G10 FX Weekly – Rate hike expectation supports USD

by: Roy Teo , Georgette Boele

151105-G10-FX-weekly.pdf (210 KB)
  • USD extends gains on expectations of higher rates
  • AUD gains as RBA on hold and China growth outlook
  • SEK is the worst performer…
  • …and weak dairy prices and labour market weighs on NZD


USD extends gains as economic data firms; hawkish Fed comments

The US dollar (USD) strengthened against most major currencies because of expectations that the Fed could hike interest rates in December. This was because US economic data surprised on the upside and Fed members made hawkish comments. The expansion in the non-manufacturing sector accelerated in October. The new orders and employment sub index also rose. In addition, the trade deficit narrowed in September. Comments from Fed Yellen and Dudley that raising interest rates in December remain a ‘live possibility’ also supported the US dollar. At the time of writing, financial markets are pricing in almost 60% probability that the Fed will raise the Fed funds rate by 25bp at the December meeting, compared to 50% probability a week ago. It remains to be seen whether the pricing of an earlier rate hike negatively impacts sentiment and leads to a renewed tightening of financial conditions. Our base case is a hike will be delayed to 2016, but chances of an earlier move have risen. If US employment report surprises on the upside tomorrow, the upward momentum in the US dollar will become stronger.

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Australian dollar as RBA left OCR unchanged and China outlook improves

The Reserve Bank of Australia (RBA) decided to leave monetary policy unchanged at 2% earlier this week. The RBA stated that the inflation outlook may allow a looser monetary policy and that the AUD is adjusting to significant declines in key commodity prices. Nevertheless as financial markets were pricing in a 40% probability that the RBA will cut the Official Cash Rate (OCR) by 25bp on 3 November, the AUD rose to above 0.72. In addition, a narrower trade deficit in September and improving China outlook supported sentiment in the AUD. However, the trade deficit in the first three quarters of this year is more than twice the size of 2014. In addition, the expansion in the service sector for four consecutive months faltered, contracting in October at the fastest pace since December last year. The new orders and employment sub index also declined for the second consecutive month. We maintain our view that the RBA should step up monetary stimulus sooner than later to support the fragile economic recovery. The RBA is likely to lower their economic growth and inflation outlook in their next quarterly update on 6 November. Our year end AUD/USD forecast is 0.70.

Swedish krona worst performer…

The Swedish krona was most out of favour this week. The central bank (deputy Governor Per Jansson) signalled that it moves closer to FX interventions as it may exhaust other measures in its effort to boost inflation. As the prospect of further quantitative easing by the ECB has clearly increased, the Riksbank tries to neutralise the spill-over effects. We expect further monetary policy easing in the form of more quantitative easing, a lower repo-rate path, further rate cuts or a combination of these. As a result, there will be downward pressure on the krona. Our target for EUR/SEK for the end of this year is 9.5.

…and weak dairy prices and labour market weigh on NZD

The New Zealand dollar (NZD) declined by about 2 cents to below 0.66 in the past week as dairy prices declined for the second consecutive auction. In addition, employment in the third quarter declined by 11k, the first quarterly fall in three years. We maintain our view that the Reserve Bank of New Zealand is likely to lower the OCR by 25bp to 2.5% next month. This is not fully priced in by financial markets. In our view, the NZD is likely to ease lower to around 0.64 by the end of this year.

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