Weekly FX – Learning to live with the taper

by: Georgette Boele

Last week’s better-than-expected US data pushed up US Treasury yields. Initially this resulted in some nervousness in currency markets pushing safe haven currencies higher and emerging market currencies lower. But the mood changed after the strong US employment report as investors focused on the positives for the economy and appeared to have digested the idea of Fed tapering. The Japanese yen dropped on improved investor sentiment. Meanwhile, the inaction of the ECB and its less-dovish communication compared to expectations, resulted in a stronger euro.

Stronger US data resulted in a modest rise in the dollar

Last week US economic data came in above expectations and this resulted in higher US Treasury yields. At first, these higher yields made currency markets modestly nervous showing a similar trend to earlier this year as Fed tapering approached. This was reflected by the Japanese yen (JPY) regaining some ground across the currency spectrum and higher equity market volatility. However, the strong US employment report resulted in a change in sentiment. The Japanese yen was no longer in vogue versus emerging market currencies, which signals that investor appetite improved. This suggests that markets have largely digested the idea that Fed will taper sooner or later. Overall, the US dollar – reflected by the US dollar index – rose after the report mainly driven by strength versus the JPY and some other majors. However over the week the US dollar had another mixed performance. The USD has underperformed the Swiss franc, euro, Swedish krona and New Zealand dollar, while it has outperformed the rest.


The ECB repeated its mantra…and EUR strengthened…

The ECB left monetary policy unchanged as widely expected. Although President Draghi indicated that monetary easing options are still on the table, he also suggested that policy easing was not imminent and did not seem to be worried about the relatively strong euro for now. Surprisingly the euro has outperformed the US after better US data, because short-term German government bond yields have risen at a higher pace than US Treasury yields. In addition, there has been some upward pressure on eurozone interbank rates. This appears to be a year-end effect and would imply that the euro will unlikely be sold off aggressively in the near-term unless exceptionally strong US data result in US Treasury yields even rising at a faster pace. So for now EUR/USD appears to be well supported, because of tighter liquidity and demand for peripheral government bonds.


… but other central banks managed to indirectly trigger weakness in their currencies

The Bank of Canada (BoC) left monetary policy unchanged as widely expected, but the statement was more dovish. It put a greater emphasis on downside risks to inflation, while risks associated with elevated household imbalances have not materially changed. As a result, the Canadian dollar (CAD) underperformed due to increased market speculation that further monetary stimulus may be on the cards further down the road. The risk has increased that the BoC may loosen monetary policy next year as core inflation is edging away from its 2% target. However, we maintain our view that monetary policy will remain unchanged as there are encouraging signs that economic growth troughed in Q2 2013. Exports are also expected to benefit with the recent depreciation of the CAD and stronger US economy next year.

The Norges Bank was also more dovish than expected. It left monetary policy unchanged in line with market consensus, but surprised the market by stating that it expects the key policy rate to be hiked one year later than projected in September. As a result, 3 months interest rates implied from December 2014 futures fell by 5bp and the Norwegian krone came under pressure.

In Australia, the weaker than expected GDP release resulted in speculation of a possible rate cut early 2014. This is in line with our view that the RBA will deliver a final 25bp rate cut in early 2014 to accelerate the rebalancing of the economy.

Better domestic data have supported CHF, SEK and NZD

In Switzerland, the PMI and inflation data came in above expectations and this supported the Swiss franc (CHF). The New Zealand dollar (NZD) received support from the better terms of trade numbers, while a strong Swedish PMI helped the Swedish krona (SEK). The CHF and the NZD were even able to outperform the euro. We think that the upside in the NZD is limited as the Reserve Bank of New Zealand (RBNZ) is expected to reiterate its concern about the strong NZD at its monetary policy meeting on 11 December. In the case of the SEK, the Riksbank will meet on 17 December.


EM currencies recover after US employment report

Since the end of October, Fed tapering fears increased and resulting in higher US Treasury yields. At first, some emerging market currencies with weak fundamentals were affected, but later on more emerging market currencies came under pressure, because of a modest deterioration in overall investor sentiment. This deterioration has come to a halt after the release of the better than expected US employment report. Since then, most emerging market currencies have recovered, reflecting stronger expectations on the global economic recovery and an improvement in investor sentiment. Some emerging market currencies have done better than others. The Indian rupee (INR) and the Polish zloty (PLN) have fared particularly well. Fundamentals in India have improved and investors are optimistic about changes on the political front. The outlook for both the manufacturing and services sectors strengthened and the current account deficit in Q3 narrowed. So the INR received support from these developments. The sentiment towards Poland is also relatively constructive. The central bank left interest rates on hold at 2.5% and no further easing is on agenda. Moreover, the PLN is a growth sensitive currency that will do well in an environment of strong global growth, which we expect. The Mexican peso has also performed well. Investors are optimistic that the energy bill may be passed in the short term. Over the weekend senators from the two political parties agreed to allow output sharing contracts and licenses for outside workers. At the other end of scale was the South African rand that weakened by more than 2%. A larger than expected current account deficit and reports of the longest stretch of bond outflows on record has put the ZAR under pressure. In the case of the Thai baht, political uncertainty has continued to weigh. The Indonesian rupiah was also under pressure, weakening beyond levels seen in September. But later during the week the IDR recovered somewhat. We do not expect the current weakness in the IDR to be sustainable given that the valuation in the currency is increasingly attractive after its 19% slide this year. The IDR should also receive support as inflationary pressures and current account imbalances are likely to improve next year.