The more hawkish than expected FOMC provided strong support to the US dollar across the board. Meanwhile, emerging market currencies were mostly under pressure last week as financial markets priced in a higher profile for US short term interest rates next year. A change in focus from safe-haven to yield, also resulted in lower temporary safe-haven demand for the euro and the Swiss franc. We remain positive on the US dollar versus major currencies and most emerging market currencies, because of our above consensus outlook for growth and Fed interest rate hikes. Therefore, we see a higher USD/JPY and a lower EUR/USD.
From safe-haven to yield focus
Ahead of the FOMC decision, currency markets moved sideways. The improvement in risk appetite has shifted the focus from safe-haven assets to higher yielding ones. The Australian dollar and the New Zealand dollar could profit the most from this shift in sentiment. The New Zealand dollar profited, because of its relatively attractive carry among major currencies. Furthermore, expectations of monetary tightening also helped. The Australian dollar outperformed other major currencies, because the market has started to price in rate hikes by the Reserve Bank of Australia early in 2015. However, we only expect rate hikes the start in the third quarter of 2015. Therefore, also in combination with a US dollar rally, we expect the Australian dollar to weaken versus the US dollar this year and next. In the case of the Norwegian krone, lower short-term interest rate expectations hurt. This week the Norges bank will decide on monetary policy. Market consensus and our expectation is that the policy rate will remain unchanged at 1.5%. The Swiss franc was also under pressure last week, but recovered somewhat on Friday. The improvement in sentiment and the pledge by the SNB to keep the Swiss franc cap versus the euro in place were the main reasons for its performance.
Hawkish Fed drives the US dollar higher
The FOMC statement caused some confusion in the market. Initially, the US dollar fell under pressure, but afterwards it recovered strongly, mainly because of the Fed’s higher projected path of interest rate hikes and Chair Yellen’s comments. USD/JPY rallied above 102.50 but consolidated afterwards at around 102.30. EUR/USD dropped below 1.3800 and then consolidated. The better-than-expected US data on Thursday did not accelerate the move though. Bank of Japan Governor Kuroda remained optimistic that the 2% inflation target will be achieved in late fiscal year 2014 or fiscal year 2015. Nevertheless, Mr Kuroda reiterated that there is room for the Japanese yen (JPY) to fall further due to the divergence between US and Japanese monetary policies. We maintain our year end USD/JPY target of 110. We also remain positive on the US dollar versus other major currencies, because of our above consensus outlook for US economic growth and Fed interest rate hikes.
Fed outlook pressures emerging market currencies
Emerging market currencies were mostly under pressure last week due to more hawkish Fed comments on monetary policy next year. The ZAR declined by 2% as domestic labour strike continue to weigh on the currency. On the other hand, the RUB recovered as the market is less worried about a further escalation of the tensions related to Ukraine.
The Chinese yuan extended its slide as the People’s Bank of China (PBoC) fixed a weaker CNY, putting pressure on both the onshore CNY and offshore CNH. However, sentiment in the forwards market improved after China State Council stated that they will already roll out determined measures to expand domestic demand and stabilize growth. The short-term technical outlook for both the CNY and CNH remains weak. However, we believe that the bearish sentiment in the currency is near its peak and a correction is likely to follow soon. We maintain our optimistic view that the yuan will recover when domestic economy improves later this year.