year. We remain positive on the kiwi against the US dollar. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 201 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been mixed: Annualized GDP increased by 1.3% quarter-on-quarter in Q3, well below the 3.5% quarterly growth in the second quarter. The Markit manufacturing PMI slightly increased to 51.4 in November. The Ivey PMI also soared to 60 from 48.2 on a seasonally-adjusted basis in November. Imports slightly increased to C$51 billion in October. Exports also increased to C$49.9 billion. The trade deficit, as a result, narrowed to C$1.1 billion. USD/CAD fell by 1% this week. On Wednesday, the BoC held interest rates unchanged at 1.75%. A catalyst was probably early signs of a global growth recovery. The BoC is one of the few central banks that haven't eased monetary policy this year amid the trade war and a manufacturing sector slowdown. Going forward, we are positive on energy prices, and believe that the loonie is primed for a breakout. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been soft: The KOF leading indicator fell to 93 from 94.8 in November. Real retail sales increased by 0.7% year-on-year in October, from 1.6% the previous month. Headline inflation increased from -0.3% to -0.1% year-on-year in November. The Swiss franc increased by 1.2% against the US dollar this week, amid broad dollar weakness. Inflation has been negative for a second consecutive month in November, and a strong franc does not offer any help. While we remain positive on the Swiss franc, the biggest risk to an appreciating franc is intervention from the central bank. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been negative: Retail sales fell by 0.8% month-on-month in October. The current account surplus narrowed by NOK 2.6 billion to NOK 23.9 billion in Q3. The Norwegian krone increased by 0.8% this week against the US dollar, supported by rising oil prices and a brightened outlook for global growth. The EIA reported a decrease of crude oil stocks by 4.9 million barrels for the week ended November 29th. Combined with a revival in oil demand, this is bullish for the oil prices and the Norwegian krone. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 A Few Trade Ideas - Sept. 27, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been mostly positive: GDP increased by 1.6% year-on-year in Q3, an improvement from 1% the previous quarter. The manufacturing PMI fell to 45.4 from 46 in November. This was in contrast to other euro area countries. The current account surplus improved to SEK 69 billion from SEK 37 billion in Q3. USD/SEK decreased by 1% this week. Typically, a weak krona helps the manufacturing sector by a lag of about 12 months. Moreover, the weak krona is also improving balance of payments dynamics in Sweden. Going forward, we remain bullish on the Swedish krona, and are playing krona strength via the New Zealand dollar. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights A few indicators suggest that global growth will soon bottom. The bottoming process could prove volatile, but the duration of the slowdown suggests a V-shaped rather than U-shaped recovery. The dollar should weaken as higher-beta cyclical currencies rebound from deeply oversold levels. Sell the DXY index at 100. Aggressive short USD bets can be played via the NOK and SEK. The euro is also a natural beneficiary. Our favorite dollar-neutral bets include long AUD/CAD, SEK/NZD, GBP/JPY and short CAD/NOK. Feature The biggest question facing global investors is whether growth will pick up next year, and if so, what the durability of such a rebound will be. Any additional growth hiccups will cause the dollar to soar, and this week’s disappointing credit and industrial production numbers from China are a sober reminder that we are not out of the woods yet. Nevertheless, we believe a pickup in demand, especially emanating from outside the US, is forthcoming. This will favor more pro-cyclical currencies. Cyclical sectors of the equity market are already sniffing a growth rebound, and the dollar is off its peak for the year (Chart I-1). Historically, these have been good reflation indicators, especially when they are sending the same message. This is also a reminder to focus on where economic data will be six to 12 months from now rather than trade on yesterday’s news. Chart I-1The Dollar Tends To Weaken When Cyclicals Are Outperforming The Dollar Tends To Weaken When Cyclicals Are Outperforming The Dollar Tends To Weaken When Cyclicals Are Outperforming Policy shifts affect the economy with a lag, with a bottoming process that can be volatile and/or protracted. However, the duration of the current slowdown suggests we might be entering a V-shaped rather than U- or W-shaped recovery. Investors can track a few indicators to help calibrate the probability of the different scenarios playing out. The Message From Economic Variables There are a swath of economic variables one can follow to track the health of an economy, but we tend to focus on purchasing managers’ indices. This is because they are timely and have a good track record of confirming cyclical shifts in the economy. The problem is that for the most part, they tend to be coincident rather than leading indicators. Gauging the magnitude and duration of the cycle is also important to avoid false starts. The message is that the European manufacturing recession will be over by the first quarter of 2020.  In the US, financial conditions lead the ISM manufacturing index with a tight correlation (Chart I-2). Over the past 18 months, US bond yields have fallen. The historical precedent is that manufacturing activity should be reviving about now. The current reading is consistent with a rather explosive rise in the ISM manufacturing index, towards 60. Chart I-2The Drop In Bond Yields Is Consistent With An ISM Near 60 The Drop In Bond Yields Is Consistent With An ISM Near 60 The Drop In Bond Yields Is Consistent With An ISM Near 60 In Europe, the Sentix sentiment index, which surveys the balance of investors’ emotions between greed and fear, tends to be coincident. However, the ratio of the expectations component to the current situation, a second derivative measure of exuberance or capitulation, tends to lead changes in the PMI indices by six months (Chart I-3, top panel). Again, the message is that the European manufacturing recession will be over by the first quarter of 2020. Applying the same formula to the ZEW survey gives a similar message for Germany (Chart I-3, bottom panel). Even within the Japanese economy, which was heavily hit by the October consumption tax hike, some green shoots can still be uncovered. The expectations component of the Economy Watchers Survey, a comprehensive read across much of the smaller entrepreneurs that drive the local economy, is improving. This has nudged the difference between the expectations component and the current situation to the highest in 5 years. The message is corroborated by the economic surprise index (Chart I-4). Chart I-3A V-Shaped Recovery In European Manufacturing? A V-Shaped Recovery In European Manufacturing? A V-Shaped Recovery In European Manufacturing? Chart I-4Japan Green ##br##Shoots Japan Green Shoots Japan Green Shoots   Chinese credit growth was uninspiring in October, but the Caixin manufacturing PMI is now firmly above the 50 boom/bust level. More and more financial intermediation is being done through the bond market, and the drop in Chinese bond yields has eased financial conditions tremendously. This should encourage lending, which should lead to stronger economic activity, boosting demand for imports (Chart I-5). Rising Chinese imports will boost global growth. Chart I-5Chinese Imports Could Soon Rebound Chinese Imports Could Soon Rebound Chinese Imports Could Soon Rebound Bottom Line: For the most part, PMIs across many countries remain weak, but a few indicators are starting to point to an improvement next year. Given PMIs tend to be coincident, the most potent gains will be made by being early in the cycle. What Are Financial Markets Telling Us? The nascent upturn in our growth indicators is also coinciding with a positive signal from financial variables. Usually, when financial and economic data are in sync, the move in markets tends to be durable and powerful. Below are a few examples.  Usually, when financial and economic data are in sync, the move in markets tends to be durable and powerful.  Global cyclical stocks have started to outperform defensives, and the traditional negative correlation with the dollar appears to be holding (previously referenced Chart I-1). Correspondingly, flows into more cyclical ETF markets are accelerating. These are a small portion of overall FX flows, but the information coefficient is directionally quite good. The message is that in six months, EUR/USD will hit 1.16, GBP/USD will be at 1.4, AUD/USD at 0.75 and the USD/SEK at 8.5. Paradoxically, these are also closer to our own internal targets (Chart I-6). Chart I-6Inflows Into Cyclical ETFs Inflows Into Cyclical ETFs Inflows Into Cyclical ETFs The copper-to-gold, oil-to-gold, and CRB Raw Industrials-to-gold1 ratios often capture the transmission mechanism between easing liquidity conditions and higher growth. It is encouraging that these also tend to move in lockstep with US bond yields, another global growth barometer. The power of the signal is established when all three indicators peak or bottom at the same time, as is the case now (Chart I-7). The next confirmation will come with a clear breakout in these ratios. Chart I-7Global Growth Barometers Flashing Amber Global Growth Barometers Flashing Amber Global Growth Barometers Flashing Amber Correspondingly, in China, scrap steel prices have begun to rise faster than imported iron ore prices, suggesting an improving margin for steel producers. This is probably an indication that steel destocking has reached a nadir (Chart I-8). A renewed restocking cycle should benefit iron ore and other commodity imports and prices. In sympathy, the LMEX index appears to be making a tentative trough.  AUD/JPY breached the important technical level of 72 cents this year but has since recovered. The cross has failed to sustainably break below this level both during the euro area debt crisis in 2011-2012 and the China slowdown in 2015-2016. Again, it appears reflation is winning the tug-of-war. Given speculators are neutral the cross, it suggests that any move either way will be powerful and significant (Chart I-9). Chart I-8Bullish Bottom-Up Signals From Metals Bullish Bottom-Up Signals From Metals Bullish Bottom-Up Signals From Metals Chart I-9Breakdown Avoided For Now Breakdown Avoided For Now Breakdown Avoided For Now An improving liquidity environment will be especially favorable for carry trades. High-beta currencies such as the RUB/USD, ZAR/USD and BRL/USD have not yet broken down. These currencies are usually good at sniffing out a change in the investment landscape. The message so far is that the drop in US bond yields may have been sufficient to backstop any cascading selloff (Chart I-10). Chart I-10Carry Trades May Be Back In Style Soon Carry Trades May Be Back In Style Soon Carry Trades May Be Back In Style Soon Finally, bond yields across major markets are off their lows. Our strategy is to be selective as US dollar tailwinds shift to headwinds, by initially expressing tactical USD shorts via the more potent Norwegian krone and Swedish krona. We have discussed at length our rationale for picking these currency pairs,2 but the bottom line is that they are deeply oversold and have probably been the primary vehicles used to express US dollar long positions. Bottom Line: It is too early to tell if the dollar will retest its highs before ultimately cresting, because part of the move has been driven by risk aversion/political uncertainty. Our bias is that some sort of trade détente is sufficient to rejuvenate economic activity given part of the slowdown, especially vis-à-vis capex, has been driven by uncertainty. Meanwhile, lots of monetary ammunition has already been fired over the past year.  Notes On Australia And New Zealand This week, the Reserve Bank of New Zealand surprised markets by keeping rates on hold, a volte-face to its dovish surprise this summer. In retrospect, this makes sense. First, the RBNZ may be watching the same indicators as us, and as such is seeing an imminent turnaround in the global economy. Keeping some ammunition will allow for more room to ease down the road. Second, the weakness in the currency has probably done the heavy lifting in boosting exports and supporting domestic income. Finally, Australia and China are New Zealand’s biggest trading partners, and the trade war along with rising pork prices have allowed for a terms-of-trade boost for New Zealand’s agricultural exports (Chart I-11). Slowing migration will go a long way in eroding a meaningful supply of employment and domestic demand in New Zealand. We are positive on the kiwi but believe it will underperform its antipodean neighbor. First, the AUD/NZD is cheap on a real effective exchange rate basis (Chart I-12). Meanwhile, a more pronounced downturn in Aussie house prices has allowed some cleansing of sorts, bringing them further along the adjustment path relative to New Zealand. We are willing to overlook this week’s disappointment in Australia’s job numbers, given the unfortunate wildfires that are destroying businesses and homes. Fiscal stimulus will be forthcoming, and reconstruction efforts will go a long way to boosting domestic demand Chart I-11A Terms Of Trade Boost A Terms Of Trade Boost A Terms Of Trade Boost Chart I-12AUD/NZD Is Cheap AUD/NZD Is Cheap AUD/NZD Is Cheap Meanwhile, the RBNZ began a new mandate on April 1st that now includes full employment in addition to inflation targeting. But given the RBNZ has been unable to fulfill its price stability mandate over the past several years, it is hard to argue it will find a dual mandate any easier. Slowing migration will erode a meaningful supply of employment and domestic demand in New Zealand (Chart I-13). The final catalyst for the AUD/NZD cross will be a terms-of-trade shock (Chart I-14). Iron ore prices may face further downside, given supply from Brazil is back online, but China’s clear environmental push has lifted the share of liquefied natural gas in Australia’s export mix. Given eliminating pollution is a strategic goal in China, this will be a multi-year tailwind Chart I-13Loss Of A Meaningful Tailwind For Employment Loss Of A Meaningful Tailwind For Employment Loss Of A Meaningful Tailwind For Employment Chart I-14Terms Of Trade Favors ##br##Aussie Terms Of Trade Favors Aussie Terms Of Trade Favors Aussie Bottom Line: Remain long AUD/NZD as a strategic position and SEK/NZD as a tactical position. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com   Footnotes 1 The CRB Raw Industrials-to-gold ratio is not shown here because of the steep correction in iron ore prices, after a resolution to a supply disruption. That said, iron ore prices are up 28% this year, versus 14% for gold. 2 Please see page 24 for a summary of our recent reports. Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the US have been positive: The Michigan consumer sentiment index edged up to 95.7 from 95.5 in November. The NFIB business optimism index slightly increased to 102.4 from 101.8 in October. Headline inflation recorded modest growth to 1.8% year-on-year in October while core inflation fell to 2.3%. Headline and core producer prices both slowed to 1.1% and 1.6% year-on-year respectively in October. The housing market remains healthy, with mortgage applications up 9.6% for the week. The DXY index appreciated by 0.2% this week. During his testimony this week, Fed Chair Powell suggested the growth outlook for the US remained favorable, based on labor market trends. That said, Europe and EM probably have more scope to outperform amid a global growth recovery, which will be a headwind for the US dollar.  Report Links: Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Preserving Capital During Riot Points - September 6, 2019 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been improving: The ZEW economic sentiment index rebounded to -1 from -23.5 in November. Industrial production contracted by 1.7% year-on-year in September, however it is better than the contraction of 2.8% in the previous month and the expectations of a 2.3% drop. The preliminary GDP report showed that growth increased to 1.2% year-on-year in Q3, up from 1.1% in the previous quarter. Impressively, Germany steered clear of a recession. The euro fell by 0.2% against the US dollar this week. We expect the euro to recover along with the gradual improvement in the data. Moreover, the increased issuance of euro-denominated debt suggests some inflows into European corporate bond markets. This will benefit the euro. Report Links: On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Battle Of The Central Banks - June 21, 2019 The Yen Chart II-5JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been mixed: The trade surplus plunged to JPY 1 billion in September. The current account surplus narrowed to JPY 1.6 trillion from JPY 2.2 trillion. Machinery orders contracted by 2.9% month-on-month in September. On a yearly basis however, they grew by 5.1% year-on-year. Preliminary machine tool orders kept falling by 37.4% year-on-year in October. Preliminary annualized GDP growth slowed to 0.9% quarter-on-quarter in Q3. USD/JPY fell by 0.6% this week. Forward-looking data are showing more optimism on the domestic economy. This might prove that the damage from the tax hike is only a one-off effect. Continue to hold the yen, as both portfolio insurance, and a bet against more aggressive monetary stimulus from the BoJ. Report Links: Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 A Few Trade Ideas - Sept. 27, 2019 Has The Currency Landscape Shifted? - August 16, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the UK have been mostly negative: The total trade deficit (including EU) widened to £3.4 billion in September. Preliminary GDP growth slowed to 1% year-on-year in Q3, from 1.3% in the previous quarter. Industrial production contracted by 1.4% year-on-year in September. Average earnings kept growing by 3.6% year-on-year in September. Moreover, the ILO unemployment rate fell further to 3.8%. Headline inflation fell to 1.5% year-on-year in October, while core inflation remained at 1.7%. GBP/USD increased by 0.4% this week. Despite the recent small rally, the pound is still undervalued on a PPP basis. With a lower probability of a hard-Brexit, our bias remains that the pound has more upside and will converge towards its long-term fair value. Report Links: A Few Trade Ideas - Sept. 27, 2019 United Kingdon: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Battle Of The Central Banks - June 21, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mixed: NAB business conditions and confidence both increased to 3 and 2 in October. Moreover, Westpac consumer confidence increased by 4.5% in November. The wage price index grew by 2.2% year-on-year in Q3. The labor market data was however disappointing, the unemployment rate slightly increased to 5.3% in October. There was a loss of 19K jobs in October, with 10K full-time and 9K part-time. AUD/USD fell by 1.3% this week, weighed down by the recent slide in iron ore prices and employment data. Given speculators are already very short the cross, this could be capitulation. We discuss Australia in this week’s front section. 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 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mostly negative: Inflation expectations fell slightly to 1.8% in Q4. The REINZ house price index grew by 1.1% month-on-month in October, down from 1.4% in the previous month. Migration into New Zealand continues to slow, with only 3440 newcomers in September. The New Zealand dollar rose by 0.6% against the US dollar this week. The main driver is that the RBNZ unexpectedly kept its interest rate unchanged at 1% this Wednesday. We are positive on the kiwi, but remain underweight against both the Australian dollar and the Swedish krona on valuation grounds. Report Links: USD/CNY And Market Turbulence - August 9, 2019 Where To Next For The US Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in Canada have been mostly negative: Housing starts fell by 20K to 202K in October. Building permits fell by 6.5% month-on-month in September. The unemployment rate was unchanged at 5.5% in October. There was a loss of 1.8K jobs in October. However, average hourly wages yearly growth accelerated to 4.4%. New house prices contracted by 0.1% year-on-year in September. The Canadian dollar fell by 0.4% against the US dollar this week, given broad US dollar strength. CAD has handsomely outperformed its G10 commodity counterparts and some measure of rotation is due. We are short CAD/NOK and long AUD/CAD. Report Links: Making Money With Petrocurrencies - November 8, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 Preserving Capital During Riot Points - September 6, 2019 Swiss Franc Chart II-15CHF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been negative: Producer and import prices contracted by 2.4% year-on-year in October. The Swiss franc has appreciated by 0.6%, and the latest PPI numbers suggest deflation is becoming more and more rampant. Our bias remains that the SNB is likely to soon weaponize its currency like other central banks. We have a limit buy on EUR/CHF at 1.06. Stay tuned. Report Links: Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway have been negative: Producer prices fell by 13.8% year-on-year in October. This can largely be explained by the petroleum sector. Headline inflation increased to 1.8% year-on-year from 1.5% in October. Core inflation was unchanged at 2.2% year-on-year. The mainland GDP growth was unchanged at 0.7% in Q3. The Norwegian krone fell by 0.8% this week. The weakness in the krone remains much more than is warranted by underlying economic conditions. Should the DXY hit 100, we will be aggressive buyers of the krone. Report Links: Making Money With Petrocurrencies - November 8, 2019 A Few Trade Ideas - Sept. 27, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been positive: Headline inflation increased to 1.6% year-on-year from 1.5% in October. The unemployment rate fell to 6% from a downward-revised 6.6% in October. The Swedish krona depreciated by 0.3% against the US dollar this week. Statistics Sweden has revised down the unemployment rate for the period from July 2018 to September 2019, due to a flaw in data quality. This has dampened the credibility of the employment data in Sweden and its effect on the exchange rate. That said, we maintain a pro-cyclical stance and remain bullish on the Swedish krona.  Report Links: Where To Next For The US 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 Limit Orders Closed Trades

Highlights An expansion in the Federal Reserve’s balance sheet will increase dollar liquidity. This should be negative for the greenback, barring a recession over the next six to 12 months. Interest rate differentials have largely moved against the dollar. The biggest divergences are versus the more export-dependent NOK, SEK and GBP. A weak dollar will supercharge the gold uptrend. Gold will also benefit from abundant liquidity, and persistently low/negative real rates. Remain short USD/JPY. The path to a lower yen is via an overshoot, as the BoJ will need a shock to act more aggressively. The Bank of Canada left rates on hold, but may be hard-pressed to continue meeting its inflation mandate amid a widening output gap. Go long AUD/CAD for a trade. Feature Chart I-1A Well-Defined Channel Signposts For A Reversal In The Dollar Bull Market Signposts For A Reversal In The Dollar Bull Market The DXY index has been trading within a very narrow band this year, defined by the upward-sloped channel drawn from the February lows (Chart I-1). At 97, the DXY index is just a few ticks away from the lower bound of this channel, which could be tested in the coming weeks. A decisive break below will represent an important fundamental shift, since it will declare the winner in the ongoing battle between deteriorating global growth and easing financial conditions. Global Growth And The Dollar One of the defining features of the currency landscape last year was that U.S. interest rates became too tight relative to underlying conditions. This tightened dollar liquidity both domestically and abroad. Chart I-2 plots the neutral rate of interest in the U.S. relative to the fed funds target rate. A widening gap suggests underlying financing conditions are low relative to the potential growth rate of the economy. Not surprisingly, this also tends to track the yield curve pretty closely, assuming long-term rates are a proxy for the economy’s structural growth rate, while short-term rates reflect borrowing costs. For economic agents, a narrowing spread suggests a rising risk of capital misallocation, as the gap between the cost of capital and return on capital closes. This is most evident for banks through their net interest margins. At the epicenter of this shrinking spread are the Fed’s macroeconomic policies. These include raising interest rates (especially in the face of a trade slowdown) and/or shrinking its balance sheet. These are the very policies that also tend to strengthen the greenback. The result is a rise in the velocity of international U.S. dollars, pushing up offshore rates and lifting the cost of capital for borrowing countries. A widening gap between U.S. neutral rate of interest and fed funds target rate suggests underlying financing conditions are low relative to the potential growth rate of the economy.  This has been the backdrop for the dollar for much of the past two years. The good news is that more recently, the Fed has been quick to rectify the situation. The funding crisis among U.S. domestic banks will be resolved through repurchase agreements and a resumption of the Fed's bond purchases. Chart I-3 shows that the interest rate the Fed pays on excess reserves may soon exceed the effective fed funds rate, meaning the liquidity crisis among U.S. banks may soon be over. Correspondingly, banks’ excess reserves should start rising anew. The drop in rates and the easing in funding conditions have been partly sniffed out by a steepening yield curve (Chart I-3, bottom panel). This will incentivize banks to lend, which in turn, will boost U.S. money supply. As the economy recovers and demand for imports (machinery, commodities, consumer goods) rises, this will widen the current account deficit and increase the international supply of dollars. This should further calm dollar offshore rates, helping short-circuit any negative feedback loops that might have hampered growth in the past. Chart I-2The Fed Has Pivoted The Fed Has Pivoted The Fed Has Pivoted Chart I-3Easing Liquidity Strains Easing Liquidity Strains Easing Liquidity Strains The message from both global fixed-income markets and international stocks is that we may have reached a tipping point, where easing in financial conditions is sufficient to end the manufacturing recession. This is especially the case given this week’s breakout in the S&P 500, the Swedish OMX, and the Swiss Market Index (Chart I-4) – indices with large international exposure and very much tied to the global cycle. Such market cycles also tend to correspond with a weaker dollar, especially when the return on capital appears marginally higher outside the U.S. (Chart I-5). Chart I-4A Few Equity Breakouts A Few Equity Breakouts A Few Equity Breakouts Chart I-5Europe And EM Leading The Rally Europe And EM Leading The Rally Europe And EM Leading The Rally Chart I-6Less Stress In Offshore USD Funding Less Stress In Offshore USD Funding Less Stress In Offshore USD Funding Bottom Line: Rising dollar liquidity appears to have started greasing the international financial supply chain. One way to track if dollar funding is becoming more abundant is through the convenience yield, or cross-currency basis swap.1 This measures the difference in yield between an actual Treasury bond and a synthetic one trading in the offshore market. On this basis, we are well below the panic levels observed over the past decade (Chart I-6). Interest Rate Differentials And International Flows If the rise in global bond yields reflects a nascent pickup in growth, then the message from interest rate differentials has been clear: This growth pickup will be led by non-U.S. markets, similar to the message from international equities. Should the nascent pickup in global growth morph into a synchronized recovery, this will go a long way in further eroding the U.S.’ yield advantage. More specifically, the currencies that have borne the brunt of the manufacturing slowdown should also experience the quickest reversals. This is already being manifested in a very steep rise in their bond yields vis-à-vis those in the U.S. (Chart I-7A and Chart I-7B). For example, yields in Norway, Sweden, Switzerland and Japan have risen by an average of 75 basis points versus those in the U.S. since the bottom. Should the nascent pickup in global growth morph into a synchronized recovery, this will go a long way in further eroding the U.S.’ yield advantage. Chart I-7AInterest Differentials And Exchange Rates Interest Differentials And Exchange Rates Interest Differentials And Exchange Rates Chart I-7BInterest Differentials And Exchange Rates Interest Differentials And Exchange Rates Interest Differentials And Exchange Rates International investors might still find U.S. bond markets attractive in an absolute sense, but the currency risk is just too big a potential blindside at the current juncture. Markets with the potential for currency appreciation such as Australia, Canada, Norway or even the European periphery within Europe might be better bets. Flow data highlights just how precarious being long U.S. dollars is. As of last August, overall flows into the U.S. Treasury market have been negative, which may have contributed to the bottom in bond yields. Net foreign purchases by private investors are still positive at an annualized US$166 billion, but the momentum of these flows is clearly rolling over. This is more than offset by official net outflows that are running at $314 billion (Chart I-8). As interest rate differentials have started moving against the U.S., so has foreign investor appetite for Treasury bonds. More importantly, private purchases have not been driven on a net basis by foreign entities, but by U.S. domestic concerns repatriating capital on the back of the 2017 Trump tax cuts. On a rolling 12-month basis, the U.S. was repatriating back close to net $US400 billion in assets, or about 2% of GDP. Given that the tax break was a one-off, flows have since started to ease, contributing to the ebb in Treasury purchases (Chart I-9). Chart I-8A Growing Dearth Of Treasury Buyers A Growing Dearth Of Treasury Buyers A Growing Dearth Of Treasury Buyers Chart I-9Repatriation Flows Are Ebbing Repatriation Flows Are Ebbing Repatriation Flows Are Ebbing Meanwhile, while U.S. residents have been repatriating capital domestically, foreign investors have been fleeing U.S. equity markets at among the fastest pace in recent years. On a rolling 12-month total basis, the U.S. saw an exodus of about US$200 billion in equity from foreigners earlier this year, the largest on record. Foreigners are still net buyers of about $265 billion in U.S. securities (mostly agency bonds), but the downtrend in purchases in recent years is evident. Bottom Line: Flows into U.S. assets are rapidly dwindling. This may be partly because as the S&P 500 makes new highs amid lofty valuations, long-term investors are slowly realizing that future expected returns will pale in comparison to history. Given that being long Treasurys and the dollar remains a consensus trade (Chart I-10), international investors run the risk of a potential blindside from a sharp drop in the dollar. Chart I-10Unfavorable Dollar Technicals Unfavorable Dollar Technicals Unfavorable Dollar Technicals Dollar Reserve Status And Gold The decline in the dollar may not mark the ultimate peak in the bull market that began in 2011, but at least it will unveil some of the underlying forces that have been chipping away at the dollar’s reserve status over the past few years. China has risen within the ranks to become the number one contributor to the U.S. trade deficit over the past few years. At the same time, Beijing has been destocking its holding of Treasurys, if only as retaliation against past U.S. policies, or perhaps to make room for the internationalization of the RMB. In a broader sense, there has been an underlying shift in the global economy away from dollars and towards a more diversified basket of currencies. This makes sense, given that a growing proportion of trading – be it in crude, natural gas, bulk commodities or even softs – is being done outside U.S. exchanges. Gold continues to outperform Treasurys, which has historically been an ominous sign for the U.S. dollar. Ever since the end of the gold/dollar link in the early ‘70s, bullion has stood as a viable threat to dollar liabilities. With the Fed about to embark on a renewed expansion of its balance sheet, we may have just triggered one of the necessary catalysts for a selloff in the U.S. dollar. This means that holding gold in dollars may become more profitable compared to other currencies (Chart I-11). Given that being long Treasurys and the dollar remains a consensus trade, international investors run the risk of a potential blindside from a sharp drop in the dollar.  The one tectonic shift that has happened over the past decade is that central banks have become net gold buyers, holding 20% of all gold that has ever been mined. If that number were to rise to say 25% or even 30%, it could have the potential to propel the gold price up towards $2800/oz (Chart I-12). If you think such an idea is far-fetched, just ask the Swiss, who a few years ago called a referendum to increase their gold holdings from 7% of total reserves to 20%, or Russia that has seen its gold holdings rise from 2% to over 20% of total reserves. Chart I-11Watch Gold In ##br##USD Terms Watch Gold In USD Terms Watch Gold In USD Terms Chart I-12What If Central Banks Bought Gold More Aggressively? What If Central Banks Bought Gold More Aggressively? What If Central Banks Bought Gold More Aggressively?   Bottom Line: Reserve diversification out of U.S. dollars is a trend that has been underway for a while now, and unlikely to change anytime soon. Gold will be a big beneficiary of this tectonic shift. A Few Trade Ideas If the dollar eventually weakens, the more export-dependent economies should benefit the most from a rebound in global growth, and by extension their currencies should be the outperformers. Within the G-10 universe, there would notably be the European currencies led by the Swedish krona, the Norwegian krone and the pound. The countries currently experiencing the steepest rise in interest rate differentials vis-à-vis the U.S. could be a prelude to which currencies will outperform (previously mentioned Chart I-7A). We expect commodity currencies to also hold firm, but this awaits further confirmation of more pronounced Chinese stimulus, which so far has not yet materialized. The Canadian dollar should also be a beneficiary from dollar weakness, with a technical formation that looks categorically bearish USD/CAD (Chart I-13). Should the 1.30 level be breached, the next level of support is around the 2017 lows of 1.20. The BoC left rates unchanged this week, but the dovish tone from Governor Stephen Poloz was a big reminder that no central bank wants to tolerate a more expensive currency for now. Looser fiscal policy and rising oil prices will eventually become growth tailwinds. Chart I-13A USD/CAD Breakout Or Breakdown? A USD/CAD Breakout Or Breakdown? A USD/CAD Breakout Or Breakdown? Chart I-14Canadian House Prices Canadian House Prices Canadian House Prices However, we will favor the Aussie over the loonie since the downturn in the Australian housing market appears much further advanced compared to Canada. And with macro-prudential measures already implemented in Vancouver and Toronto, there is a rising risk that Montreal could follow suit (Chart I-14). Historically, policy divergences between the Reserve Bank of Australia and the BoC have followed the relative growth profiles of their biggest export markets, and the message so far is that the RBA is well ahead of the curve in its dovish bias (Chart I-15). Go long AUD/CAD for a trade. Chart I-15Buy AUD/CAD Buy AUD/CAD Buy AUD/CAD Finally, the Bank Of Japan left interest rates unchanged but signaled it was willing to ease should the path towards their 2% inflation target be in question. As the central bank that has been pursuing the most aggressive monetary stimulus over the last few years, it is fair to say this week’s policy meeting was a non-event. The yen will continue to be buffeted by powerful deflationary tailwinds that are holding the Japanese economy hostage, as well as global economic uncertainty. In the event that global growth picks up, the yen will depreciate at the crosses, but can still rise versus the dollar. This puts long yen bets in a “heads I win, tails I don’t lose much” scenario. Bottom Line: Go long AUD/CAD and stay short USD/JPY. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Arvind Krishnamurthy and Hanno Lustig, “Mind the Gap in Sovereign Debt Markets: The U.S. Treasury basis and the Dollar Risk Factor,” Stanford University, August 29, 2019. Currencies U.S. Dollar Chart II-1USD Technicals 1 USD Technicals 1 USD Technicals 1 Chart II-2USD Technicals 2 USD Technicals 2 USD Technicals 2 Recent data in the U.S. have been mixed: Preliminary GDP growth slowed to 1.9% quarter-on-quarter from 2% in Q3. PCE slowed to 1.5% quarter-on-quarter in Q3. Core PCE, on the other hand, increased to 2.2%. New home sales contracted by 0.7% month-on-month in September, while pending home sales grew by 1.5% month-on-month. The trade deficit narrowed marginally by $2.7 billion to $70.4 billion in September. Initial jobless claims increased by 5K to 218K for the week ended October 25th. The DXY index fell sharply after the Fed's press conference, ending with a loss of 0.6% this week. On Wednesday, the Fed cut interest rate by 25 bps for the third time this year to 1.75%, as widely expected. The fading interest rate differential will continue to be a headwind for the U.S. dollar. Report Links: On Money Velocity, EUR/USD And Silver - October 11, 2019 Preserving Capital During Riot Points - September 6, 2019 Has The Currency Landscape Shifted? - August 16, 2019 The Euro Chart II-3EUR Technicals 1 EUR Technicals 1 EUR Technicals 1 Chart II-4EUR Technicals 2 EUR Technicals 2 EUR Technicals 2 Recent data in the euro area have been firm: GDP growth in the euro area slowed marginally to 1.1% year-on-year in Q3, down from 1.2% in the previous quarter. On a quarter-on-quarter basis, the growth was unchanged at 0.2%. Headline inflation in the euro area slowed slightly to 0.7% year-on-year in October. Core inflation however, increased to 1.1% year-on-year. Retail sales in Germany grew by 3.4% year-on-year in September, up from 3.1% in the previous month. EUR/USD increased by 0.5% this week amid broad dollar weakness. The current debate among central bankers in the Eurozone is whether ultra accommodative monetary policy is still warranted. This espouses the view that at least, to some members of the ECB, the neutral rate of interest in the Eurozone is higher than perceived. Report Links: On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 Battle Of The Central Banks - June 21, 2019 Japanese Yen Chart II-6JPY Technicals 1 JPY Technicals 1 JPY Technicals 1 Chart II-6JPY Technicals 2 JPY Technicals 2 JPY Technicals 2 Recent data in Japan have been mostly positive: Headline inflation was unchanged at 0.4% year-on-year in October. Core inflation however, increased marginally to 0.7% year-on-year in October. Retail sales soared by 9.1% year-on-year in September in anticipation of the consumption tax hike. Industrial production grew by 1.1% year-on-year in September, compared to a contraction of 4.7% year-on-year the previous month. Consumer confidence increased marginally to 36.2 from 35.5 in October. The yen appreciated by 0.5% this week against the U.S. dollar. The BoJ left its policy rate unchanged this Thursday, while reassuring markets that more stimulus could be added if needed in the future. Report Links: A Few Trade Ideas - Sept. 27, 2019 Has The Currency Landscape Shifted? - August 16, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 British Pound Chart II-7GBP Technicals 1 GBP Technicals 1 GBP Technicals 1 Chart II-8GBP Technicals 2 GBP Technicals 2 GBP Technicals 2 Recent data in the U.K. have been mixed: On the housing front, nationwide house prices increased by 0.4% year-on-year in October. Mortgage approvals increased marginally to 65.9K in September. Money supply (M4) grew by 4% year-on-year in September, up from 3.3% in the previous month. GfK consumer confidence fell further to -14 in October. The pound appreciated by almost 1% against the U.S. dollar this week. The E.U. has agreed on yet another Brexit extension until January 31st. An earlier exit is also possible if the U.K. so chooses. Meanwhile, the U.K. economy is holding up quite well despite the cloud of uncertainty. We remain tactically long GBP/JPY. Report Links: A Few Trade Ideas - Sept. 27, 2019 United Kingdon: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Battle Of The Central Banks - June 21, 2019 Australian Dollar Chart II-9AUD Technicals 1 AUD Technicals 1 AUD Technicals 1 Chart II-10AUD Technicals 2 AUD Technicals 2 AUD Technicals 2 Recent data in Australia have been mostly positive: Headline inflation increased to 1.7% year-on-year in Q3, up from 1.6% in the previous quarter. HIA new home sales grew by 5.7% month-on-month in September. Building permits contracted by 19% year-on-year in September. However on a monthly basis, it grew by 7.6% in September. AUD/USD surged by 1.2% this week. During a speech this Monday, RBA Governor Philip Lowe ruled out the possibility of negative interest rates in Australia, and urged businesses to start investing given historically low interest rates. Going forward, we expect the Aussie dollar to rebound amid a global growth recovery.  New 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 NZD Technicals 1 NZD Technicals 1 Chart II-12NZD Technicals 2 NZD Technicals 2 NZD Technicals 2 Recent data in New Zealand have been mixed: Building permits increased by 7.2% month-on-month in September. Business confidence came in at -42.4 in October. This was an improvement from -53.5 in the previous month. The activity outlook fell further to -3.5 from -1.8 in October. The New Zealand dollar soared by 0.9% against the USD this week. While we expect the kiwi to outperform the USD amid global growth recovery, it will likely underperform its pro-cyclical peers. Report Links: USD/CNY And Market Turbulence - August 9, 2019 Where To Next For The U.S. Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Canadian Dollar Chart II-13CAD Technicals 1 CAD Technicals 1 CAD Technicals 1 Chart II-14CAD Technicals 2 CAD Technicals 2 CAD Technicals 2 Recent data in the Canada have been firm: GDP grew by 0.1% month-on-month in August. Bloomberg Nanos confidence index fell marginally to 57.4 for the week ended October 25th. The Canadian dollar has depreciated by 0.7% against the U.S. dollar, making it the worst performing G-10 currency this week. The BoC decided to keep interest rates on hold this Wednesday, with relatively strong domestic growth and inflation on target. While growth in Canada has surprised to the upside, it might not prove sustainable. We are shorting the Canadian dollar this week against the Australian dollar. Report Links: Preserving Capital During Riot Points - September 6, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Swiss Franc Chart II-15HF Technicals 1 CHF Technicals 1 CHF Technicals 1 Chart II-16CHF Technicals 2 CHF Technicals 2 CHF Technicals 2 Recent data in Switzerland have been mixed: KOF leading indicator increased to 94.7 in October, up from 93.9 in the previous month. ZEW expectations fell further to -30.5 in October. The Swiss franc has increased by 0.7% against the U.S. dollar this week. Domestic fundamentals remain strong in Switzerland, but are at risk from the global growth slowdown. As a safe-haven currency, a rising gold-to-oil ratio points to a higher franc. Report Links: Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Norwegian Krone Chart II-17NOK Technicals 1 NOK Technicals 1 NOK Technicals 1 Chart II-18NOK Technicals 2 NOK Technicals 2 NOK Technicals 2 Recent data in Norway has been positive: Retail sales increased by 0.8% year-on-year in September. USD/NOK is flat this week amid broad dollar weakness. The Norwegian krone has diverged from the ebb and flow of energy prices, and is currently trading around two standard deviations below its fair value. While energy prices have recently been soft, the selloff in the Norwegian krone is exaggerated. We are looking to short CAD/NOK. Report Links: A Few Trade Ideas - Sept. 27, 2019 Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Swedish Krona Chart II-19SEK Technicals 1 SEK Technicals 1 SEK Technicals 1 Chart II-20SEK Technicals 2 SEK Technicals 2 SEK Technicals 2 Recent data in Sweden have been positive: Consumer confidence rebounded to 92.7 in October. Retail sales increased by 2.6% year-on-year in September. Trade balance of goods shifted back to a surplus of SEK 2 billion in September, following the deficit of SEK 5.5 billion in August. Both imports and exports increased by SEK 6.6 billion and SEK 14.1 billion month-on-month, respectively. USD/SEK fell by 0.6% this week. The Swedish krona is much undervalued. A cheap krona should help to improve the balance of payments dynamics in Sweden. We expect the krona to bounce back sharply once global growth shows more signs of recovery amid a U.S.-China trade war détente. 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 Limit Orders Closed Trades