The US dollar was strong across the board. This mainly reflected strong US economic data, which suggested the Fed will raise rates in the coming months. In contrast, the ECB is on the verge of QE, while other central banks cut rates. EUR/USD dropped below 1.09. We think it will fall further.
US dollar shines
The US dollar made strong advances last week because of monetary easing in other economies, hawkish comments from Fed officials and a strong US employment report. The non-farm payrolls came in very strong at 295k and the unemployment rate dropped to 5.5%. Hourly earnings were a bit softer though. As a result of this strong report, US rates and yields moved higher and the US dollar rallied strongly. EUR/USD dropped below 1.09 and USD/JPY moved above 120.50 again. We expect the strengthening of the US economy to continue and the Fed to start hiking interest rates in June.
Lower euro after ECB…
The euro initially rose on the ECB’s upward revision in eurozone growth forecasts. Also his comments that the downside risks have decreased also gave support to the euro. As a result, EUR/USD moved back above 1.11 and made a high of 1.1114. During the Q&A session the euro fell under pressure again after Draghi’s comments that the ECB could continue buying government bonds until they “reached the level of the negative deposit rate”. EUR/USD dropped below 1.10 (our target for the end of June). The strong US employment report added further pressure on EUR/USD. We expect the euro to fall further versus the US dollar going forward because of the impact of QE and diverging monetary policy paths on either side of the Atlantic. There is a rising risk that if US economic data continue to come in strong and the Fed starts its hiking cycle in June, then parity in EUR/USD (our Q1 2016 forecast) will likely be reached earlier.
…also the Swiss franc was weak
The Swiss franc was also weak, because lower safe haven demand has hurt the Swiss franc. We suspected that currency interventions by the Swiss National Bank were behind the weakness in the Swiss franc. However, the increase in FX reserves is more or less reflecting the impact of the weakening of the Swiss franc on the SNB’s FX reserves. For example, around 50% of the FX reserves are denominated in euros and around 20% in US dollars. In February the Swiss franc weakened versus the euro and the US dollar resulting in an increase in FX reserves in Swiss franc terms.
The Canadian dollar was resilient
In the past week, the Canadian dollar (CAD) was resilient after the Bank of Canada outlook shifted from a dovish bias to more neutral. As a result, financial markets have priced out rate cuts this year, which is in line with to our view. Nevertheless, we expect any recovery in the Canadian dollar versus the US dollar to fade towards 1.2350 before easing to 1.27 later this year. This is supported by our view that both economic growth and monetary policy tightening bias in Canada will lag the US this year.
The Australian dollar also did relatively well
The Australian dollar (AUD) was also supported as the Reserve Bank of Australia (RBA) chose to keep the official cash rate at 2.25% (in line with our view), against market consensus of a 25bp rate cut. Nevertheless, we maintain our dovish view on the Australian dollar as we expect the RBA to continue its monetary easing cycle in April.
EM currencies under pressure
The Brazilian real was the weakest currency among our emerging market coverage. The political crisis has jeopardized the country’s fiscal adjustment. Financial markets continue to worry about the fiscal situation and inflationary pressures. In addition, inflation remains significantly above the central bank’s target and currency weakness is adding to the problem. Last but not least, the economic outlook is deteriorating, while the central bank continues to hike interest rates. On 5 March it raised interest rates by 50bp to 12.75%. The statement did not signal a bias for the next meeting though. Going forward, the Brazilian real will likely weaken further until the situation improves somewhat.
In Asia, the sentiment in the Chinese yuan improved after the People’s Bank of China poured cold water over market speculation that a wider currency trading band is imminent. As highlighted in our FX Watch – More bearish on Chinese yuan published on 11 February, we maintain our view that there is a case for the trading band to be widened from +/-2% to +/-3% as soon as the second quarter of this year. We also expect the yuan to decline to around 6.35 later this year.
On the other hand, the Indonesian rupiah broke the 13,000 level after Bank Indonesia signalled that it will tolerate a weaker currency. The central bank has also stated that a weaker exchange rate is needed to improve the trade balance and is unlikely to have a negative impact on the government’s budget. We have downgraded our 2015 and 2016 USD/IDR forecasts to 13,300 (from 13,000) and 13,700 (13,300) respectively given the central bank’s increased tolerance for a weaker currency.
The Indian rupee also underperformed after the Reserve Bank of India (RBI) cut the policy repo rate by 25bp in an unscheduled monetary policy meeting. We also suspect that the RBI has been intervening in the currency market to weaken the INR since the last quarter of 2014. Given that the INR has appreciated by more than 2% against its trade weighted basket of currencies since the second half of 2014, a weaker exchange rate is needed to support exports growth which has been weak. Our year end USD/INR target of 64 remains unchanged.