– Risk supported as the contours of the fiscal-cliff deal emerge
FX markets are predictably slowing ahead of the year-end holidays, but we suspect the outcome of the fiscal cliff negotiations will be the dominant driver for FX price action over last two weeks of the year. The latest negotiations suggest that a constructive scenario is playing out. News reported that President Barack Obama was considering concessions over Social Security after House Speaker Boehner signalled readiness to support an increase in marginal tax rates on top income earners. The overall gap between the Republican and Democratic position on revenue increases – the most contentious part of the talks – appears to be narrowing. According to some reports, in his latest offer John Boehner said he would accept USD 1tn in extra revenue (up from USD 800bn), while President Obama has reduced his revenue target to USD 1.2tn (from USD1.6tn). Obama also raised the threshold of tax hikes to USD 400k, up from the initial USD 250k, albeit still below Boehner’s threshold of USD 1mn Given these developments, we think the focus is gradually shifting to securing broader party support for the deal currently being worked out between the negotiators. For markets, the most immediate risk is could be that a positive outcome is well anticipated; hence any stumble in the talks could hurt sentiment and support the USD. A successful resolution would shift the focus back to the impact of Fed easing, which we believe will remain the key market driver in the medium term. Yesterday’s US Treasury TIC data for October offered the first hint of the QE3 impact on international capital flows. Overall net long-term capital flows were soft at just USD 1.3bn, with US based investors increasing their net purchases of foreign securities to USD 27.1bn. This increased outflow was characteristic during QE1 and QE2 and in our view will remain an important “transmission mechanism” for USD weakness during QE3.
– Less dovish RBA minutes; stay long AUDUSD
RBA minutes of its 4th December meeting was less dovish than expected. RBA saw the case to cut given that a peak in resource investment was near, while non-mining investment was subdued But the minutes revealed that RBA did consider waiting for more information, albeit the soft inflation outlook provided ‘some scope’ to provide addition stimulus. This suggests that the latest rate cut was more of an insurance cut. The RBA stated that some of the expected effects from its lower rates were starting to be observed and further effects could be anticipated over time. They also appear optimistic on global economic condition and expect the stabilisation in China to support key commodity prices. Our economists expect RBA to keep rates unchanged in February against OIS market’s pricing of a 60% chance of a 25 bp rate cut. The risk is for unwinding of rate cut expectations on the back of improvement in domestic and Chinese data, in favour of AUD gains. In addition, we expect AUDUSD to remain firm on USD re-balancing by reserves managers before year-end. We stay long AUDUSD, targeting 1.0850.
– SEK could recover on a less dovish Riksbank
Today’s Riksbank monetary policy announcement has the potential to offer some support to SEK, in our view. Our economists expect one last 25bps rate reduction, which is now a consensus call with Bloomberg poll showing 16 of 17 economists calling for lower rates. While the rates market has priced in a 90% probability of a rate cut. Hence, the bigger risk is for a rate cut coupled with a less dovish statement, which should see SEK recover some of the lost ground. The outside risk of a ‘no change’ decision would be very bullish for SEK near term, though we continue to strategically favor NOKSEK upside with the Norges Bank likely to enter a tightening cycle in H1 2013.
BNP Paribas