USD: slightly firmer
The DXY dollar index firmed slightly to 80.55 this week, helped by the Democrats and Republicans resuming talks over the US budget. That said, the government shutdown continues, and the 17 October deadline for the debt ceiling is fast approaching.
Equity markets have stabilised and 10-year long rates have marginally recovered to 2.68%, which is still low compared with the 3% level reached a few weeks ago. Meanwhile, the 5-year CDS has hovered at around 40 basis points – below the 67 level reached during the 2011 debt ceiling negotiations.
Naturally, the extent to which the shutdown will affect the economy remains a concern for many investors, as does the Federal Reserve’s short-term reaction. However, as data for October will be dangerously skewed and unreliable – with few statistics being released due to the shutdown, and September’s Employment Situation Report still not being published – the Federal Reserve is likely to err on the side of caution at its next meeting.
Expectations have therefore strengthened that tapering will be delayed until January. We’ve maintained our belief that tapering will start in December, however, since the November data should be adequate enough to make a decision. Furthermore, the minutes of the Federal Open Market Committee (FOMC) held on 18 September revealed that the decision to put off tapering was a close call.
Of course, the government shutdown has taken place since then, which could make some FOMC members become cautious in future meetings. In fact, the decision will largely be data-dependent, which means the October and November employment statistics are of key importance. In the real estate sector, the easing of long rates since September has already paved the way for an upturn in mortgage lending.
Be that as it may, the nomination of Janet Yellen as the next chair of the Federal Reserve (effective as of the end of January 2014) suggests that the central bank could prolong the scaling back of QE3. This is especially as forward guidance could be ratcheted up – even though this would have a negative effect on the US dollar.
In the short-term, a “wait-and-see” attitude is likely to exist until the debt ceiling is increased. Once a decision has been made, the US dollar should recover very slowly. In past instances where there has been an impasse over raising the debt ceiling, the currency has tended to make a strong recovery, like in 2011 and 2012. This time, however, the rebound could be more subdued given the uncertainties over the employment data and, more generally, over the state of the economy. It is possible employment and retail sales figures will be released at the end of next week, and we predict the DXY dollar index could recover to 81.5.
EUR: set to inch lower vs. USD in very near-term
The euro hardly moved this week, with the EUR/USD unable to break below 1.35.
The single currency has drawn strength from some positive statistics, notably the strong increase in German industrial production in August (+1.4% month-on-month). In addition, it was bolstered by the renewed investor confidence in the Eurozone’s peripheral countries. Spain successfully placed EUR 4 billion of 30-year bonds, with strong demand from non-resident investors. This means that Tesoro Público (Spain’s public treasury) has now completed 90% of its 2013 issuance programme.
Meanwhile, the European Central Bank appears reluctant to ease its monetary policy, either by staging another VLTRO or cutting its rates, particularly as business surveys remain rather upbeat.
Even so, we still expect the EUR/USD to correct in coming weeks, as the pair remains overvalued, notably in light of the 2-year interest rate spread between the Eurozone and the US. Also, the US dollar will recover over the next few months once the Fed starts to taper asset purchases – albeit more slowly than expected. A final factor to be wary of, however, is that European economic recovery is likely to be disappointing, with growth only reaching 0.8% in 2014 against 2.3% for the US.
In our opinion, the Asset Quality Review (AQR) will once again expose the fragility of certain European banks. In this respect, the International Monetary Fund has warned banks in peripheral countries of the risk of defaulting on corporate loans, with losses that it said could run to around EUR 250 billion. In this environment – and once the US debt-ceiling saga is over – we remain negative on the EUR/USD, and will expect the pair to pull back towards 1.31 at the end of the year.
JPY: expected to weaken
Due to renewed risk aversion over concerns of the US debt ceiling, the USD/JPY corrected to 96.60 – its lowest level since last August. Most likely, this comes in the wake of profit-taking on US bonds (last week, Japanese investors sold approximately USD 23 billion of foreign bonds). Risk appetite was revived at the end of this week, however, which enabled the USD/JPY to recover back above 98.
The Japanese yen may have been penalised by the current surplus falling to JPY 161.5 billion in August – significantly short of the JPY 520 billion consensus. The deterioration in this indicator stems from both the weaker yen and the increase in crude oil imports, as several nuclear power plants have now been taken offline. This has raised apprehension that Japan will run a current deficit in the next few months, which will be difficult to finance given that the public debt towers at 235% of GDP.
Yet this risk is limited, as the Bank of Japan buys large chunks of Japanese sovereign bond issues (as shown by the steady decline of the 10-year rate to a low of 0.65%, down from 1% in May). In the short-term, upward pressures linked to a significant current account surplus will lessen, which will be another negative factor for the Japanese yen. The USD/JPY is likely to recover toward 100 in coming weeks, and the EUR/JPY should remain between 132 and 135 in the short-term.
GBP: buy on any rebound
In the face of weaker statistics – notably the decline in industrial production in August (-1.1% month-on-month when a 0.4% increase had been expected) – sterling ended the week by correcting, which triggered additional profit taking on the British currency.
Economic prospects remain positive, however. GDP growth is expected to strengthen further in coming quarters, which is stoking expectations of the Bank of England tightening monetary policy earlier than scheduled. On the other hand, the trend for sterling is likely to remain negative in the coming week – at least until next week’s publication of the September retail sale statistics.
Meanwhile, any positive outcome to the US fiscal crisis could bolster the US dollar against most currencies. Under these conditions, we would be buyers of GBP/USD on any correction to 1.580. The EUR/GBP has already reached attractive selling levels to play a pullback towards 0.8325.
CHF: expected to weaken
As announced this week, the Swiss National Bank has not intervened in the foreign exchange market for more than one year, but it still considers the Swiss franc to be overvalued and stands ready to defend the 1.20 floor rate for the EUR/CHF (or take any other necessary measures).
The weak inflation in September (-0.1% year-on-year) suggests the central bank will maintain its monetary status policy. In the short-term, the performance of the USD/CHF will depend predominately on the US dollar, hence on the importance of a resolution to the US budget crisis. If no agreement is reached in the US, there is a risk that the pair could test anew 0.90, while the EUR/CHF could pull back below 1.22. The mere fact that budget discussions resumed at the end of the week was enough for the USD/CHF to recover above 0.912 and for the EUR/CHF to break above 1.23. Next week, if the US budget standoff continues, the EUR/CHF could test 1.24.
AUD: not much upside potential
This week the Australian dollar held relatively stable above 0.94 against the US dollar, despite the US budget uncertainty. In fact, 0.95 appears the limit for the AUD/USD and may remain so in coming weeks, particularly if the US dollar recovers.
Australian economic growth remains fragile, which could prompt the Reserve Bank of Australia to ease its monetary policy. The unemployment rate declined to 5.6% in September (from 5.8% in August) but the labour participation rate also declined, down to 64.9%, while there were only 9,100 new jobs created (clearly missing the 15,000 consensus).
Furthermore, Australia remains at the mercy of China, whose economic prospects are uncertain. In this respect, the IMF has warned of the risks associated to China’s economic transition – where it would be more sparing in its consumption of raw materials. Such a position could penalise Chinese raw material imports, and consequently hurt ore producers like Australia. We recommend selling AUD/USD on any rebound above 0.95.
NZD: firmer in short term
The New Zealand dollar remained upbeat as prospects of a monetary tightening in 2014 emerged due to economic growth continuing to show signs of improving. The Reserve Bank of New Zealand remains particularly hawkish because the property bubble is not subsiding, even though the central bank imposed restrictions on mortgage lending by commercial banks.
As inflation (due to be published next week) remains relatively subdued (expected to have risen to 1.2% in Q3), property prices will monopolise the central bank’s attention next week. If property prices have risen sharply, it is likely this will push up the NZD/USD towards 0.84. As for the AUD/NZD, it is likely to pull back towards 1.12.
Natixis