G10 FX Weekly – Dollar recovery ahead

by: Georgette Boele , Roy Teo

  • Government bond developments support the euro…
  • …while the US dollar sell-off continues
  • Conservative win boosts sterling

Government bond developments support the euro…

In general, expectations about monetary policy have an important effect on currency behaviour. However, since March, developments in bond markets have claimed a leading role. Initially, the 10y spread between Germany-US and EUR/USD moved lower. In April, the recovery in EUR/USD has coincided with higher spreads, especially for the last two weeks. The euro is a very rate sensitive currency. So more favourable yield spreads are supportive. This has happened in an environment of an overall improvement in investor sentiment. The rally in EUR/USD lost momentum around 1.14, where earlier peaks were set (in February). We expect EUR/USD to decline below 1.10 again on positive surprises of US economic data and less favourable spreads and/or monetary policy developments for the euro.


…while the dollar sell off continues

The US dollar remained under pressure up to the release of the US initial jobless claims report on Thursday. The stronger-than-expected jobless claims supported the dollar. In contrast, Friday’s non-farm payrolls report had no significant impact, as job growth was strong, but average earnings were a bit weaker than expected. For a rally of the dollar to continue, US economic data need to surprise positively in the weeks and months ahead. It is likely that these will trigger an upward adjustment in Fed rate hike expectations for this year and next year. In addition, bonds spread movements will probably become more dollar friendly.

Conservative win boosts sterling

Sterling outperformed other major currencies following the results pointing to an outright Conservative majority in parliament. This came as a complete surprise as polls had suggested that no party would win a majority. With political election uncertainty now behind us, sterling rallied strongly across the board. Going forward, the pace of fiscal consolidation will probably be almost 5% GDP during the next government period. The Conservatives rely largely on spending cuts. Finally, the Conservatives promised that they would hold a referendum on whether the UK should stay in the EU by 2017. In the long term, an in-out referendum would be a negative for UK assets.

Mixed commodity currencies

Firmer oil prices supported oil exporting currencies like the NOK and CAD. Despite the RBA delivering a 25bp rate cut earlier this week, the Australian dollar recovered due to market speculation that the monetary easing cycle in Australia has paused. We do not think this is likely and continue to expect a 25bp rate cut in the third quarter of this year. As this is not fully priced in by financial markets, we remain bearish on the AUD. The NZD underperformed as financial markets priced in that the RBNZ will cut interest rates later this year. This was triggered by weaker than expected employment numbers.