– AUDUSD up slightly to 1.074 amid muted price action
– Canadian Ivey unlikely to provide strong support for CAD
– ECB is likely to signal a July hike at Thursday’s meeting
What to watch for today
CAD: Stronger Ivey. Our economist expects to see a moderate recovery in the seasonally adjusted headline Ivey index to 59.5 after the sharp decline last month. This would leave the Q2-to-date average still running below Q1 and consistent with slower Q2 growth. The Bank of Canada signaled last week that it might need to begin tightening policy at some point, but data in line with our expectations would put little pressure on the bank to move soon. We see scope for USDCAD to trade back through 0.95 in the weeks ahead as US slowdown fears fade but see little scope for extended downside below that level.
What to watch for this week
EUR: ECB to signal a July hike. We expect ECB President Trichet to signal a July rate hike at this Thursday’s press conference, using the “strong vigilance” language. The OIS market is fully priced for a 25bp hike in July. However, even as preparations for policy tightening continue, we would not look for the ECB to take steps to reduce liquidity assistance to peripheral banking systems. We expect the ECB to announce a new set of fixed-rate, full-allotment, three-month repo tenders for the third quarter. The ECB will release updated forecasts for the euro area and our economists expect to see growth and inflation forecasts revised higher. We remain bullish on the EUR heading into this meeting and continue to look for EURUSD to reach 1.52 in Q3.
In data, Germany releases orders and production numbers on Tuesday and Wednesday, respectively. Our economists expect orders to have rebounded sharply in April from the sharp decline in March but look for industrial production growth to slow to 0.5% mom, the slowest pace in four months and consistent with the Q2 moderation in other major economies.
GBP: Production slowdown. Our economists expect a sharp moderation in UK April industrial production (data due out Friday). While the earthquake-related supply chain disruption and the extra bank holiday will be a big part of the story here, the data will still likely be viewed as diminishing prospects for an August policy tightening. Our UK economics team has pushed back their expectations for Bank of England policy tightening to November from August in this week’s Sterling Investor. The Bank of England meets on Thursday, but with no prospect for any change in policy, we will need to wait for the minutes in two weeks for insight into how committee views are evolving. We maintain our forecast for the GBP to weaken to 0.91 vs. the EUR.
USD: Fed speeches to dominated the data. With monthly data flow limited to April trade and consumer credit numbers, markets are likely to focus on speeches by Fed Presidents Dudley and Plosser on Monday and Fed Chairman on Tuesday. In data, weekly jobless claims are the highlight with our economists forecasting 410k, an improvement from the spike in late April and the best week since 15 April. We expect markets to grow increasingly comfortable with the idea that May marked a trough in the Q2 slowdown. We remain short USD vs. the EUR, AUD, and MXN in our cash recommendations portfolio, expecting the USD to lose ground broadly as risk appetite improves.
CHF: More disinflationary pressure. Our economists forecast Swiss headline inflation to ease further to 0.1% yoy in May, from 0.3% yoy in April, below the consensus forecast of 0.3% yoy (data due out Tuesday). We don’t see this affecting the CHF directly, but it should retard the market from trying to price for Swiss National Bank policy tightening any time soon. Our VARex model for Swiss policy rates suggests that with the CHF at current levels the SNB would need to begin signalling policy rate hikes only in Q1 2012. We recently lowered our three- and 12-month EURCHF forecasts to 1.26 and 1.30, respectively, from 1.34 and 1.41.
CAD: A slow month for jobs. We expect to see jobs growth slow to 10k for May from the strong 58k reading in April (data due out Friday). Our estimate is below the +20k consensus. Our economist notes that he expects last month’s surge in service sector hiring to give way to a correction this month, leading to a more modest showing. Limiting the downside should be hiring for the 2011 Census, although these jobs are temporary and in the public sector, not the more cyclical private sector. The data will leave the Bank of Canada under little pressure to resume policy tightening, despite the slightly more hawkish message sent in last week’s policy statement. We remain neutral on USDCAD at these levels and, while the pair should be able to trade back through 0.95 as US growth fears fade, we see limited downside below that level.
JPY: An upward GDP revision thanks to inventory. The second release of Japan Q1 GDP should show an upward revision to -3% qoq annualized from the initial estimate of -3.7% qoq annualized (data due out Thursday). Our economists note that the MoF’s corporate survey suggests a 4% increase in inventories in Q1, in contrast to preliminary GDP estimates showing a net negative inventory effect. Despite the inventory effect, we have raised our estimates for Q2 GDP to flat from -1.3% qoq annualized. However, we expect strong acceleration in industrial production through June, contributing to our bullish view on global IP and risk appetite heading into the summer.
AUD: Hawkish Reserve Bank of Australia. The probability of a rate hike at the next RBA meeting on Tuesday remains low, but we expect the RBA to at least keep its hawkish tone and possibly signal a rate hike in July or August. Stronger retail sales and the surge in household income in the GDP report suggest that the consumer restraint that helped contain inflation late last year and in Q1 might soon start to wane. We see at least some risk that the recent weakness in global data could lead the RBA to remain non-committal on future policy action. But with the market pricing only a 50% chance of a 25bp hike by the August meeting, we doubt this would be decisive for AUD direction. In other data, the consensus forecast for employment is for a 25k gain after the very weak -22k print in April. We remain bullish on AUDUSD targeting 1.10 in three months and retain a long recommendation in our cash recommendations portfolio.
NZD: RBNZ on hold, positive tone on domestic development. We expect the RBNZ to keep the policy rate unchanged at 2.5% at Thursday’s meeting, in line with consensus forecasts. Recent data leading to the RBNZ meeting has shown encouraging signs of further recovery. In particular, the business activity outlook, which is a good leading relationship to GDP, has now risen above the level before the February earthquake. Furthermore, measures of inflation expectations have crept up, including the RBNZ’s own two-year inflation expectations series, now at 3%, from 2.6% previously. This could cause some concerns for the RBNZ given its previous assessment that medium-term inflation expectations were well anchored and suggests a risk for a hawkish development in the statement.
Nonetheless, we think the RBNZ will balance these upside risks to inflation against the background of recent sharp appreciation of the NZD and softer-than-expected growth prospects amongst main trading partners. We remain bearish the NZD against the AUD at current levels as we think the market has priced in a near-perfect recovery for the New Zealand economy with close to a 70% likelihood of a December rate hike. Our rate strategist expects the first RBNZ hike only in Q1 2012 while he thinks the Reserve Bank of Australia (RBA) could raise the policy rate by August this year. We acknowledge, however, that the scope of a sustained appreciation in AUDNZD is increasingly limited as we approach the September Rugby World Cup. Tourist income inflows into NZD are likely to rise substantially in the run-up to the event, keeping the NZD supported. In this respect, our current three-month AUDNZD forecast of 1.38 may look too stretched.
PLN: A hike is more likely in July than June. Our economist forecasts that the Polish MPC will raise the policy rate once again by 25bps to 4.50% within the next three months, but more likely at the 5-6 July meeting than at Wednesday’s meeting. The consensus forecast is for a 25bp hike and an unchanged policy will likely push EURPLN higher temporarily. However, we believe that strong growth momentum and the government’s FX conversion policy should continue to support the zloty, particularly as the euro zone periphery concerns subside and risk appetite improves. We remain bullish on the zloty, targeting EURPLN at 3.8 in three months.
TWD: Still tame inflation. Our economist forecasts that Taiwan’s CPI inflation edged slightly higher to 1.4% yoy in May from 1.3% yoy in April, below the consensus forecast for 1.6% yoy (data due out Tuesday, Exhibit 1). A still tame inflation outlook and CBC’s concern over the outlook for exports (data due out Wednesday) suggest that USDTWD downside is limited near term, in our view. Our economist forecasts that export growth slowed to 11.5% yoy in May, from 24.6% yoy in March. A narrowing of the trade surplus will make it easier for CBC to manage the USDTWD on a slow and controlled down move.
PHP: Rising inflation. CPI inflation likely jumped to 4.9% yoy in May, slightly lower than the consensus forecast for 5.0% yoy (data due out Tuesday, Exhibit 2). A spike in inflation to the top of BSP’s 3-5% target range will increase the likelihood of the central bank continuing to hike rates 25bp at its policy meeting on 16 June. But our economists expect exports to remain sluggish and to fall 9.5% mom in April (data due out Friday). Monetary policy is unlikely to be supportive of the peso, as we think the BSP is unlikely to tighten onshore liquidity and lift peso interest rates even if it hikes policy rates.
IDR: On hold. We expect Indonesia’s central bank (BI) to keep its policy rate unchanged at 6.75% on Thursday, in line with the consensus forecast. The moderation in CPI inflation to 6% yoy in May from 6.2% yoy in April allows BI to pursue a gradual policy tightening without hurting portfolio inflows. BI has stated that it will allow some IDR appreciation, as it helps to curb imported inflation. We remain bullish the IDR and continue to target USDIDR 8,400 in three months.
KRW: No change. Our economist forecasts Korea’s central bank (BoK) will maintain the policy rate at 3.0% on Friday. The recent moderation in CPI inflation just above BoK’s 2-4% has made Friday’s decision difficult to forecast. Bloomberg consensus is evenly split between a 25bp hike and unchanged policy stance. We believe the more sanguine inflation outlook has reduces the urgency for the BoK to use won appreciation to manage inflation. We remain of the view that the BoK will continue to use a mix of FX intervention and tighter capital controls to counter rapid moves below 1,070 and to limit won volatility.
CNY: Larger surplus. Imports likely fell 8% mom pushing China’s trade surplus to $28.7bn in May from $11.4bn in April (data due out Friday), on our estimates. If in line with our estimates, markets will likely be concerned that the slowdown in China is leading to a decline in Chinese demand for imports and will likely be negative for growth-sensitive currencies like the AUD.
INR: Further signs of slowing growth. Industrial output, out Friday, probably fell to 4.8% yoy in April from 7.3% yoy in March, reversing the improvement in March. We believe that the current mix of still rising WPI inflation and further policy rate hikes presents risk to already slowing GDP growth at a time of weak global risk sentiment. This is likely to weigh on portfolio inflows and in turn the rupee, in our view.
What happened overnight
The pace of USD selling has slowed in Asian trading. Price action has been subdued as the North Asian markets (China, Hong Kong, Korea and Taiwan) are closed for a bank holiday. EURUSD is holding on to last Friday’s gains around 1.464 while USDJPY is steady around 80.3. AUDUSD is just off last Friday’s peak of 1.0771 despite mixed Australian data. Inflation as measured by TD Securities fell to 3.3% yoy in May from 3.6% yoy in April but still above the RBA’s 2-3% target range. Job advertisements fell 6.5% mom in May, but we note that this is only the second decline in 13 months and can be quite volatile. Asian currencies only made slight gains vs. the USD, likely weighed by US growth concerns with equities down broadly by 0.3-0.8%.
In Portugal the Social Democratic Party (PSD) seems to have won a strong mandate in elections over the weekend. According to Reuters news, the PSD won 105 seats in the 230-seat parliament and is expected to form a majority coalition government with the conservative People’s Party (CDS-PP), which won 24 seats. The ruling Socialist Party only won 73 seats, 24 less than at the last election. PSD Chief Passos Coelho pledged after the results that he will honour the terms of the €78bn EU/IMF bailout.
This should make markets more optimistic about Portugal and, combined with the contours of the new financing package for Greece announced on Friday, a bit more constructive on EURUSD, in our view. A strong mandate for the PSD should reduce the risk that the new government struggles to implement Portugal’s fiscal consolidation and reform programme. The PSD is a centre right party that broadly supports fiscal consolidation and has said that it would speed up privatization plans and extend austerity plans beyond the terms of the EU/IMF bailout.
US growth to pick up in July. Our US economists argued in their new report that the rebound in the ISM Non-Manufacturing Survey in May reaffirmed their expectations of a “speed-up” in US growth in July. This should pave the way for a first step towards Fed policy normalization within six to nine months but actual Fed policy rate hikes are still over a year away.
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