Commodity currencies well placed to benefit post-FOMC
The FOMC statement overnight was rather dovish and should see the USD sell off versus the commodity currencies. The announcement has seen nominal yields declining even as inflation expectations move higher. This has resulted in US real yields moving more in the negative; since late December, 5Y real yields (5Y US treasury yield minus TIPS) has declined from -65bps to -95bps at present. Such an outcome has led to a broad based USD sell-off in the past, though it has been emphasised against the commodity FX block. We see a similar situation this time around, but underline that this should not apply to EURUSD. With Greek PSI+ risks far from being resolved (more below), the rally in EURUSD will likely be limited to the 1.3200-1.3250 area. With USD/Asia in particular looking soft and with our Asia based strategists expecting higher CNY fixings as China returns from the lunar holidays next week, the AUD seems well placed to benefit near term. This especially so with the recent firmer than expected core-CPI data having reduced expectations of a RBA rate cut next month. However, CAD has lagged the commodity complex severely over the past month, and we think the CAD should play catch up especially with the Bank of Canada having moved to a more neutral policy bias. Bigger picture, we should see the commodity currencies outperform against both the USD and EUR.
Fed as dovish as could be barring a QE3 announcement
The FOMC issued an unambiguously dovish post-meeting statement making clear that rates were going nowhere before late 2014 at the earliest. Any reference to inflation concerns was dropped, the recent improved US data flow was all but ignored (instead weakening in business investment was emphasised) and the Fed evidently remains disposed to further securities purchases. Our US economists’ interpretation of the statement is that the barrier to additional QE is very low – the economy will have to outperform current expectations to prevent it, rather than underperform current forecasts to justify it. The dollar took its cue from the fresh bull flattening in the Treasury curve and fall in swap rates (See chart). The Staff Economic Projections published 90 minutes after the FOMC statement saw the dollar pare losses, on the revelation that only 6 of the 17 FOMC members project 2015 or later for the first Fed rate hike. This doesn’t mean that the ‘late 2014’ date won’t get pushed into the future at a subsequent FOMC meeting, but the bell curve of forecasts (albeit representing all FOMC voters, not just current voters and who are a more dovish sub-group than the entire FOMC) failed to provide the pretext for an immediate fresh leg lower in all things USD.
Euro zone backdrop remains troublesome; EURUSD will lag behind
Meanwhile, the euro backdrop remains troublesome and headline risk still runs high. We are evidently still a long way from a Greek deal that would allow the troika to project a 120% debt/GDP ratio by 2020 with any degree of confidence. The spat between the IMF and ECB over whether the ECB should participate in haircuts on Greek government bond
holdings is now public. BNP Paribas’ chairman Baudouin Prot made clear in a Reuters interview that the offer now on the table is the ‘maximum acceptable’ for a voluntary (bond swap) deal with banks. Contagion risk from Greece to Portugal is becoming more evident (5yr Portugal-German sovereign spread blew out by a further 75bp on Wednesday). For these reasons, we continue to expect EUR-crosses to remain under pressure multi-week even though the EURUSD could continue to retrace higher, though gains above the 1.3244 big retracement level should prove difficult.
BNP Paribas