US dollar edged higher
Last week, market expectations that the Fed may delay the conclusion of asset purchases faded because of commentary from Fed officials and better than expected US data releases. As a result, US Treasury yields, interest rate expectations for 2015 and the US dollar edged higher. However, there were two major currencies that outperformed the US dollar. For starters, the Australian dollar (AUD) was the strongest performing major currency last week. The Australian dollar outperformed the US dollar because Chinese economic data came in better than expected. This confirms our view that the Chinese economic slowdown will remain gradual. Given that Australia relies on Chinese demand for its commodity exports, this is of key importance to the Australian economy. Meanwhile, the Canadian dollar rose after the Bank of Canada (BoC) raised its core inflation forecast going into 2015. We maintain our view that the BoC will only tighten monetary policy in the second half of next year given that there is a lot of slack in the economy.
On the other hand, the Japanese yen was the weakest performing currency, because investor sentiment improved. In addition, there were expectations that the Government Pension Investment Fund would allocate more funds towards foreign securities. Moreover, there were rumours that the ECB is considering buying corporate bonds. This put the euro under pressure. The Swedish krona was also weak last week, mainly because of the possibility of a 20bp rate cut to 0.05% this week. Last but not least, the New Zealand dollar came under pressure after inflationary pressures in New Zealand declined more than expected in the third quarter.
FOMC to continue tapering but no change in the statement
This week the Fed will decide on monetary policy. We expect the central bank to end its asset purchases altogether. In addition, it is likely that the Fed will keep the statement unchanged including the “considerable time” phrase. If it were to remove this, it would signal that it would start hiking interest rates in 6 months from now, hence in March. This would be far ahead of market consensus. If it sounds confident and signals that rates are likely to be increased in June next year, in line with our view, then this would already be seen as hawkish. This is because interest rate markets have recently sharply reduced these expectations. Such an outcome would be positive for the US dollar. We keep our bullish US dollar forecasts in place with our forecast EUR/USD being at 1.25 at the end of 2014 and 1.15 at the end of 2015.
BoJ to lower GDP and inflation forecast and signal more easing on the cards
We expect the Bank of Japan to lower its economic growth and inflation forecast in the coming monetary policy meeting. Consequently, we think that the BoJ could signal that more stimulus measures will be announced after preliminary third quarter GDP is released in the middle of November and/or when the government announce their decision (by the end of 2014) to raise the sales tax as planned. According to a Bloomberg poll conducted from 26 September to 2 October, less than 25% of economists expect the BoJ to embark on more easing measures in 2014 with slightly more than 40% of those surveyed expect the BoJ to wait till early next year while 33% do not expect more actions. Hence the surprise element of BoJ moving later this year will exert further downward pressure on the yen. We expect the JPY to decline towards 115 against the USD by the end of this year.
RBNZ to maintain wait and see stance
We expect the Reserve Bank of New Zealand (RBNZ) to maintain its view that the current monetary policy stance remains appropriate as it monitors the moderating effects of previous policy tightening and export price reductions. However, given that Q3 inflation print of 1.0% yoy was lower than the RBNZ 1.3% forecast, we think the risk has increased that the next rate hike might be delayed until the middle of 2015. The relief rally in the NZD/USD, which started in early October, seems to have come to an end. We continue to expect a lower NZD/USD towards 0.77 and 0.73 by the end of 2014 and 2015.
Mixed performance emerging market currencies
In general emerging market currencies showed a mixed performance versus the US dollar. The South African Rand outperformed the US dollar because of a slight improvement in investor sentiment. This was the result of lower than expected inflation data and expectations that actions to improve the fiscal outlook will be implemented. In addition, the South Korean won extended its second consecutive week of gains as economic growth in China, South Korea’s largest export partner, slowed less than market expectations. The Russian ruble and the Brazilian real both underperformed last week. The market is concerned that Russia’s credit rating may be cut to junk. As a result Russian assets were sold off. The central bank was unable to halt the slide in the ruble despite currency intervention. In fact, last Thursday the central bank said that it eventually would like to halt these interventions and to move to inflation targeting. In the case of the Brazilian real, political uncertainty weighed on the currency. On Sunday, the second round of Presidential elections was held with Rousseff winning re-election.
Since the start of June the Chinese yuan has picked up its slow appreciation path again. Last week, USD/CNY moved below 6.13, because Chinese economic data were better than expected. We think that further strength towards 6.09-6.11 are good levels to take profit as we expect the USD to strengthen in the coming months. Our USD/CNH 2014 year-end target remains unchanged at 6.17.