The US dollar recovered last week, as the FOMC signalled that the bar to stopping tapering is high, while uncertainty in emerging markets was also supportive. The weaker-than-expected US data was largely ignored. The Swedish krona was out of favour after inflation data surprised on the downside, increasing the risk that the Riksbank will further cut interest rates. Meanwhile, the Chinese yuan declined against the US dollar, with concerns surrounding slower growth in China as the key driver.
USD recovered despite the weaker US data
The US dollar recovered last week mainly because the FOMC minutes showed that the bar to stopping tapering is high. The market interpreted the Fed as being less dovish and as a result the US dollar recovered across the board. Weaker than expected US data was mostly ignored, because they will unlikely change the course of the tapering, and the overall market perception is that the cold spell in the US will only temporarily depress economic data. Moreover, the US dollar also received support, because there was some deterioration in overall emerging market sentiment. This also supported the Swiss franc, which even outperformed the US dollar.
The Japanese yen, however, fell under pressure because the BoJ took further steps to ease monetary policy. The BoJ unexpectedly enhanced its fund provisioning measure to stimulate bank lending. Though the BoJ maintained their expectations that the domestic recovery will continue and that their inflation goal will be achieved. However, we judge that the BoJ’s move to improve and extend its bank loan program is a signal that the central bank is increasingly worried after the weaker than expected Q4 2013 GDP numbers. We maintain our view that it is highly likely that the BoJ will be pressured to step up its monetary stimulus later this year and this is expected to weigh on the JPY, towards 110 in the coming year.
The Swedish krona (SEK) dropped because inflation data surprised on the downside, increasing the risk of another rate cut by the Riksbank this year. We are currently reviewing if we would like to keep the SEK as one of our high conviction long calls. The Euro has been resilient once again, driven by better economic data and lower ECB excess liquidity, but we think that further monetary easing will undermine the single currency.
Emerging market currencies under some pressure
Expectations that the Fed will continue scaling back monetary stimulus in each subsequent FOMC meeting supported the US dollar against emerging market currencies last week. Concerns of slower growth in China weighed on Asian and commodity currencies. The escalation of unrest in Ukraine mainly hurt currencies from neighbouring countries such as the Russian rouble, which was, after the Ukrainian hryvnia, the weakest performing currency. The South African rand was also under pressure, because of higher than expected inflation data last week. The Brazilian real was the outperformer in our EM currency coverage last week. Brazilian inflation data came in lower than expected and so did the unemployment rate. In addition, the government announced a revised budget, which includes spending cuts. This reduced concerns about the fiscal balance. Moreover, central bank governor Tombini sounded somewhat dovish. This signals that inflation risks are decreasing. Next week, the central bank is expected to raise rates by 25bp to 10.75%.
Both the onshore (CNY) and offshore (CNH) Chinese yuan also declined last week, despite the People’s Bank of China announcing that they will push forward the yuan convertibility under the capital account and orderly expand the yuan trading band in 2014. This is because concerns over slower growth was the dominant driving force and the market has already discounted that the currency’s trading band will be widened this year. In addition, the PBoC has allowed the CNY fix to weaken at the fastest weekly pace since September 2011, sparking market concerns that it is a deliberate attempt to cool capital flows and support the economy. The CNH extended its slide to the USD, to 6.10, the highest since October 2013. Technical indicators imply that the CNH is oversold and hence a correction (stronger) is likely. The options market bias implies that the CNH discount to the CNY is likely to persist this week and hence the direction in the CNY fix will be crucial for cues in the CNH. We believe the current weakness in the CNH is likely to be transitory as we judge that China’s authorities can fine tune policy to keep GDP growth at a steady pace around 7.5% and that they have the sufficient firepower and policy levers to manage the process of off-balance sheet activities, including trust funds, liquidity issues and the broader implications of credit tightening. We maintain our year end USD/CNH target of 6.0.