FX Weekly – Flying higher

by: Georgette Boele , Roy Teo

FX-Weekly-6-October.pdf ()

The stronger than expected US employment report led to a further strengthening of the US dollar. The US dollar index is on its way to challenge the 2010 peak, while EUR/USD is very close to our new end of year target of 1.25. Emerging market currencies felt the brunt of the US dollar rally.

Strong US employment report let the US dollar fly

The US dollar showed a mixed performance ahead of the US employment report. This was mainly due to mixed US economic data. The euro remained under pressure. Lower eurozone inflation data resulted in an increase of expectations of more monetary easing by the ECB. After the ECB decision and during the Q&A session, the EUR/USD edged up on a less dovish tone by President Draghi. However, after the Q&A session it moved lower again. On Friday, the US employment report came in much stronger than expected. This not only resulted in an upward adjustment of the market’s view of the Fed path of rate hikes in the coming year but also in a strengthening of the US dollar across the board. EUR/USD dropped to 1.2501 while USD/JPY approached 110 again. The US dollar index is on its way to challenge the 2010 peak layered at 88.40. We see further dollar strength in the coming months.


Central banks to remain on hold

The Bank of Japan (BoJ) is widely expected to keep monetary policy unchanged later this week. The BoJ might be comforted by last week’s Q3 Tankan survey, which showed that large enterprises intend to increase their capital expenditure plans and that large manufacturers business conditions and outlook remain positive and stable. Employment conditions are also getting stronger and this bodes well for wage growth. On the other hand, non-manufacturers were less optimistic on the business outlook. A recent survey by the Japan Chamber of Commerce and Industry showed that 80% of all companies polled do not consider a yen weaker than 109 as desirable. We suspect that the negative sentiment on the weak yen is due to the recent sharp weakness in the currency rather than the level of the currency. In fact, historically both manufacturing and non-manufacturing profits to sales ratios tend to increase when the currency weakens. According to the recent Tankan survey, net income for FY 14 for all industries is also expected to rise by 1.5% yoy. On balance, we do not think that a weak currency is bad for the economy. We maintain our view that the BoJ is likely to ease monetary policy further later this year and that the yen will depreciate to 115 against the USD.

Similarly the Reserve Bank of Australia (RBA) is also widely expected to maintain its period of interest rates stability view. The contraction of the service sector since February this year will remain a concern for the central bank. In response to the strong housing market, more stringent bank lending measures and other macro prudential tools are likely to be announced later this year for both owner occupied and investment purchases. The RBA is likely to welcome the decline in the exchange rate in the past month though still highlighting that the exchange rate remains high by historical standards given the decline in commodity prices. In the short-term given oversold technical indicators, we do not rule out a relief rally in the Australian dollar. However we continue to favour fading any rallies towards 0.89-0.90 for lower levels of 0.86 and 0.80 by the end of 2014 and 2015 respectively.

Emerging market currencies

It was another negative week for emerging market currencies. For example the Brazilian real lost 3% versus the US dollar, because of the election uncertainty and disappointing fiscal data. Soon exit polls will release the outcome. In Asia, the South Korean won declined by more than 1% due to continued concerns that the weak Japanese yen will reduce exporters’ price competitiveness. Economic data releases also generally disappointed with inflation in September declining to the lowest level since February this year. The Indonesian rupiah also fell to the lowest level in eight months as the trade balance unexpectedly reversed to a deficit. Furthermore, the currency is also weighed by concerns that incoming President Widodo may compromise on tough reform measures given that opposition parties control more than 60% of seats in parliament.

A few currencies have been relatively resilient though. For example the Hungarian forint did well on better economic data and an overall improvement in sentiment. In Asia, the Singapore dollar was supported. The Monetary Authority of Singapore is expected to keep its modest and gradual appreciation path of the S$NEER policy band with no change to its slope, width and level at which it was centred later this month (10-14 October) as economic growth is expected to accelerate and core inflation remains elevated. Our USD/SGD year-end target at 1.29 remains unchanged.