Weekly FX – Silence before the storm

door: Georgette Boele , Roy Teo

It was a quiet week on currency markets, but this might be the calm before the storm. The ECB monetary policy decision, global PMI data and the US employment report on Friday can all give currency markets more direction this week. It is likely that the US dollar will have the upper hand at the end of this week on stronger US data and a dovish ECB. EUR/USD is on its way to reach our target for the end of June of 1.35. Emerging market currencies came under some pressure as investors took a more cautious stance.

US employment report in the picture…

Although, US economic data were stronger than expected, they were not able to push the US dollar and US Treasury yields higher. The US dollar is failing to rally as economic data are not changing the market’s view about the future path of short term interest rates. In contrast, the US employment report that is due on Friday may well change the market’s view on the interest rate outlook if the outcome surpasses market consensus. This could then give a boost to the US dollar. As a result EUR/USD will move towards our target for the end of June of 1.35.


…but ECB monetary policy decision even more in focus

The euro remained on the defensive last week. This is because ECB officials continued their dovish rhetoric. Why did the euro not weaken more substantially? This is because a rate cut of 15bp is already widely expected by financial markets. In addition, the market is also of the opinion that some kind of credit easing (we expect an ABS purchase programme) will be announced at this meeting together with lower inflation forecasts. The ECB will be dovish in our view and this will add pressure on the euro. However, the euro is unlikely to fall by much unless the ECB announces or leaves the door open to a large scale QE programme. On the other hand, if the ECB does not deliver negative rates and credit easing, the euro could sharply recover.

Australian dollar was the outperformer, while the New Zealand dollar underperformed major currencies

The Australian dollar (AUD) rose by more than a cent to above 0.93 as the total capital expenditure outlook report, which was better than expected. The outperformance of the AUD came despite a disappointing private capital expenditure print in the first quarter of this year. The improvement in the capital expenditure outlook will provide comfort to the Reserve Bank of Australia (RBA) that the mining investment cliff might not be as severe as previously forecast. The RBA is widely expected to leave monetary policy unchanged this week. Though the AUD trade weighted index has remained steady since the last monetary policy meeting on 6 May, the divergence between the currency and iron ore price has continued to widen. This may be a concern to the central bank resulting in a more dovish tone reiterating that a strong currency may hinder the rebalancing of the economy. Australia’s Q1 GDP release will also be crucial for the direction of the AUD this week. We expect the economy to expand by 0.6% qoq, slower than previous quarter’s 0.8% qoq. Leading indicators also imply that the growth outlook in the coming quarters will remain challenging. We maintain our AUD/USD year end forecast of 0.85.

The New Zealand dollar underperformed as business confidence and the activity outlook in May declined to the lowest level since October and November 2013 respectively. Nevertheless, inflation expectations remain steady at 2.6% (close to the upper end of the Reserve Bank of New Zealand 3% inflation range) and employment confidence remains high. As such we maintain our view that the RBNZ will tighten monetary policy by 25bp on 12 June which is fully priced in by the market.

The Bank of Canada is also expected to leave monetary policy unchanged this week. Speculators have reduced their short positions in the currency as downside risks to inflation have abated recently. This has pushed the Canadian dollar up by almost 4% against a trade weighted basket of currencies in the past two months. We will be surprised if the central bank is comfortable with the currency’s recent gains as the economy and employment outlook remain far from rosy.

The Japanese yen did well on reduced expectations of monetary stimulus

The Japanese yen (JPY) slightly outperformed the US dollar. This was due to a better than expected jobs to applicant ratio and inflation print. The likelihood of stronger economic growth has resulted in an adjustment in the market’s opinion about additional monetary stimulus. They have decreased the probability of stepping up or extension of asset purchases. However, the Trade Ministry survey showed that 84% of 908 companies surveyed intend to raise base wages by less than 1% in fiscal year 2014. This will increase the risk of weakness in household consumption, because of wage growth lagging inflation, which could threaten the economic recovery. This will put further pressure on the Bank of Japan to further increase stimulus later this year in order to achieve their 2% inflation target.

A more cautious stance in emerging market currencies

Emerging market currencies that showed a strong performance over the last three months came under pressure last week. For example, the Russian rouble, South African rand, Indian rupee and Turkish lira all underperformed the US dollar. Why is this? After the recent elections in South Africa and India, investors appear to have taken a more cautious stance. Furthermore, continued unrest in Ukraine hurt the Russian rouble again. The Taiwan dollar and the Korean won continued to perform well on the prospect of a further improvement in global growth and therefore better export opportunities.