Weekly FX – US dollar loses some momentum

by: Roy Teo

The US dollar lost some momentum last week after the post-FOMC rally. The weakness is likely to be transitory as we expect a marked strengthening in the US economic data flow going forward. The AUD rose to the highest level since November 2013 due to increased market speculation that interest rates could be raised sooner rather than later. On the other hand, the EUR eased lower after Germany’s Ifo was lower than expected and on the back of dovish commentary from ECB officials. The ECB is likely disappoint and keep policy on hold this week but we think widening US-eurozone rate differentials will weigh on the euro in coming months. In the emerging market space, most currencies rebounded as sentiment improved.

USD loses momentum after FOMC gains

The US dollar lost some momentum last week after the post-FOMC rally. The weakness is likely to be transitory as we expect a marked strengthening in the US economic data flow going forward after the end of the exceptionally cold weather. Indeed we expect the labour market report to be published this week to show that the economy added 225K jobs in March compared to market consensus of 191K. The USD should get a lift from the report

 

The NZD continues to perform well on higher interest rate expectations and a better than expected outcome for the trade surplus. However Finance Minister English warned that the strength in the currency would hinder the rebalancing of the economy. Higher oil prices supported the CAD, which erased the previous week’s losses. The GBP rose after short term rates edged higher. The latter was triggered by better than expected retail sales and hawkish comments from MPC member Martin Weale. He noted the strength of the UK economy and signalled that the policy rate would likely rise next year. As tensions surrounding Russia and Ukraine continue, safe haven demand supported the JPY. However rising expectations that the BoJ will increase monetary stimulus within the next six months limited the currency’s gains. On the other hand, weaker than expected data weighed on the SEK.

 

AUD strength unlikely to be sustainable

The rebound in the AUD continued last week as the market starts to price in that the RBA could be pressured to tighten monetary policy earlier than expected due to strong gains in the housing market. In addition despite the recent strength in the AUD, RBA governor Stevens did not specifically voice any concerns. We believe that further strength in the AUD is unlikely to be sustainable as it would hinder the rebalancing in the economy and curb goods inflation. In addition, when the AUD was previously at current levels (above 0.92) in late 2013, the RBA voiced its displeasure, stating that the exchange rate is uncomfortably high. Moreover, we judge that macro prudential tools will be implemented first before monetary policy is tightened to cool the housing market. Furthermore technical indicators imply that the currency is in overbought territory and hence a correction (weaker) is likely. We maintain our view that a lower terms of trade and divergence in monetary policies between Australia and the US should result in a lower AUD towards 0.85 later this year.

Divergence in monetary policy to weigh on the EUR

Last week, the EUR closed lower for the second consecutive week despite a weaker USD trend. Though a weaker than expected German Ifo was the catalyst, dovish comments from various ECB officials also weighed on the EUR. ECB President Draghi repeated that the ECB considers the level of the EUR in its assessment of the outlook for inflation. In addition, Bundesbank Weidmann – one of the hawks of the Governing Council – surprised the market by stating he would support QE in certain circumstances, though there was no need for such policies at the moment. The ECB is likely disappoint and keep policy on hold this week, even though action is very much justified in our view. Nevertheless, looking further forward, both short term and long term interest rate differentials between the US and eurozone continue to imply a much weaker EUR towards 1.30.

 

EM currencies rebound on domestic sentiment

In the emerging market space, most currencies rebounded as sentiment improved. The ZAR rebounded last week erasing the previous week’s losses after sentiment surrounding labour strikes improved. The BRL gained for the second consecutive week due to better than expected data and expectations that monetary policy will be tightened due to rising inflationary expectations. The TRY was supported by strong data and rising expectations of post-election continuity. Indeed, the lira appreciated further after the ruling AKP did well in Sunday’s local elections. The RUB recovery is largely based on the fact that EU/US sanctions against Russia following the annexation of Crimea has remained rather ‘light-touch’ so far. In Asia, the KRW rose 1% due to rising optimism that the economy will continue to improve this year. Pre-election optimism continues to support the INR for the fifth consecutive week. We believe that the market has priced in that the new government led by BJP will be able to revive the economy. Hence, the risk has increased that profit taking could follow after the election outcome. In addition, high inflationary pressures will limit the ability of the RBI to loosen monetary policy to stimulate growth. On the other hand, the THB extended its slide due to concerns that the political crisis may lead to a sovereign credit rating downgrade. The government also lowered the country’s GDP and export growth forecast this year to 2.6% (from 3.1%) and 5% (from 6.5%) respectively.

 

Stronger CNY fix likely in the coming month

The PBoC continued to fix a weaker CNY last week despite a weaker USD and rebound in most Asian currencies. This weighed on both the onshore CNY and offshore CNH. In addition, a deposit run on a small rural bank weighed on sentiment. There are signs that the tide will turn going forward. For instance, there has been an improvement in the CNH forwards market, reflecting that offshore investors perceive the current weakness in the spot market as being temporary. The US department of the Treasury is due to release its semi-annual report on International economic and exchange rate policies in April. Historically, the PBoC tends to fix a stronger CNY weeks after the report in response to US pressure for a stronger and more flexible currency. More fundamentally, we expect China’s economic data to gradually improve later this year, helped by policy stimulus. Indeed, Premier Li said that the authorities are confident of keeping economic growth at a reasonable range and has policies in reserve to deal with economic volatility. An improvement in domestic data later this year should support the CNY towards 6.0 against the USD. Our view is reinforced by comments from ex PBoC advise Li who stated that the currency is likely to recover by 3-5% in 12 months’ time.