The euro extended its correction this week, setting a low of 1.33 against the US dollar, before recovering above 1.34 following Thursday’s surprise interest rate cut by the European Central Bank (ECB). This form of monetary easing – which saw the lowering of the ECB’s repo rate by 25 basis points, to a historic low of 0.25% – came in response to the sharp fall in inflation across the eurozone. Now levelled at 0.7%, this weak inflation rate could lead to tighter monetary conditions and an increase in real rates.
The ECB expects inflation to remain weak for a prolonged period and, if growth becomes disappointing, risks may well tilt on the downside. Although the danger of deflation is limited, it is worth noting that the latest Purchasing Manager’s Index (PMI) surveys were rather disappointing, and September brought an increase in the unemployment rate and contraction in lending to the economy.
Despite the repo rate cut, the ECB’s tone remains dovish, with President Mario Draghi reiterating his ‘forward guidance’ strategy. Markets should still expect key ECB interest rates to remain at current or lower levels for an extended period. Mr Draghi also indicated that, while the deposit rate is presently on hold at zero, the central bank is ready to set a negative rate or, if necessary, take other measures. These indications led to a sharp flattening of the Eonia Forward curve. The 1Y1Y Eonia Forward fell by 11bp to 0.18%, below the current 0.25% repo rate.
Against this backdrop, the spread between eurozone and US 2-year rates has further contracted, pushing the EUR/USD temporarily down towards 1.33 – most likely as a result of reduced long positions held by speculative accounts (which reached historically high levels at the end of October). Having said this, the short-term performance of the EUR/USD will, in fact, be ultimately determined by the US dollar, particularly when the results of the US Employment Situation Report are published.
If the employment data is in line with expectations, the EUR/USD could rapidly weaken and test 1.3250. If, however, the data is weaker than expected, the EUR/USD could hover between 1.33 and 1.35 in coming weeks. In both cases, the EUR/USD will lean towards 1.33 – or perhaps even lower – come the end of the year, in response to the increasing strength of the US dollar, which is being bolstered by the prospect of tapering starting in January.
USD: could strengthen
The recovery of the US dollar continues on the back of the better-than-expected macroeconomic data, helping the DXY dollar index bounce back above 81. The currency drew strength this week from the improvement in the October PMI. This had been expected to weaken on account of the government shutdown, but the employment component of the manufacturing and non-manufacturing PMI boasted positive results. In addition, GDP for Q3 was better than expected at 2.8%, when the consensus had been for 2.0%.
The market seems to expect – once again – that tapering will be under way soon. Our view, however, is that the Fed will not act before January, when the December Employment Situation Report is published.
All eyes are now on the October employment data. If, as expected, there is a 120, 000 increase in jobs, this ought to bolster the greenback. Otherwise, the currency could display some nervousness in the short-term.
GBP: stronger
Sterling recorded one of the best performances of all the G10 currencies against the US dollar this week, bolstered by a sharp improvement in business surveys. The construction and services PMI reached new highs, while manufacturing output increased by 0.9% month-on-month in September. This higher-than-expected increased – an increase of 0.6% was the general consensus – supports the development of a particularly strong economic recovery.
Last month’s Monetary Policy Committee (MPC) meeting can be deemed a non-event – particularly in terms of forex – but there is greater potential for the Bank of England’s quarterly report (published on 13 November) to be more of a market-mover. It will be interesting to see if the central bank is more optimistic with regard to the outlook for growth and, notably, whether it anticipates a rapid decline in the unemployment rate.
Next week will be marked by the publication of the October unemployment data and retail sales, which ought to confirm that the economic situation is on the mend. We believe that the GBP/USD should appreciate towards 1.62, while the EUR/GBP has potential to fall back to a 0.8260 in the short-term.
JPY: weaker
Over the past week, the Japanese yen weakened sharply against most G10 currencies, but has managed to hold its ground against the US dollar. In the absence of major Japanese economic news, it will be the US news flow that chiefly influences the performance of the USD/JPY in the coming week.
The steady increase in the Bank of Japan’s monetary base (to JPY 190 trillion in October, up 45.8% year-on-year) has not had any impact on the yen for several months. This liquidity is mainly being used to purchase Japanese government bonds – which in turn keeps long rates at a low level of 0.6%, even though the past three weeks have seen the buying of foreign bonds by Japanese investors.
In the short-term, the USD/JPY will remain under the influence of the greenback, and notably the publication of US employment data. That said, the market’s attention will shift somewhat to Japan’s current account balance, which is due to be published next week.
Next week, the USD/JPY has upside to 99.6, while the GBP/JPY could appreciate as high as 160. As for the EUR/JPY, it still has downside to 130.6 (before recovering in 2014).
CHF: weaker
Given the keener risk appetite and the weaker-than-expected consumer prices in October (-0.3% year-on-year), the Swiss franc weakened against most G10 currencies. The USD/CHF rebounded back above 0.912 on the back of a stronger US dollar – buoyed by better-than-expected ISM manufacturing surveys during October’s shutdown.
As for the EUR/CHF, this week it has remained stable at around 1.23, mostly due to expectations of an interest cut by the ECB. Further to the risk of a technical rebound by the single currency, the EUR/CHF has upside potential to 1.2415.
AUD: levelling off
The AUD/USD was unchanged at around 0.95 this week. Australia’s Employment Report was disappointing, with just 1,100 job creations, falling below the 10,000 market consensus. Meanwhile, the unemployment rate held steady at 5.7%.
These figures confirmed that the Australian labour market remains frail – and justifies the caution shown by the Reserve Bank of Australia. The central bank has continued to stress that the Australian dollar remains too strong to facilitate an economic transition away from the mining sector.
Furthermore, the central bank’s quarterly report published on Thursday was particularly dovish. It did not rule out another cut in key monetary policy rates, and its growth forecasts were revised downwards to 2.3% for 2014 and 2.5%-3.5% for 2015.
The Reserve Bank of Australia is set to publish its quarterly report today. It will be interesting to see if the central bank adopts a completely neutral bias for its monetary policy – particularly if it is more optimistic about the growth outlook.
Next week, watch out for the publication of the NAB business surveys. Additionally, the Australian dollar’s performance will depend on that of the US dollar, which in turn will be influenced by the US employment data.
Under these conditions, we are sellers of the AUD/USD on any rebound above 0.96 and of the EUR/AUD, with as target 1.395. Finally, we see the AUD/NZD going on to test 1.12.
NZD: bolstered by RBNZ
The NZD/USD appreciated this week to a high of 0.84. The macroeconomic data out of New Zealand remains particularly upbeat, notably for employment, with a 1.2% increase in Q3 (which was significantly more than the 0.6% consensus). The unemployment rate declined to 6.2%, its lowest level in three years.
As salaries increased by only 1.6% year-on-year, the Reserve Bank of New Zealand can still delay an interest rate hike for a little while longer, potentially until the second quarter of 2014. And if the New Zealand dollar appreciates significantly in the interval, the central bank could wait even longer before embarking on a monetary tightening cycle.
Next week, the market will focus on property prices and the PMI, both of which could extend their rise, which could extend the NZD/USD’s rise towards 0.846, then 0.8855.
Natixis