What happened overnight
– Japanese authorities intervene aggressively in USDJPY
– Chinese official downplays scope for G20 to discuss funds for Europe
– Italian 10-year bond yields back above 6%
– Norway announces upsized daily FX purchases
The USD is broadly firmer, most notably against the yen after the Bank of Japan intervened for the first time since early August. USDJPY rallied from new historic lows ahead of the intervention to highs of 79.53 before drifting back below 78. Pressure on yen crosses undermined other G10 currencies, and renewed deterioration in euro zone dynamics added to selling pressure on the EUR. EURUSD has extended its retreat from Thursday’s 1.4247 highs to lows this morning around 1.3975, while AUDUSD has slipped back to 1.0507 lows. Italian bond yields remain under upward pressure despite reports of ECB buying, with the 10-year trading up 10bp to new highs around 6.1% this morning and the European bank shares index is down 3%.
The Bank of Japan entered the market around 1:30 GMT and buying has been described as very aggressive, with large bids left in the market after active purchases ended. Exporters have been aggressive sellers, but the government was bidding in very large size we estimate very roughly that intervention may be in excess of $50bn, equivalent to roughly 6 months of accumulated current account surpluses and probably the largest intervention ever.
Profit taking in short JPY crosses pushed EURUSD and AUDUSD lower to 1.401 and 1.053 respectively and most of USD-Asia higher. We expect these moves to be temporary, particularly in EM Asia. We see little change to Asian FX policy in response to the yen intervention. The continuing improvement in the global macro cycle is the more important development, in our view. In particular, we are focused on whether the US ISM rises again in October which would signal August marked a trough. Asian currencies have historically appreciated in the two tot three quarters following troughs in the US ISM, led by the KRW and the IDR. For details, see our 12 October 2011 report Returning to Asian FX – trade with the central banks.
USDJPY will trade back down to at least 75-76, in our view. Today’s intervention came after a new intra-day low just below 75.50 on USDJPY, but was not a new high or critical level on JPY trade-weighted indexes. Tempting as it may be to argue the government wants to defend the 75-76 level, one would have said 76-77 in response to the August intervention, yet the government allowed 76 to break and has not pushed it back above 80.
We doubt Japan will establish a floor under USDJPY akin to the Swiss floor under EURCHF. We think this would be politically unacceptable globally. Japan is the world’s fourth-largest exporter, accounting for 4.6% of global exports versus Switzerland’s #21 position with only 1.4% of global export market share. Most important, a Japanese floor would create a powerful precedent for the rest of Asia, something both the US and Europe are loath to see. Unlike the CHF, the JPY is not trading at very rich levels relative to most equilibrium fair value models.
Fundamental pressure for JPY appreciation remains solidly intact. Japan’s trade balance surprised strong in September and is likely to return to a small surplus over the next several months. However, recycling this surplus out of yen should remain unattractive for Japanese investors given both the Fed and the ECB are likely to ease over the next couple of quarters. See our 20 October 2011 FX Strategist, Weekly Update: Revisiting the yen – please recycle for details.
Two other key points stand out. If the Japanese government commits to buying EFSF bonds at the coming G20, it may rapidly be, albeit temporarily, a EURUSD buyer, perhaps taking the other side of Swiss National Bank selling of EURUSD. More generally, with two G10 central banks intervening in size, the broad FX market seems even more a function of reserve diversification.
Before the JPY intervention, China’s central bank fixed USDCNY 57pips lower to 6.3233. We note that the recent lower USDCNY fixes have come in an environment of USD weakness. It is easier for the Chinese government to appreciate the CNY against a depreciating USD. We remain short USDCNY one-month NDF in our cash recommendation portfolio.
Meanwhile, in Europe sentiment has taken a turn for the worse again this morning. Comments from Chinese officials over the weekend that funding for Europe would not be on the G20 agenda got some of the blame for the turn, but the main source of concern is likely the continued grind higher in Italian government bond yields. With the ECB unwilling or unable to contain yields in sustainable ranges, risks are rising that we begin to slip back into an environment of significant systemic stress.
On the data front, European inflation was flat at 3%yoy in October, a touch above consensus. Our economists think inflation is likely to have peaked at this level and price pressures should ease in the coming months. This supports our expectation for the ECB to turn more dovish and to start preparing the ground for rate cuts this Thursday.
UK data showed foreign buying of gilts in September rose the most since April 2010. Despite the prospect of BoE resuming QE, foreign investors bought ?12bn of gilts. The data confirms the extent to which the euro sovereign crisis and the search for AAA alternatives has limited outright flight from GBP. We expect EURGBP to be capped around 0.89-0.90, close to the upper two-standard deviations limit for both our fair value model and short-term model based on interest rate spreads.
In other UK data, M4 excluding intermediate OFCs rose 0.2%mom in September after a 0.4% rise in August. While consumer credit improved in September, both lending secured on dwelling and mortgage approvals remain weak.
The Swiss National Bank published its September balance sheet, providing more tools to gauge the extent of intervention after establishing the cap. We estimate that during the month of September, the SNB bought around CHF 12bn in the FX spot market amid efforts to establish the 1.20 floor under EURCHF. We believe most of the purchases happened on the 6th September when the SNB announced the EURCHF floor. The estimate has taken into consideration of the valuation effect due to currency fluctuation, as well as the amount of FX forwards / swaps the SNB rolled off during September. The SNB also reported a profit of CHF 5.8bn for the first three quarters of 2011. We note that the profit can be largely attributed to high valuation gains on SNB’s holding (1) gold and (2) fixed interest rate investments, whilst the appreciation of the Swiss franc contributed negatively to the SNB’s P&L during the period.
Norges bank scaled up daily FX purchases for the Global Pension Fund to NOK 1.6bn per day in November. The flow is NOK negative and is significantly above the average daily purchase of NOK 560mn since 2004 and NOK 550mn in October. The increase reflects reduced need for domestic spending of energy revenues and/or an increase in energy related receipts by the government, and is not a reflection of policy preference for a weaker NOK. Still, the flows should help contain NOK gains. We remain neutral on NOK, targeting 7.80 in coming months. On the data front, retail sales fell 0.5%mom in September, weaker than consensus for a modest 0.2%mom rise after a strong gain in August.
Singapore’s Q3 unemployment rate fell to 2.0%, lower than the 2.1%mom Q2 and the consensus forecast of 2.3%. This suggests higher wage pressure if Singapore’s growth prospects improves. Also, loan growth rose to 31.1%yoy in September from 29.7%yoy in August. We expect inflation to stay above 5% for the rest of the year and only ease slowly to mid-4% in Q1 2012. Singapore’s central bank is likely to keep the SGD nominal effective exchange rate (NEER) on an appreciating path. We estimate that the NEER is currently trading 0.1% above the middle of the policy band and thinks it can rally another 1%. This implies USDSGD at 1.239 assuming that the other currency pairs in the basket remain unchanged at current levels and makes today’s pop higher to 1.2508 an attractive level to sell, in our view.
Korea manufacturing rebounded in September, but the outlook is softer. Industrial production gained 1.1%mom in September after two consecutive monthly falls. However, the manufacturers business confidence fell to a 27-month low of 82 in November. We think the recent stabilization of US leading indicators should provide some support for Korea’s industrial output and export. We also note that the KRW tends to outperform other Asian currencies when the US ISM had based and starts to recover.
Taiwan GDP growth slowed to 3.4%yoy in Q3 from 5.0%yoy in Q2, largely in line with the consensus forecast. With the export and manufacturing sector still weak, we think Taiwan’s central bank is likely to resist aggressive TWD appreciation
What to watch for today
CAD: Softer growth. Our economists forecast that August GDP rose 0.1%mom, below the consensus forecast of +0.2%mom and +0.3%mom in July. Data in line with our expectations would support the Bank of Canada’s more cautious approach implied in last week’s policy statement, but it would not prevent CAD from reacting positively to stronger US data. Based on expectations of a dovish FOMC and improved data in the US, we expect USDCAD to drift lower in the near term.
USD: Chicago PMI. The consensus forecast is that October Chicago PMI fell to 59.0 from 60.4 in September. With the ISM and NFP due later in the week, we would expect limited impact from the Chicago PMI data.
What to watch for this week
The rest of the week features the ECB’s policy meeting under a new president, a two-day FOMC meeting, Australia’s central bank policy meeting, key PMIs, and US employment data. Just to make sure the week is not boring, the G20 meets in Cannes on Thursday! We expect an RBA cut, dovish Fed language, a chance of a more pragmatic approach to supporting euro area activity from new ECB President Draghi and a stronger US ISM.
PMI roundup – softer. Manufacturing PMI data are due out on Tuesday in China, Switzerland, Sweden and Norway. The consensus forecast is for a small 0.6pt rise in the Chinese PMI to 51.8 but for a deterioration in the other indicators. Switzerland’s and Sweden’s PMIs are expected to print below 50. In the case of Switzerland, the softer PMI would further justify the SNB’s accommodative policy. PMI data will also be important for the SEK as the Riksbank has become increasingly data dependent and lowered its forecasts for inflation and growth outlooks in the latest monetary policy statement.
USD: Stronger ISM, softer payrolls, and more guidance from the Fed. Our economists think the FOMC is likely to indicate it will make future policy decisions more contingent on the progress towards its inflation and employment objectives. Recent statements by FOMC officials suggest to us that the Fed is open to a new round of asset purchases. Our economists believe QE3 is possible before “operation twist” is completed, in June 2012. The FOMC statement will be released at 12:30 EDT, followed by a press conference with Fed Chairman Bernanke at 14:15 EDT. See US Economics Digest – FOMC Preview: The Never-ending Story.
The US manufacturing ISM is likely to inch higher from 51.6 to 52.0 on Tuesday, in line with the consensus forecast. We expect 53.5 on the ISM non-manufacturing on Thursday, a tenth below the consensus. Our economists forecast an 85K rise in non-farm payrolls, weaker than the 95k rise the consensus expects and down from 103K in September. Overall the data should further our expectations that the economy will avoid a recession. Our economists estimate the probability of a recession now at 30%, down from 36% in September (see US Economics Digest – Recession Probability Update: Waiting to Exhale; Poised for Speed-Up Scare).
EUR: ECB to turn dovish? Our economists see a chance that new ECB President Mario Draghi will use the press conference and following Q&A session to prepare markets for a December rate cut (European Economics – Mario to the rescue?). This break from the ECB’s traditional cautious approach would likely have a positive impact on risk appetite, in our view. In the absence of a stronger commitment to the peripheral bond purchase programme, however, we expect limited impact on EURUSD.
On the data front, we expect German factory orders (Friday) rebounded by 1%mom in September after two consecutive monthly falls.
CAD: Soft data offset by US growth expectations. Our economists forecast employment (Friday) rose 5.0k in October and the unemployment rate rose from 7.1% to 7.2%. We also expect a softer Ivey PMI on Friday at 54.0 in October, down from 55.7 in September. While data in line with our expectations would reduce rate support for CAD, we expect the repricing of US growth expectations higher to offset domestic factors, driving CAD appreciation. We are short USDCAD in our cash portfolio with a 0.95 target.
AUD: Rate cut likely. Our Australia interest rate strategist, Jarrod Kerr, expects the Reserve Bank of Australia (RBA) to cut 25bps on Tuesday. The OIS market is pricing an 85% probability of a cut while the Bloomberg survey shows 15 out of 26 economists expecting the RBA to ease. Downward revisions to inflation and growth forecasts in Friday’s Statement of Monetary Policy are also likely. However, better data out of the US, solid growth in China and stronger global risk appetite argue against a 50bp cut or a signal of continuing dovishness. As such, we do not foresee a large negative impact on AUDUSD.
GBP: Better than expected Q3 GDP growth, but still weak. Our economists expect GDP rose 0.5%qoq in Q3, stronger than the 0.3%qoq consensus forecast, after an unusually weak Q2. We remain bearish the GBP but have turned more cautious in expressing further QE risk through GBPUSD shorts, given renewed USD selling pressures. We continue to hold option structures geared towards GBPCAD downside in our derivative portfolio.
NZD: Strong labor force survey. The consensus forecasts a solid reading in NZ Q3 employment and private wages, +0.6%qoq and +0.9%qoq, respectively, boosted by hiring during the Rugby World Cup. This should help bring the unemployment rate a touch lower to 6.4%, roughly in line with the RBNZ projection. As systemic fears over euro area crisis subside, we see scope for NZD to sustain the rally against the USD in the near term.
CZK: On hold. We expect the Czech National Bank to keep rates on hold on Thursday, in line with the consensus forecast. The PMI should moderate further following the weak flash October PMI print in Germany. CZK is likely to strengthen on euro zone’s policy progress, in our view, but given heavy exposure to faltering growth in Europe, we do not expect larger gains.
KRW: Slower inflation and weak exports. We expect CPI inflation fell slightly to 4.2%yoy in October from 4.3%yoy in September, in line with the consensus forecast. Trade data in October are likely to be sluggish, with export growth moderating to 10.6%yoy from 19.6%yoy in September. However, the recent recovery US ISM is likely to exert further KRW appreciation pressure even though the Bank of Korea is likely to keep the pace gradual.
IDR: Tame inflation, robust exports. We expect CPI inflation moderated to 4.5%yoy in October from 4.6%yoy in September, much lower than the consensus forecast for 4.8%yoy. Export growth likely rose to 40%yoy in September, supporting a widening in the trade surplus to $4.5bn. In addition, we note that the IDR tends to outperform other Asian currencies after the US ISM has troughed.
INR: Narrowing trade deficit. We expect import growth slowed to 28%yoy in September, helping to drive a narrowing of the trade deficit to -$9.8bn from -$14.0bn in August. This suggests less portfolio inflows are required to finance the current account deficit and should support a further rally in the INR. Given the recent recovery in risk sentiment and the RBI signaling that the current rate hiking cycle may be over, we should see renewed interest in portfolio inflows into India.
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Credit Suisse
FIXED INCOME RESEARCH & ANALYTICS
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