FX Weekly – The Scandi easing cycle

by: Georgette Boele , Roy Teo

FX-Weekly-13-February1.pdf ()

The global central bank easing cycle continued this week. The Swedish Riksbank cut the repo rate to -0.1% and announced a small-scale QE programme. It also said that it is ready to do a lot more. The euro outperformed other major currencies during the week because of a weaker US dollar and stronger than expected eurozone GDP growth data. We have adjusted our Swiss franc forecasts to reflect a proactive Swiss National Bank stance, which seems to have established a new floor. Our new end of 2015 EUR/CHF forecast is 1.05. In addition, we downgraded the Brazilian real because of weak fundamentals.

ECB forces its policy on other central banks

Other central banks in Europe have reacted forcefully to the ECB’s upcoming large-scale QE programme. Most of them face similar challenges: far below target inflation and a strengthening currency versus the euro, which will intensify disinflationary forces. As a result, they are being forced to increasingly step up monetary easing to avoid the negative side-effects of the ECB’s turn to bazookanomics.

The Riksbank goes negative

Yesterday, the Swedish central bank cut the repo rate to -0.1% and also announced a small-scale QE programme. It plans to buy SEK 10bn government bonds. A day after the decision Governor Ingves said that he is ready to expand the bond-purchase programme “by a lot” should it prove necessary. The action seems to have been bigger than expected as the EUR/SEK rallied by more than 1.5% and Scandinavian government bond yields moved sharply lower. It is likely that the Riksbank will ease monetary policy more aggressively going forward. This will keep the Swedish krona under pressure.

Danish central bank already negative

Last week, the Danish central bank further reduced interest rates and intervened in FX markets to defend the EUR/DKK peg. Denmark’s FX reserves as a percentage of GDP are relatively low. However, they are rising at an increasing high pace. In January FX reserves increased by around 26% month-on-month from 446bn DKK to 564DKK. This is a massive increase. It is unlikely that Danish central bank will keep up this pace of increases. So it needs to find other ways to make its currency less attractive such as more interest rate reductions and/or quantitative easing.

SNB could also move to QE eventually

Last month, the Swiss National Bank judged that further increasing its balance sheet – already at unsustainable levels – would pose serious risks. Instead it preferred to allow the Swiss franc to rise, and tempering this with more negative interest rates. The SNB may need to cut rates further into negative territory or engage in QE eventually to fight against deflationary risks. Over time such a strategy should dampen the Swiss franc. Since 15 January the Swiss franc has stabilized and recently EUR/CHF has moved above the 1.05 level. It is likely that the Swiss National Bank has intervened in currency markets to push EUR/CHF above 1.05. If this is the case FX reserves to be released on 6 March will likely reveal a significant jump. It seems that the SNB has established a new floor for EUR/CHF. Therefore, we have adjusted our Swiss franc forecasts. Our new forecasts in EUR/CHF for the end of Q1, Q2, Q3 and Q4 2015 are 1.05.

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Strong start but weak finish of the week for the US dollar

At the start of the week, the positive momentum in the US dollar continued because financial markets adjusted their expectations of Fed rate hikes this year upwards. As a result, USD/JPY moved above 120 and EUR/USD below 1.13. However, it gave back most of its gains because of the weaker than expected US retail sales numbers on Thursday. In addition, eurozone GDP growth data on Friday (Germany, France and the Netherlands) were stronger than expected. This supported the euro.

BoJ not criticized at G20…

The G20 meeting was not a market moving event. It was interesting that the Bank of Japan’s (BoJ) monetary stimulus was not criticized as for indirectly weakening the yen. This is not surprising, because more and more central banks have aggressively eased monetary policy, which also weaken their currencies.

…and to continue its course

Despite market rumours that the BoJ may view further monetary easing to inflate the economy as counterproductive for now, we maintain our view that the BoJ is likely to increase its quantitative and qualitative easing program in July. This is earlier than market consensus of a move in October. As we expect the Fed to tighten monetary policy in the middle of this year, widening interest rate differentials between the US and Japan will push USD/JPY higher towards 130 by the end of this year, in our view.

Lower probability of rate cuts supported NZD

The New Zealand dollar outperformed other major currencies this week. Financial markets have scaled back interest rate cut expectations, because of continued strength in the housing market and recovery in food prices. As a result, the New Zealand dollar (NZD) moved higher. On the other hand, short covering in the currency continued as the market pared back rate cut expectations.

RBA to cut rates in March?

The Australian dollar (AUD) was the worst performing major currency. Weaker than expected employment numbers fuelled speculation of another rate cut next month by the  Reserve Bank of Australia (RBA). We judge that the disappointing employment print in January was partly due to rise in participation rate and payback from strong job hires in the last two months of 2014. Hence we think that there is room for the RBA to pause in March before easing again either in April or May. Our year end AUD/USD forecast remains unchanged at 0.72.

Mixed picture in EM currencies

At the start of the week, most emerging market currencies declined due to worries surrounding Greece and the view that the Fed may tighten monetary policy sooner than later.  But later on, some of them recovered. The Russian ruble recovered more than 2% as oil prices stabilized and sentiment in the currency improved. In Asia, both the Indonesian rupiah and Indian rupee underperformed more as their external imbalances remain the weakest among Asian currencies. The South Korean won (KRW) also eased lower as weaker export and import prices are expected to exacerbate disinflationary pressures in the economy.

We lowered our BRL forecasts

The momentum in the Brazilian real remains very negative on the back of weak fundamentals and political scandals. We have adjusted USD/BRL quite strongly to 3.0 (from 2.7) end of 2015 and to 3.1 (from 2.80) end 2016. The rationale behind this is the further deterioration of the current account deficit in combination with les FDI coverage of it and as a result a huge increase in the foreign/debt to export ratio.

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