Weekly FX – Euro strengthens on ECB inaction

by: Roy Teo

The EUR surged after the ECB left policy on hold and sounded relaxed about the low inflation outlook in its press conference. Still, we continue to expect EUR/USD to move lower in coming months. Meanwhile, a slew of better economic data releases supported the AUD, while an improvement in risk sentiment eased demand for safe haven currencies like the JPY and CHF. The flipside of this move was that most emerging market currencies rebounded. The Chinese yuan strengthened after China maintained its growth target.

EUR surged above 1.38 as ECB remains on the sidelines

The EUR surged to above 1.38 after the ECB left policy on hold and sounded relaxed about the low inflation outlook in its press conference. Short term interest rate differentials between the eurozone and the US narrowed and this supported the single currency. Nevertheless, we still judge that the EUR will underperform the USD as we expect eurozone monetary policy to remain extremely accommodative through 2015, while the central bank should maintain an easing bias in the next few months as inflation undershoots even the its current low expectations. We also think that further strength in the EUR would add to the downward pressure on inflation and Mr Draghi noted that the euro was an important input in its expectations for growth and inflation. Meanwhile, downward pressure on EUR/USD should come from the US side, as we expect economic data to strengthen noticeably as the economy shakes off the bad weather. In addition, the Fed is likely to continue to taper its asset purchases, while expectations of rate hikes next year should start to build later this year.

 

Improvement in risk sentiment weighs on JPY

Meanwhile, an improvement in risk sentiment weighed on safe haven currencies like the JPY last week. In addition, there is heightened market expectations that Japan’s Government Pension Investment Fund may increase its allocation to overseas assets to seek higher returns. This weighed on the JPY. Later this week, the BoJ is widely expected to leave monetary policy unchanged as they await further data after the April sales tax to assess if their optimistic outlook on the economy and inflation is likely to materialise. We continue to expect a weaker JPY towards 110 against the USD later this year, as the BoJ is likely to step up its monetary easing, while the Fed goes in the opposite direction.

Strength in non-mining sectors supports AUD

The AUD jumped last week as the market started to price in a small probability of a rate hike in early 2015 as the rebound in the non-mining sectors are gaining some momentum. The economy expanded 0.8% qoq in the last quarter of 2013, faster than expectations of 0.7%. We do not expect a similar pace of expansion as consumer confidence has faded since the beginning of this year and this is likely to weigh on household consumption. Indeed, RBA Governor Stevens said that the strong growth seen in the last quarter of this year does not change their view that growth will remain below trend this year. We remain comfortable with our view that any monetary tightening is likely to only materialise in the second half of 2015. Furthermore, we judge that further gains in the AUD are likely to slow the rebalancing in the economy and trigger a more dovish stance from the RBA in subsequent meetings. We maintain our year-end AUD/USD target of 0.85.

RBNZ to hike rates by 25bp, dovish tone on strong NZD

The RBNZ is widely expected to raise its official cash rate by 25bp to 2.75% this week. This is fully priced in by the market. The central bank’s growth and monetary outlook update will be more crucial for the direction in the NZD. We expect the RBNZ to maintain their positive economic growth outlook which will support a higher cash rate of 3.5% by the end of this year. However given that the NZD has appreciated by more than 2% against a trade weighted basket of currencies since the last monetary policy meeting on 30 January, we would not be surprised to see the RBNZ strike a disapproving note on the recent strength in the currency.

Risk sentiment supports EM currencies

Most emerging market currencies rebounded last week due to the improvement in risk sentiment. The IDR rose almost 2% after the central bank continued to fix a stronger currency and investors’ confidence in the economy improved. However we remain sceptical that the recent rally in the IDR will continue given that we are likely to see a deterioration in the trade balance in the coming months due to the mineral exports ban put in place earlier this year. This is already evident with mineral exports plunging 70% mom in January resulting in the trade balance returning to deficit. Bank Indonesia is widely expected to leave monetary policy unchanged later this week. The THB strengthened as political uncertainty eased. Both the INR and BRL were also supported due to better than expected domestic data. On the other hand, RUB extended its slide due to continued uncertainty surrounding tensions in Ukraine.

 

The CNY strengthened after China maintained its 2014 growth target steady at 7.5%. The optimism did not fade despite comments from Finance Minister Lou who stated that a growth of 7.2-7.3% can still be considered to be within the acceptable range. We remain optimistic that China will be able to achieve its 7.5% growth target as they have the necessary policy options to support the economy. After the weaker than expected trade and inflation numbers over the weekend, the PBoC fixed a weaker CNY and this weighed on both the CNY and CNH. Though the short term outlook remains weak for the CNY, we remain cautiously optimistic that the CNY will strengthen towards 6.0 against the USD later this year as economic growth remains resilient.