– Weak USD view intact on Fed move, but fiscal cliff anxiety could slow the move
Following yesterday’s big Fed announcement, the boost to risk sentiment has tapered off somewhat (stocks mixed in Asia and Europe) while the USD has retraced most of its losses seen post the FOMC announcement, with EURUSD and AUDUSD closer to 1.3040 and 1.0540 respectively. We think that market reaction has been somewhat suspended given the resolution of the US fiscal cliff negotiations. Yesterday’s late session move lower in the S&P 500 was linked to Bernanke’s press conference where he admitted the Fed would not be able to counter the negative implications of going over the cliff. In the near term, continued tensions between the House Republicans and Senate Democrats (Boehner yesterday said “serious differences” exist with Democrat proposals) could slow the pace of USD weakness. However, the direction remains clear and an eventual compromise (closer to Christmas) should pave the way for the USD to sell-off more aggressively heading into 2013. Given the Fed’s more explicit guidance via quantitative targets (more below), the market reaction to today’s US data is worth monitoring. Previously weaker US data has tended to weaken the USD, and our economists expect weaker outturns in today’s activity (Nov retail sales) and inflation (PPI) data. We maintain a bearish USD view and stay with our long AUDUSD trade recommendation, targeting 1.0850.
– SNB no change sparks mild disappointment; Stay long EURCHF on declining Euro zone risks
The SNB maintained policy unchanged (floor at 1.2000, 3m LIBOR at 0%) while lowering the near term profile for inflation. While this was the consensus expectation amongst economists, the spike in money market rate futures, back down in EURCHF below 1.2100 and the drop in implied volatility indicate a mild sense of disappointment. The SNB message however remains that all options remain on the table, including potentially negative rates. We continue to expect EURCHF to continue to move higher (target 1.2500 H1 2013, 1.3000 in H2 2013) as eurozone risk premia continues to decline. The successful completion of the Greece buyback should allow the aid tranche to be released to Greece after today’s eurozone finance ministers meeting. We maintain our current long trade recommendation, targeting a move to 1.2500.
– More on the Fed decision
As we had expected, the Fed announced that it will continue to purchase USD 45bn in long-term Treasuries as Twist winds off. This leads to a net balance sheet expansion of USD 85bn per month (up from 40bn before) and could eventually lead to a huge USD 1.2-1.7trn in balance sheet expansion by mid-2014. This, in our view, will remain a huge drag on the USD and remains central to our USD bearish view. Somewhat more unexpected was the Fed announcing numerical targets to guide zero interest rate policy, which was expected at some point early next year. The Fed is now linking the duration of zerointerest rate policy to thresholds on the dual employment and price stability mandate (unemployment rate <= 6.5%, inflation <= 2.5%). The numerical targets set a high threshold for the eventual Fed policy exit and our economists’ view this as consistent with the previous guidance that a tightening cycle may not come before 2015 at the earliest. The substantial pace of balance sheet expansion is in line with our expectation and forecast for a weak USD next year. Finally the Fed’s decision to maintain the 9Y duration of its bond holdings as under Twist has resulted in a steeper curve and has helped USDJPY extend higher up to 83.67 in Asia. However, we expect this to be a short-lived phenomenon. Although the JPY is likely to remain vulnerable for now, the Fed move a very high threshold for the Bank of Japan to match in terms of balance sheet expansion. Moreover, we believe markets may be overestimating the dovish voice of the LDP (likely election winner on Sunday). A shift to more conservative rhetoric (especially from LDP head and potential PM Abe) after Sunday’s Japan election could see the JPY snap back next week.
BNP Paribas