G10 FX Weekly – Fed outlook supports USD

by: Roy Teo

  • US dollar gains after hawkish Fed comments
  • AUD strengthens after RBA less dovish on the exchange rate
  • Sentiment towards the NZD remains bearish
  • Downward revisions in CAD forecast






US dollar gains after hawkish Fed comments

The US dollar (USD) outperformed other major currencies after Atlanta Fed President Lockhart, a centrist among FOMC members, said that it would take a significant deterioration in economic data to convince him not to vote for a rate increase in September. Indeed we expect the next two US non-farm payrolls to convince the FOMC to raise the Fed funds target range by 25bp to 0.25-0.50% next month. As the Fed funds futures is only pricing in about 50% probability of a 25bp rate hike, we expect further gains in the USD in the coming months.


AUD gains after RBA less dovish on the exchange rate

The Australian dollar (AUD) bucked the trend among major currencies, rising by almost 1% after the Reserve Bank of Australia (RBA) sounded less convinced on the need for further depreciation of the exchange rate. The RBA stated that the AUD is adjusting to the significant declines in key commodity prices, leaving out its previous comment that further depreciation in the currency seemed both likely and necessary. We think that the recent 20% recovery in iron ore prices in the past month has provided some comfort that the gap with the exchange rate has narrowed. As financial markets have priced in about a 10bp of rate cuts by the end of this year, failure to reduce rates would support the AUD. However, we expect the Australian economy to grow at a below trend rate in the coming two years and house price inflation to moderate. As such, further monetary stimulus is still likely. We maintain our year end AUD/USD forecast of 0.70.


NZD slides as dairy prices and labor market deteriorates

The New Zealand dollar (NZD) declined by more than 1% to around 0.65 after dairy prices extended their slide in the recent auction. The terms of trade shock due to the 50% plunge in dairy prices since March is only partially mitigated by a 15% decline in the NZD. In addition, the unemployment rate has been edging higher in the past year. Though speculators’ short futures positioning in the NZD is overcrowded and weekly technical indicators imply that the NZD is in oversold territory, we expect the bearish sentiment in the currency to persist until the next monetary policy meeting on 10 September. We expect the Reserve Bank of New Zealand to lower the Official Cash Rate by 25bp to 2.75%. Another insurance rate cut of 25bp later this year is increasingly likely. Hence there are downside risks to our year end NZD/USD forecast of 0.63.


Downward revisions in CAD forecast

We have become more bearish on the Canadian dollar (CAD) and now expect it to decline further towards 1.36 against the USD later this year (compared to our previous forecast of 1.32). Economic growth in May slowed more than expected to 0.5% yoy, the slowest pace since December 2009. In addition, we are less optimistic on the recovery in oil prices as highlighted in our recent Energy Monitor (‘Further fall in oil prices on oversupply concerns’ published on 30 July 2015). Since the Bank of Canada (BoC) lowered the overnight lending rate by 25bp on 15 July, the Western Canada select (WCS) crude oil price (benchmark price for heavy oil produced in Alberta) has dropped by another 25% and is at the lowest level since early 2009. The WCS has plunged by almost 70% since June last year compared to 25% decline in the CAD. Though the trade deficit narrowed in June, we expect it to widen again as the fall in energy exports value outweigh the recovery in non-energy exports. Consumer confidence is expected to deteriorate further, resulting in weaker retail spending. We expect the BoC to cut interest rates by 25bp in the next monetary policy meeting on 9 September. This is to provide further insurance to the economy ahead of elections on 19 October. This is not fully priced in by financial markets.