Better than expected domestic data supported the SEK and the NZD last week, while the JPY received safe haven demand from China growth concerns and uncertainty surrounding the North Korean peninsula straits. Downside risks to the EUR/USD increased, but the higher than expected inflation number changed the momentum. In the emerging market space, domestic drivers remain the dominant force, resulting in a mixed performance. The CNY extended its slide as markets seeks further clarity from this week’s National People’s Congress.
Weak data weighs on the USD
Weaker than expected US data weighed on the USD last week though losses were minimised due to safe haven support from uncertainty surrounding Ukraine and China. The USD received some temporary support after Fed Chair Yellen implied that scaling back monetary stimulus will not pause until they are able to ascertain how much of the recent weak data is due to unseasonably cold weather and what portion is attributed to a softer outlook. The Swedish krona (SEK) and New Zealand dollar ( NZD) rallied by more than 1.5%. The upward surprise in Swedish GDP pushed SEK higher, while a larger trade surplus in New Zealand and higher business confidence supported the NZD. China growth concerns and cross straits uncertainty surrounding North Korea missile launch into the sea supported the JPY due to safe haven flows.
Eurozone inflation surprise supported EUR/USD
For most of the week, he EUR/USD edged lower as investors took profit on recent weeks of gains ahead of the ECB’s monetary policy decision later this week. The European Commission’s upgrade of economic growth in the Eurozone gave little support to the EUR/USD as the inflation forecast was also revised lower. In addition, comments from ECB President Draghi that they are ready to counter downside inflation risks capped the upside in the EUR/USD. Short term interest rate differentials between the Eurozone and US and the options market bias were implying that further downside risks in EUR/USD had increased. However, the higher than expected inflation data in the eurozone changed the sentiment. This week, we do expect the ECB to end its liquidity absorbing operations used to sterilize the SMP. As a result, short term interest rates are likely to edge lower which should put further downward pressure on the EUR.
RBA to maintain neutral stance
Short covering supported the AUD after private capital expenditure came in much weaker than expected. We doubt that the RBA will revert back to an easing bias this week due to last week’s disappointing business investment data. This is because the RBA has previously stated that it is willing to accept short term weakness while waiting for the full effects of previous monetary easing to filter through to the economy. In addition, the decline in the AUD should help to rebalance the economy. As a result, we maintain our view that monetary policy will remain unchanged this year as economic growth gradually improves. Indeed, the economy is expected to growth 0.7% qoq in Q4, slightly faster than 0.6% qoq recorded in Q3. However, the decline in iron ore prices and increased options demand to hedge further weakness in the AUD imply that any rally in the AUD/USD above 0.90 is unlikely to be sustained. We maintain our year end bearish target of 0.85.
EM currencies – mixed domestic drivers
EM currencies had a mixed performance last week driven by domestic drivers. On the bright side, the ZAR rallied by 2% after inflationary pressures rose, which fuelled market speculation that interest rates could be raised as soon as this month. The currency was also supported by the government budget, which showed that fiscal consolidation is on track. The BRL appreciated by 1% after the central bank hiked interest rates last week to cool inflationary pressures. The BRL received further support from optimistic comments by Finance Minister Mantega, who stated that the economy does not need additional stimulus and that the recovery will continue this year after Q4 GDP came in better than market expectations. In Asia, the IDR strengthened for the fourth consecutive week as the central bank continued to fix a stronger currency. However the central bank governor has cautioned that further gains in the currency are likely to be limited and that inflation will remain elevated in the short term. On the other hand, escalated tensions between Russia and Ukraine continued to weigh on the RUB which declined almost 2%. Weaker economic data also pushed the TRY lower by more than 1%.
The Chinese yuan extended its slide last week as the PBoC fixed a weaker CNY for the third consecutive week. The closing of positions by investors in the onshore market have exacerbated the CNY weakness, which is trading at 0.7% discount to the fix; a level not seen since August 2012. In the offshore market, investor interest to buy the CNH on dips slowed the extent of depreciation. Various market indicators imply that we have not seen the trough in both the CNY and CNH yet. Looking ahead, we believe that this week’s National People’s Congress is likely to calm market concerns surrounding growth, reforms and the direction in the currency. As a result, the yuan is likely to receive some support. We remain cautiously optimistic that the CNY will recover towards our year-end target of 6.0 against the USD as domestic growth recovers and net capital inflows resume later this year.