FX Weekly – Policy divergence

by: Georgette Boele , Roy Teo

FX-Weekly-8-September-2014.pdf ()
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Positive USD momentum is gaining…

Since the end of June 2014 the US dollar has appreciated by more than 2% driven by stronger than expected economic data releases and the policy divergence between the Fed and other central banks. Financial markets have modestly adjusted their view on the Fed path of rate hikes for 2015. This was driven by strong US economic data and less-dovish commentary from Fed officials. The weaker than expected US employment report, however, dampened the mood somewhat. Going forward, we expect financial markets to further build expectations that the Fed will hike rates in 2015. It is likely that this will start to play out in the fourth quarter of this year.

…and euro weakness continued on ECB monetary easing

In a surprise move, the ECB cut its policy rates by a further 10bp and announced a new asset purchase programme, which would focus on ABS and covered bonds. This outcome resulted in a sharp fall of the euro of around 1.5% versus the US dollar and the Japanese yen. EUR/USD dropped from 1.3150 to 1.2930. This move was mainly a euro move, but the US dollar also profited indirectly. With the current momentum in place, our year-end forecast of 1.2800 in EUR/USD could already be reached this week. Previous declines in EUR/USD came to a halt in the 1.2750-1.2800 range. This is a crucial support area. When the market takes this out the sentiment on the euro could deteriorate sharply.

 

 

BoJ to follow ECB’s easing steps?

The Japanese yen’s underperformance against the dollar continued last week. This reflected rising market speculation that the Bank of Japan (BoJ) will need to ease monetary policy further and that the Government Pension Investment Fund will increase allocation in overseas assets sooner rather than later. We are of the view that the BoJ is likely to increase monetary stimulus as soon as October this year as we do not think that inflation will reach the central bank’s 2% target next year. We maintain our view that the yen will depreciate towards 110 and 120 against the dollar in 2014 and 2015, respectively, as interest rate differentials between the US and Japan widen and outward investment from domestic investors and the government pension fund accelerates.