Week Ahead: Unhappy New Year, Divergence Trade, Enough Pounding

A spike in risk aversion greeted investors at the start of 2016 with the ‘usual suspects’ – fears about China and geopolitical risks – dragging down the risk-correlated and commodity G10 currencies.

While the latest official measures seemingly arrested the market rout in China, global growth concerns and lingering geopolitical tensions could keep investors in damage limitation mode for now. We advise caution given that additional Fed tightening against the background of a slowing global economy should continue to add to market fears. Falling sovereign FX reserves should further undermine demand for global stocks and bonds, exacerbating any tightening in global financial conditions.

Further easing by the ECB, the PBOC and the BoJ as well as more official policies to restore market confidence should help alleviate investors’ worries over time. The key risk is that, in the absence of such measures, persistent risk aversion can make the Fed more cautious yet again and deal a blow to the USD-decoupling trade.

So far, however, there is little to suggest that the Fed is on the verge of changing its outlook. What is more, given that its cautiousness had added to investors' worries in September, we expect the Fed to continue to signal confidence in the US recovery, which should come across as relatively hawkish. That should support demand for the USD divergence trade.



What we’re watching

USD: threats to the divergence trade? – Risk aversion can still challenge the Fed’s outlook. Solid US retail sales needed next week to limit any risk aversion-driven USD underperformance against JPY, EUR and CHF.

GBP: enough pounding? – Improving UK data and the largely unchanged BoE outlook could offset Brexit fears to a degree and support GBP.

AUD: remain cautious – AUD latest underperformance could continue next week in view of Australian and Chinese data releases.

NOK & SEK: ahead of CPI – CPI data out of Sweden and Norway may matter less in the face of low oil prices and Riksbank’s FX intervention threat.

XAU: Gold shines – Gold has been the best performing asset in our universe since the start of 2016 as risk aversion burnished its safe haven appeal.

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