The yen was aggressively sold off after the Bank of Japan expanded its qualitative and quantitative monetary easing. Meanwhile, a more optimistic FOMC resulted in a surge higher of the US dollar. The euro had a good start to the week, but gave back all its gains versus the US dollar afterwards. This week, the ECB will probably sound dovish enough to keep the euro under pressure, in our view. We continue to have strong conviction in a further rise of the US dollar, especially versus the euro, the yen and the Australian dollar. However, the upside versus the Swiss franc could be limited in the near term because of the Swiss gold referendum on 30 November. Therefore we have decided to close our high conviction long US dollar short Swiss franc.
Yen slides after BoJ expands monetary easing…
The Japanese yen was heavily sold off after the Bank of Japan (BoJ) announced that it will increase its monetary base at an annual pace of about 80 trillion yen from the current 60-70 trillion yen. This completely surprised financial markets. For example, market consensus was that the BoJ would only take action in the first quarter of 2015. The BoJ announced that it will purchase Japanese Government Bonds (JGBs) so that its amount outstanding will increase at an annual pace of about 80 trillion yen, a 30 trillion yen increase. The average remaining maturity of JGBs purchases will be extended to about 7-10 years, an extension of about 3 years. In addition, the Bank of Japan will also increase annual purchases of Exchange Traded Funds (ETF) and Japanese Real Estate Investment Trusts (J-REITS). For example, the increase in annual pace of the former is about 3 trillion yen, while for the latter about 90 bln yen. This is about three times the current pace. The size of Commercial Paper (CP) and corporate bond purchases will remain unchanged. We had expected an increase in asset purchases, because of the weak developments in demand and a substantial decline in crude oil prices. This was communicated in our BoJ Watch “More easing on the cards” on 30 October.
The qualitative and quantitative easing programme will be pursued in an open-ended manner. The decision was passed by a 5-4 majority vote. We continue to expect a weaker yen towards 115 versus the US dollar by the end of this year, because of diverging monetary policies. Any recovery of the yen (stronger yen) is likely to be limited as we expect Japanese life insurers to reallocate their portfolio towards more overseas assets as domestic yields continue to underperform.
US dollar firms after a more optimistic FOMC…
Last week, the US dollar (USD) firmed after FOMC members issued an optimistic statement about the US economy. They pointed explicitly to “solid job gains and a lower unemployment rate” and noted that “underutilisation of labour resources is gradually diminishing”. Moreover, the dissenter in the 9-1 vote was a dovish FOMC official. This signals that the stance of the overall FOMC is changing and becoming more hawkish. We continue to expect the Fed to start to hike interest rates at the middle of 2015 and the US dollar to rally as markets adjust their interest expectations upwards.
After a good start euro came under pressure again…
During the week, the euro recovered somewhat. Financial markets have become less gloomy about the eurozone economy despite the weaker than expected German Ifo number. After the Fed meeting the EUR/USD turned lower, because of a more hawkish tone in the statement. This week the ECB will decide on monetary policy. Expectations about further monetary easing by the ECB are high. Therefore, it will be a challenge for ECB President Draghi to keep financial markets satisfied in order to keep the euro under pressure. We expect Draghi to sound very dovish. We also expect further monetary easing by the ECB, but not this week. We do not expect sovereign quantitative easing, but rather an expansion of asset purchases into other assets (agency debt and corporate bonds). We have reached our year-end target of 1.2500. The risk has increased of an even sharper sell-off in EUR/USD once financial markets start to adjust upwards their Fed rate hike expectations for 2015.
…while Scandinavian currencies were out of favour
The Norwegian Krona was under pressure as economic data releases disappointed. The unemployment rate in August rose from 3.4% to 3.7%, which was the highest level since March 2013. Furthermore, retail sales also contracted 0.1% mom against market expectations of a 0.7% rise. The Swedish Krona also slumped more than 1% after the Riksbank unexpectedly cut interest rates by 25bp, more than market expectations of a 20bp cut. The central bank was also more dovish on its forward guidance, postponing the first rate hike from late 2015 to the middle of 2016.
We closed our position in USD/CHF
Last week, the Swiss franc weakened around 1.3% versus the US dollar, because of the general uptrend in the US dollar. We continue to have strong conviction in a further rise of the US dollar, especially versus the euro, yen and Australian dollar. However, the upside versus the Swiss franc could be limited in the near term because of the Swiss gold referendum on 30 November (see Switzerland Watch – Swiss Gold Initiative). Therefore, we have decided to closed our high conviction long US dollar short Swiss franc with a total return of 6.2%.
Emerging market currencies were mostly weaker
A stronger US dollar was a headwind for most emerging market currencies. Moreover, lower oil prices and negative mood on the Russian economy continued to hurt the Russian ruble. There is a battle going on between the Russian central bank and financial markets about the ruble. The 150bp increase in the key policy rate to 9.5% failed to turn the sentiment around. This battle will likely continue in the near-term and the Russian central bank will probably step up its FX interventions. Furthermore, more rate hikes are likely, despite the weak performance of the economy. In addition, the substantial weakness in the yen hurt most Asian currencies. They tracked weakness in the Japanese yen due to concerns that a weaker yen would adversely affect these Asian countries’ export price competitiveness. Given South Korea’s high export similarity with Japan, the won was the worst performer. On the domestic front, the Indonesian rupiah and Thai baht declined after their external balance outlook deteriorated. Bank Indonesia stated that the trade deficit in the second quarter is expected to persist in the third. The government also announced that there is no plan to change their mineral ore export ban. In Thailand, the trade surplus in August reversed sharply to a deficit in September, the widest since January this year.
The Brazilian real was one of the few exceptions. At the start of the week, the Brazilian real fell under heavy pressure, after Dilma’s Rousseff’s re-election news. Afterwards, this negative mood faded and even turned positive when the central bank surprisingly hiked interest rates by 25bp to 11.25%. Financial markets translated this move as a way to establish credibility as an independent inflation fighting central bank.