G10 FX Weekly – Overall dollar weakness

by: Georgette Boele , Roy Teo

G10-FX-weekly-15-October-2015.pdf (144 KB)

US dollar weakness as rate hike expectations fade
Dollar to recover once Fed rate hike this year is priced out…
…but we expect a relatively modest US dollar recovery for the coming months
NZD strength to increase RBNZ dovish bias


US dollar weakness as rate hike expectations fade

Most currencies have profited from a weaker US dollar in an environment of better investor sentiment. Weaker US data (retail sales) and mixed comments from Fed officials are considered as good news, because they have lowered the likelihood of the US Federal Reserve hiking this year. As a result, bad news is considered as good news and this is supportive for currencies other than the US dollar. Indeed, since the weak US payrolls print on 2 October, the US dollar has declined by more than 2% against its trade weighted basket of currencies, according to BIS metrics.



Dollar recovery once Fed rate hike this year is priced out…

Based on Fed funds futures, financial markets are pricing in less than 30% probability that the Fed will raise the Fed funds target rate by 25bp in December 2015. Last week we changed our view that the Fed would delay its first rate hike to 2016. It is likely that EUR/USD in the near-term will continue to move higher in wake of the pricing out of a possible Fed rate hike this year. Once this has happened the US dollar has room to recover. However, the recovery in the US dollar we expect at the start of next year is relatively modest. The EUR/USD will probably only start to fall again more convincingly during the course of next year when Fed rate hikes approach.
NZD strength to increase RBNZ dovish bias
The New Zealand dollar (NZD) has strengthened to the highest level since early July. The positive sentiment was supported by the government announcing a budget surplus versus a deficit forecast. In addition, house price inflation remains strong, providing less flexibility for the Reserve Bank of New Zealand (RBNZ) to lower monetary policy further. The manufacturing sector and consumer confidence also improved. Nevertheless, we expect the RBNZ to increase their dovish tone on the recent strength in the NZD given that the NZD trade weighted index is about 7% stronger than the RBNZ year-end forecast. A stronger NZD will weigh on inflation and increase the divergence with key commodity export prices. In our view, a combination of rate cut (forecast in December 2015) and intervention to weaken the currency are likely options the RBNZ will take. We expect the NZD/USD to decline to around 0.64 by the end of this year.