Weekly FX – Finally some US dollar support

door: Georgette Boele , Roy Teo

Better than expected US data supported the US dollar last week as financial markets adjusted their expectations for short-term rates upwards. Both the ECB and Reserve Bank of Australia left monetary policy unchanged as expected. However, both central banks continue to closely monitor their currencies. The RBA was quite explicit in signalling that a stronger currency is not welcome. Meanwhile, the Swedish krona weakened sharply following the Riksbank’s bigger than expected rate cut.

Stronger payrolls supports the US dollar

US employment report surprised on the upside on last week. This resulted in an adjustment in the market’s view about the Fed’s future path of interest rates. The 3M rates as well as the 2Y, 5Y and 10Y US yields moved higher by around 4bp. This supported the US dollar across the board. For example EUR/USD dropped below 1.36 while USD/JPY moved above 102. The US dollar also gained versus emerging market currencies, high yielding currencies such as the Australian dollar and New Zealand, and gold. However, the adjustment in interest rates was not big enough to lead to a major move in the USD. Financial markets are significantly underestimating the likely upside for US rates next year. We therefore we see upside for short rate expectations and the dollar in coming months. The FOMC minutes will be released later this week.

 

Monitoring of currency developments…

As expected the ECB left monetary policy unchanged last week. However, ECB President Draghi reiterated that the central bank is looking at the exchange rate with great attention as it is an important driver for inflation. The options market is implying that price movements in the EUR/USD will remain narrow in the short term with little demand to hedge downside risks. However, prices seem to be forming a lower top around 1.37 with downside risks towards our Q3 target of 1.35.

Another central bank which also left monetary policy unchanged but signalled that a strong currency is not welcomed was the Reserve Bank of Australia (RBA). RBA governor Stevens surprised the market by stating that the central bank still has ‘ammunition’ in terms of cutting interest rates. The central bank is also increasingly concerned about the weak consumer confidence and resilient Australian dollar (AUD). Stevens reiterated that investors are under-estimating the likelihood of a significant decline in the exchange rate at some point. We have reinitiated our bearish view in the AUD as a high conviction trade as outlined in our FX watch – Changes to our conviction views on 3 July. The main reasons for this are as follow: diverging interest rate expectations, overcrowded long AUD positions, the slowing of the rebalancing of the Australian economy, the fact that the RBA could ease monetary policy further if the AUD stays strong and a stronger USD.

 

…and drastic action by the Riksbank

We have removed the Swedish krona long position of our high conviction list. The Swedish krona was on our list versus the euro, because we judged that financial markets had gone too far in pricing in monetary policy easing by the Riksbank. Moreover, we judged that the Swedish krona, which tends to be leveraged to the global cycle, would strongly benefit from a pickup in global growth we expect. However, the SEK strongly underperformed the euro since we have put it on our high conviction list on 20 November 2013. Why? Swedish inflation has undershot expectations and the Riksbank surprised financial markets by cutting interest rates by 50bp to 0.25% compared to a market consensus of only a 25bp cut to 0.50%. What is more, the Riksbank adjusted its view of future repo rate-path dramatically downwards. As a result, increases in the repo rate are not expected to begin until the end of 2015 (see graph above). Even though the Swedish krona was already on the defensive ahead of the rate decision, this surprise decision triggered another sell-off. We have reviewed our Swedish krona call. We have adjusted our forecasts in EUR/SEK for the end of 2014 to 9.25 in EUR/SEK (from 8.50) and for the end of 2015 to 8.75 (from 8.00). We have also removed the Swedish krona from our high conviction list with a negative total return of 4.2%.

…while emerging market currencies were mixed

Lower oil prices and improvement in economic data out of China were the dominant drivers for currencies in Asia. As a result, Asian currencies remained resilient despite a stronger USD. Currencies of net oil importers, the Indian rupee and Indonesian rupiah recovered as concerns that higher oil prices would lead to a deterioration in both countries’ inflation, external imbalances and fiscal deficit outlook faded. Investor sentiment in the Chinese yuan improved as the central bank announced additional targeted min-stimulus to ease lending, while both the manufacturing and non-manufacturing PMI continued to rise. However, gains in the currency were limited as the central bank fixed a weaker rate over the course of last week. The Russian ruble and the South African rand underperformed the US dollar. The former mainly because of more increased tensions at the start of the week that have eased somewhat during the week. Concerning the latter, a recent strike by the largest labour union and comments from Moody’s ratings agency hurt the ZAR