FW Weekly – Fading uncertainty

by: Georgette Boele , Roy Teo

FX-Weekly-30-January.pdf ()
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The EUR/USD has posted its first positive week since 5 December as uncertainty about ECB quantitative easing and Greek elections have faded. The FOMC maintains its optimistic view and the Fed is likely to hike rates mid-2015. The Danish central bank cut rates further into negative territory to support the EUR/DKK peg. Meanwhile, central banks across the globe remain dovish as well and this weighed on currencies. Ratings agency S&P cut of Russia to junk and this sent the Russian ruble lower.

First positive week for EUR/USD in 8 weeks

EUR/USD had its first positive week in 8 weeks. The timing may have surprised some. This is because the outcome of the Greek elections was in line with the fears: a victory by Syriza. As a result, there is now the prospect of tough negotiations between Greece and the eurozone about its programme. So why did EUR/USD recover after it dipped below 1.11 on early Monday morning? In short, uncertainty is out of the way. Not only has uncertainty about the ECB’s QE ceased after it announced a powerful package on 22 January. It is also clear now that the anti-austerity government in Greece has a clear mandate and it there to stay. The absence of uncertainty can have a very powerful impact. Often this triggers action. In general, it is more difficult to cope with uncertainty than with a certain yet unfavourable outcome. Both ECB QE and a Syriza victory at the Greek elections were the topics on investors’ minds for quite some time. So the results left some vacuum and time to rethink the strategy. As a result, investors in financial markets can focus on/worry about new events such as: Will the Fed start hiking interest rates in 2015?

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 FOMC maintains optimistic view

Ahead of the FOMC meeting, financial markets had mostly priced out rate hikes for 2015. Investors expected the federal funds rate to be at 0.45% at the end of 2015 and 1.2% at the end of 2016. In fact, regardless of the Fed’s guidance, markets have been pushing rate hike expectations beyond September. This is mainly the result of lower inflation expectations and more monetary easing elsewhere. The adjustment in the statement was not strong enough to change the market view that the Fed will probably hike interest rates only after September. As a result, currency markets barely moved. We remain of the view that the Fed will hike rates in mid-2015. This should push the US dollar higher across the board.

Danish central bank cut rates further

On 29 January Danmarks Nationalbank reduced the interest rate on certificates of deposit by 0.15bp to -0.5% (see graph below). “This interest rate reduction follows Danmarks Nationalbanks purchases of foreign exchange in the market”.

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The main objective of Danmarks Nationalbank is to ensure stable prices, i.e. low inflation (below but close to 2%, similar to the target of the ECB). This is achieved through the monetary and exchange rate policy. Its policy is aimed at keeping the krone stable against the euro. Usually it changes its interest rates in sync with policy rates of the ECB.

It is likely that the central bank will continue to intervene in currency markets and that it will cut interest rates to below that of the ECB because of the absence of QE in Denmark (apart from FX intervention) and inflation being far below the target.

We judge that the abandoning of the EUR/DKK peg is unlikely. For starters, since the 1980s Denmark has had its exchange rate anchored to the Deutschmark/euro, as it judged that the resulting stability would have positive effects on inflation and growth. The eurozone is its largest trading partner. For example 38% of its exports are destined to the eurozone. As Denmark is part of ERM2 the ECB is also committed to protecting the peg (see our Denmark Watch: “DKK peg to remain in place”.

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The RBNZ unlikely to hike this year

The New Zealand dollar (NZD) closed more than 2% lower in the past week as the Reserve Bank of New Zealand (RBNZ) signalled that it is unlikely to tighten monetary policy this year, a view consistent with ours. However, market speculation that the RBNZ will cut interest rates this year has increased. We think that this is unlikely as the domestic economy remains strong in our view. Nevertheless, we do not rule out a rate cut to support the economy should commodity prices remain low for longer than currently envisaged. On the exchange rate, the RBNZ also stated that the level of the NZD remains unjustified and that it expects to see a further significant depreciation. Separately, data released from the RBNZ showed that they have intervened to weaken the currency in December 2014. We have lowered our NZD/USD year end forecasts from 0.71 to 0.68.

RBA to cut OCR by 25bp

Against market consensus, we expect the Reserve Bank of Australia (RBA) to cut the official cash rate by 25bp this week. Since the RBA paused on its monetary easing cycle in August 2013, we judged that the rebalancing in the economy has been slow. The recent plunge in Australia’s key commodity export prices is expected to weigh on economic growth and LNG investment pipelines. In the past one-and-a-half year, consumer confidence has declined sharply and core inflation currently is at its lowest level since the first quarter of 2013. There is a strong case for the RBA to act sooner than later. We expect the Australian dollar (AUD) to be sold off aggressively towards 0.77 as a result. Our year-end AUD/USD forecast has been lowered from 0.74 to 0.72 as the market is underestimating the pace of rate cuts in our view.

Asian central banks also dovish

In Asia, the South Korean won closed more than 1.5% lower due to market speculation that the Bank of Korea will cut interest rates sooner rather than later as domestic demand remains weak. The Singapore dollar also was sold off, from 1.34 to 1.35 against the US dollar after the Monetary Authority of Singapore unexpectedly eased monetary policy in an unscheduled policy meeting on 28 January. We see upside risks to our year-end target of 1.37 and are currently reviewing our forecasts.

On Monday, S&P cut Russia’s credit rating by one notch to the highest speculative grade. As a result, the Russian ruble tumbled. Both Fitch and Moody’s have also reduced Russia’s rating in the past month, though they still see the country at the minimum investment grade level. Russia still benefits from its very low public debt, it’s still sizeable amount of reserves, and relatively low external debt.

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