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What Happend to the Reflation Theme ?

 

After March's markets meltdown, we saw the reflation trade taking place, long Equities and Metals, and short US Dollar, in FX the commodity currencies benefited the most from this narrative, and that's played well until this month, when the Dollar index DXY reclaiming its 94 status, the S&P 500 lower for the fourth consecutive week which is the worst since August 2019, and Gold down 10% from its August highs.

Well, what the hell has happened ?

First, from a macro view I think the reflation theme has changed to the growth theme, in other words, investors were expecting a strong third and fourth quarter, but the recent resurgence of Covid-19 cases in Europe has halted that optimism, the UK announced more lockdown restriction, France shutting down bars and restaurants in the city of Marseille and the same thing for the Spanish capital of Madrid and health experts say we should expect a second wave of Covid-19 infections in the winter.
Second, the Economic data has been a bit disappointing, latest US Unemployment claims indicate that jobs growth has stalled in the last several weeks, UE services PMIs this week went below expansionary territory, and that raises a lot of questions on the Eurozone path of recovery and what could the ECB do next.
Third, the market was pricing in more fiscal stimulus from Congress, but at this point it seems that a deal is unlikely before 2021 or at least before the November Election.
And finally, is the FED who went QE infinity back in March, but in its September meeting was less dovish than the market expected and that gave US$ bears the green light to cover some shorts.

Now, what's next for FX ?

If this theme would play out till the end of 2020, I think you should stay away from the commodity block (AUD, NZD, CAD, NOK) and be more favorable on the Yen and the Euro.
The Euro could underperform against US$, but in this market environment, it's more likely that will outperform the high beta currencies such as the Aussie or the New Zealand dollar, so a EURNZD long doesn't seem a bad idea.
The yen is the ultimate safe haven in these market conditions, but also the long term picture seems promising for the JPY, with the narrowing rate differential against the US, and the country of Japan who in this time relying more on fiscal policy rather than just monetary policy.

 

Article by Halim Haddad,

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