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The moves in the EUR, AUD, and GBP are the talk on the floor today, and volumes have skyrocketed. I addressed the lack of volatility in G10 FX yesterday, and that hasn’t materially changed overnight, but there’s defiantly been a pick-up in client flow, with this squared firmly at EURUSD and GBPUSD.
Before taking a crack at central banks lagging behind markets, GBP continues to head higher. The new news has been led by The Sun that the DUP Party are leaning on supporting May’s ‘Plan B’ if it includes a time-limit on the backstop. The EU has said they won’t accept this, but the fact we are hearing a key player say what they will accept, and not what they wont is new, and GBP shorts continue to feel the pinch, with GBPUSD hitting a high if 1.3128 on the news. 

EURUSD has broken below the November uptrend around 1.1450 and is hugging the lower Bollinger Band, which is starting to turn lower. After 52 trading sessions where EURUSD has held either a 1.13- or 1.14-handle (on an intra-day basis), the significance of the pair moving off this two handle range seems one of psychological significance. Clearly, one to watch, but we are in a period where the news flow on the Eurozone seemingly gets worse by the day, and we look towards tonight’s (20:00aedt) German IFO survey for further clarity on the prospects of German hitting a technical recession. 
My EURAUD long from yesterday is off to a tough start, but I am still holding with a view that the risks to the AUD next week are skewed to the downside. GBPAUD has flown of late and is the momentum play. 
Euro rates market leading the ECB
Certainly, the German manufacturing PMI data yesterday was woeful, as was the French services PMI, but the impressive situation here is the EU rates market did not move. Even though Mario Draghi broke ranks from his tradition of only given guidance on economic trends in quarterly meetings, the rates market hardly moved as this outcome was already discounted. We can see that the yield differential between March 2019 and December 2019 has 5.5bp priced in through this period, having already reduced rate hike expectations throughout late 2018 in-line with the deterioration in the data flow. 
Incredibly, the rates market is pricing in a slightly higher degree of tightening in Europe this year than the US, and that seems bizarre.
(white – rate pricing differential between EU-US rates for March to December, yellow – EURUSD)
(Source: Bloomberg)
The fact is, just as we have seen in the US and here in Australia, the markets have interpreted the news flow and made their view on the local and global economy clear and central banks are last to the party. Certainly, in a world where liquidity is leading markets and markets are leading economics and central banks, it seems the RBA will likely be digging their heels more than most, and the 42% probability of a rate cut priced in by year-end simply has to be met by a more dovish response on the 5th February. Of course, much of this hinges on Tuesdays NAB business confidence and Wednesdays Q4 CPI, but, if these come in on the soft side, then the rates markets will move closer to 50-60% chance of a cut by December. 
A material growth downgrade by the German government due next week?
Back on Europe, and the speculation is the German government will cut its economic forecasts for FY2019 by a material 80bp to 1% next week. That will all but cement expectations for the ECB to materially downgrade its forecasts for FY2019 growth from 1.7% towards 1.2% to 1.3% in its now highly anticipated March meeting. However, by then, should the ECB downgrade in March it will be old news. The markets are merely two steps ahead, although Draghi et al. have bought themselves time in case there is stabilisation in the data flow. 
Stabilisation is a big ‘if’, of course, but the base case is we see new economic forecasts, while the stage is set in March to formally announce a new TLTRO (i.e. cheap loans to EMU banks). The ECB could push their guidance for the first hike in deposit rates into early 2020.
It’s interesting to see EURUSD implied volatility expiring 8th March at such subdued levels, and we can see the implied move in spot is 205-points by the 8 March. That move includes time premium, so there is a trade there, and I would expect vols to go higher into that meet. I feel there is still juice in German bunds and French 10yr bonds and sit in the camp that German bund yields will trade closer to zero this year and ironically this could support the EUR as investors move capital out of US assets. Let’s not forget that the US economy was largely an island on to its own in 2018, but the government shutdown is showing no signs of a resolution, and the (analysts) consensus forecasts for Q1 GDP of 2.1% seems far too high and should be closer to a 1.5% to 1.8% range. 
The fact that the US is now fully part of the synchronised global growth slowdown is likely seeing investors pair back some of their US exposures and European fixed income market seem to be the beneficiary here. 
(Eurostoxx50 / S&P 500 – both legs priced in USDs)
So, the growth slowdown is real, and it doesn’t feel like it will simply turn around just because of an agreement on the shutdown or between China and the US on trade, although equities would rally hard on relief. The damage to economics is done, and markets are already pricing a story that central banks are lagging. 
A new Plaza Accord in the making?
One aspect Bloomberg have floated is the idea of a new Plaza Accord after reading into Steven Mnuchin’s (overnight) comments that the yuan could be an important aspect of the trade talks with China. Next weeks meeting between Vice Premier He and Robert Lighthizer will take centre stage and should the market feel the yuan could be a key pawn in the trade puzzle and we see signs that USDCNY is headed lower, then that would be a game changer. One where the biggest issue for the likes of the RBA and ECB will actually be their currency and the idea that exchange rates could be the huge consideration for 2019. USDCNY could feasibly be the centre of the financial markets, driving the USD and significantly impacting central bank’s thinking.  
Published by Chris Weston, Head of Research, Pepperstone