USD: under pressure because of the Fed
As expected, the US dollar failed to appreciate in a week shortened by the Thanksgiving celebration and bereft of any major economic statistics. But the currency remains under pressure due to the Federal Reserve’s dovish statements – Ben Bernanke has managed to convince the markets that monetary policy will be kept on hold for an extended period.
Despite positive October employment data, the 2-year forward rate at one year has continued its decline, now settling at levels last seen in May, just prior to the Fed’s first mention of its intention to scale back QE3. Its rise earlier this year – from May through to August – ended when Bernanke’s stance took a dovish turn. Now, it’s long market rates that react significantly to any improvement in employment and, in turn, the prospect of tapering.
By minimising the criticality of the 6.5% unemployment rate threshold – a purely quantitative benchmark – the Fed has successfully dissociated its non-conventional monetary policy measures (QE3) from its conventional monetary policy (the federal funds rate target). But Bernanke believes other factors should be taken into account before considering a rise in interest rates.
So far, Bernanke has managed to strengthen the Fed’s forward guidance without officially lowering the unemployment rate target below 6.5%. And the minutes of the last Federal Open Market Committee (FOMC) meeting revealed that several members were equally reluctant to take such a path, for fear it would undermine the Fed’s credibility.
Ultimately, many pundits believe the unemployment rate is an unreliable indicator, as it is subject to revisions. In addition, its decrease does not reflect a global improvement in the labour market if the labour participation rate continues to decline at the same time.
The Fed’s stance on the matter suggests the US dollar’s appreciation will be notably gradual unless the labour market improves dramatically. For this reason, all eyes will be on this week’s November Employment Situation Report. If the level of job creation is as high as it was in October (200,000), the market could anticipate the start of tapering as early as 18 December – the date of the next FOMC meeting. This would bolster the US dollar.
In our view, however, the Fed is more likely to act in January – suggesting a slow ascent of the greenback.
EUR: bolstered temporarily
While the US 2-year rate has continued to ease in reaction to the Fed’s dovish rhetoric, its European counterpart has picked up slightly since mid-November, contributing to a widening of the EZ-US 2-year interest spread, which in turn has bolstered the EUR/USD as high as 1.36.
The strains on the 2-year rate can be traced back to the rise of the Eonia rate from 0.07% to 0.13%. This could be due to diminishing liquidity – having declined to less than EUR 200 billion – as year-end approaches.
The euro barely reacted to European Central Bank (ECB) members’ suggestion that monetary policy could be eased further – by setting a negative rate for the deposit facility, or by staging a new VLTRO. In our view, a negative deposit rate is unlikely given there is no real emergency to call for such a move, especially with European inflation rebounding from 0.7% in October to 0.9% in November.
On the other hand, when it meets on 5 December, the ECB could announce an additional injection of liquidity to tide over the banking system through year-end. In this respect, the market could be disappointed this week if the ECB announces no new measures to its monetary policy –particularly at a time when the Eonia is under much pressure.
In the lead-up to the ECB meeting, the EUR/USD could inch higher to 1.3680. Ahead of the publication of the US Employment Situation Report, we would be sellers above 1.3680 to play a pullback towards 1.33 in the very short-term.
GBP: has extended its bull run
Sterling has continued to appreciate in line with our expectations. The GBP/USD tested 1.6350 last week after the publication of indicators that underlined the vigour of Britain’s economic recovery. GDP growth reached 0.8%, fuelled by household consumption and – to a lesser extent – company investment. Expected GDP growth for 2014 has been revised to 2.3% – one of the highest levels amongst G10 countries – and this bolstered sterling last week.
No changes are expected to be announced at this week’s Monetary Policy Committee. The market will focus mainly on the November Purchasing Manager’s Index (PMI) surveys, which should be positive, confirming the recovery in economic activity.
Under these conditions, the GBP/USD could rise to 1.645, before consolidating subsequent to the publication of the USA’s employment data for November. On the other hand, the GBP/JPY has upside potential to 168.5.
JPY: weaker
The Japanese yen extended its correction against most currencies last week, notably against the US dollar and sterling. With the current environment characterised by rising US long rates, the yen has been put in an unfavourable position as it plays the role of borrowing currency for carry trades.
The latest inflation data shows that consumer prices increased by 1.1% year-on-year in October (and by 0.3% year-on-year excluding energy and food prices) – the strongest increase since 1998. This suggests the Bank of Japan has succeeded in hauling the economy out of deflation, at least for the time being. This has had no impact on the Japanese 10-year rate, which is still pegged at 0.6%.
In this environment, Japanese investors pressed ahead with their weekly purchase of foreign bonds in search of higher yields. European bonds in particular are attracting demand from Japanese investors, taking the EUR/JPY to a new high of 139.15. This week, the firmness of the greenback could lift the USD/JPY to 103.7 and the EUR/JPY to 141.
CHF: turn buyer of USD/CHF below 0.90
Despite further statements from the Swiss National Bank that the floor rate will remain in place for as long as necessary, the Swiss franc appreciated last week in the face of a rather edgy US dollar.
The Swiss franc also benefited from positive economic data, such as the 0.5% growth in GDP seen in Q3. By contrast, the EUR/CHF was relatively stable above 1.23.
This week, the USD/CHF should recover slightly ahead of Friday’s publication of the US November Employment Situation Report. For this reason, we would be buyers of the USD/CHF below 0.90.
AUD: still under a lot of pressure
The Australian dollar tested a low at 0.9065 last week – not far off our 0.90 prediction. The currency is under pressure as the Reserve Bank of Australia repeated its view that the currency is overvalued, and that an intervention in the foreign exchange market could not be ruled out. The currency has also been penalised by the correction in commodity prices (copper in particular), along with concerns over Chinese growth after the HSBC PMI fell back in November to just above 50.
The Australian dollar will remain under pressure ahead of this week’s meeting of the Reserve Bank of Australia, which is likely to keep its cash rate on hold at 2.50%, while continuing to maintain a cautious rhetoric.
Meanwhile, the likely rise in US long rates after the publication of the November Employment Situation Report will also weigh on the Australian dollar. This week, the AUD/USD could go on to test 0.897 before pulling back to its recent lows of 0.885.
NZD: corrected
The New Zealand dollar also corrected in reaction to weakening commodity prices. The currency continues to be bolstered by strong macroeconomic data, with a better-than-expected trade deficit for October and positive November business surveys. As a result, the AUD/NZD continued to decline to test our 1.11 forecast. This week, we expect the pair to extend its retreat down to 1.10.
Natixis