FX Thoughts for the Week Ahead
Still data dependent
Last week’s cautious FOMC communication tested our stronger USD view, with larger-than-expected downward revisions to FOMC participant policy rate forecasts and Chair Yellen’s guarded responses during the press conference. Yet we still expect ongoing improvement in the data to allow the Fed to begin tightening in September, well before the market expectations, which have now shifted towards a December hike (Figure 1). Chair Yellen reiterated the data-dependent nature of the liftoff decision and that the Fed is looking for “decisive evidence” on the sustainability of moderate growth, wage increases, and rising inflation. As such, US economic data should continue to be a key driver of the financial markets this week. In particular, personal consumption and core PCE prices are likely most relevant, while other monthly data, including durable goods orders, new home sales, and Michigan consumer sentiment, will also be watched.
Overall, although we think the USD will continue to be supported in the medium-long term, as it is the currency of the country most capable of generating inflation and closest to beginning to normalise monetary policy, we think next week it will stay range-bound due to a lack of important economic releases. The USD should increasingly benefit from superior returns to capital in the medium term, driven partly by a rapidly closing output gap, and safe-haven demand, given the low variance of asset returns. In this sense, Fed rate hikes are simply a validation of the US’s superior returns to capital, which should ultimately drive currency appreciation (see Three Questions: Top Dollar).
Elsewhere, Greek political uncertainty remains the key risk for the markets. As the 18 June Eurogroup meeting ended without any significant progress, euro area heads of states have scheduled an emergency summit for 22 June in what could be a last-ditch attempt to strike a deal to avert a financial crisis for Greece. With the end-of-June IMF deadline fast approaching, if there is no progress next week, an immediate negative market reaction consistent with a crisis scenario would be likely (see Euro Themes: Greece: Capital controls imminent without breakthrough). As such, the EUR likely remains vulnerable to Greece-related headline risks in the week ahead.
Economic activity data are another focus for the euro area. While the recent improvements in the activity and inflation data are encouraging, we remain wary of downside risk. Indeed, the economic recovery seems to have been unfolding slightly slower than we expected, especially in Germany. The upcoming June euro area manufacturing and services PMI will shed more light in this front. However, we continue to believe that the relatively large negative output gap in the euro area, which we expect to remain in the coming years, along with the ECB’s commitment to the QE program, should suppress the returns to capital in the euro area, weighing on the EUR.
Figure 1: Fed and market expectations for rate hikes have been pared back
Source: Bloomberg, Federal Reserve, Barclays Research
Trades for the week ahead: Long USDCAD and short EURJPY as risk aversion extends
Recent price action signals a more cautious approach to risk exposure in FX. High beta currencies such as the CAD have had sellers emerge to stem recent gains. A bullish daily candle formation in USDCAD points to buying interest in the 1.2125 area and room for a move higher in range. Our initial targets are towards 1.2360 and then the May highs near 1.2565. Safe haven currencies such as the JPY have had investor buying. A short-term topping pattern in EURJPY signals selling interest near the 140.05 range highs and scope for downside towards targets near 137.00 in the near term.
Figure 2: Technical analysis suggests USDCAD has bottomed and EURJPY has topped
What to look for next week
USD: stuck in a range
We expect the USD to to trade sideways with a weakening bias in the short term, as the Fed seems to remain very dovish and inflation is still not showing any sign of picking up, according to last week’s release. With only tier 2 data in the US next week, we do not expect any major moves in the dollar and look for further positioning reductions. On the data front, on Tuesday, we get durable goods orders for May; we expect a monthly drop in the headline figure of 2.5% (consensus: -0.5%) and an increase of 0.7% in the core, compared with the 0.6% consensus (ex-transport). Later in the week is the final reading of Q1 GDP, which is expected to be revised up from -0.7% to -0.2%. Finally, on Thursday, the PCE index is scheduled to be published, along with personal income and spending data. Regarding the PCE, we are slightly below consensus, expecting a 0.3% increase m/m (consensus: 0.4%), while for the core series, we and the consensus expect +0.1%. For spending and income data, we forecast +0.8% and 0.4% respectively.
EUR: EA heads of state summit and PMIs the focus
As discussed above, the EUR will remain vulnerable to news regarding Greece’s ongoing negotiations with its creditors. In the wake of no progress made at last Thursday’s Eurogroup meeting, euro area heads of state will meet on Monday (from 6pm London time) in what could be a last-ditch attempt to strike a deal to avert a financial crisis for Greece. While differences remain at the technical level and the end-of-June IMF deadline is approaching, euro area leaders will likely try to strike a deal with Prime Minister Tsipras, at a minimum regarding a programme extension. Failure to do so would allow the ECB to start increasing haircuts on ELA collateral as soon as next week and likely result in an immediate negative market reaction and a worsening crisis scenario. Depending on the outcome of the euro area summit, there is also the potential for discussion to continue into Thursday’s scheduled EU summit.
In terms of data (full details below), we look for euro area flash composite PMIs to edge down in June to 53.4 (consensus: 53.5), due to lower services confidence (Barclays: 53.4; consensus: 53.6), while manufacturing PMI should inch up to 52.4 (consensus: 52.2). Wednesday’s German IFO business climate index is likely to moderate slightly in June to 108.0 from 108.5 (consensus: 108.1) but remain well above recent lows of 103.6 in October last year.
Figure 3: European data calendar
Source: Bloomberg, Barclays Research
JPY: Back to data watching after rounds of political rhetoric
After rounds of comments on FX markets by BoJ Governor Kuroda in the past two weeks, USDJPY is stabilizing in the 122-to-124 range. Looking ahead to this week, the market focus will likely return to economic data. First, on the inflation front, we expect May National core CPI (Friday) to decelerate to a flat reading, or 0.0% y/y (consensus: 0.0%) from +0.3% in April. We also expect May Services PPI (Wednesday) to decelerate to +0.4% y/y (consensus: +0.4%) from +0.7% in April. Secondly, hard data will shed some light on the latest growth picture. We expect the May household survey (Friday) to show that real spending increased 2.8% y/y (consensus: +3.6%), turning positive for the first time in 14 months.
SEK: Two Riksbank meetings of the executive board in focus – no surprises expected
The executive board of the Riksbank will be holding two meetings next week (Monday and Friday) and are likely to gain market attention. Despite recent Riksbank rhetoric about the possibility of further easing, we see increasingly less evidence for the basis on which this could be justified. As a result, we do not expect any kind of policy action during next week’s meetings. As we recently highlighted, Swedish economic data have picked up recently, helping to alleviate pressure for additional easing by the Riksbank and supporting SEK appreciation. Inflation is recovering modestly and medium-term inflation expectations have stabilized and also pointing higher. On the basis of positive economic fundamentals, the SEK’s undervaluation and the Riksbank’s increased emphasis on financial stability considerations, we recommend being short EURSEK (see FX Focus: SEK: Inflection point, 12 June 2015).
NJA: Central banks on hold amid poor manufacturing growth
Attention in Asia will focus on central bank meetings and manufacturing/industrial production data. On Thursday, the BSP in the Philippines and CBC in Taiwan are scheduled to deliver decisions that will likely leave policy rates on hold. However, we expect the BSP to maintain a hawkish tilt, albeit slightly toned down due to softer inflation, while the CBC is set to maintain a broadly cautious tone. Although China’s flash June HSBC manufacturing PMI is likely to rebound slightly (Barclays 49.6, consensus: 49.4 from 49.2 in May), hard data in Taiwan (Wednesday), Singapore (Friday) and Thailand (Friday) should paint a picture of soft manufacturing activity. Taiwan IP is set to rise only 1.0% y/y in May (consensus: 1.2%), Singapore IP is set to drop -2% y/y, (consensus: -3.5%) while Thai manufacturing production is likely to drop a sharp -5.6% y/y over the same month. We expect weak export demand to be revealed in a further contraction in Thai May exports (Thursday), highlighting the ongoing China-related pressure on manufacturing and exports in the region. While on the face of it weak exports should focus attention on weaker currencies, Asian currencies are benefiting from a softer USD tone of late.
EEMEA: Central banks in the spotlight
In EEMEA, there are four rate decisions next week. In Israel (Monday), we expect the BoI to keep the policy rate unchanged at 0.1%. It has recently signaled that it has no appetite for negative interest rates, but given its discontent with a stronger ILS, we expect it to continue FX purchases. The stronger ILS remains a concern within the context of weak export performance, and with the central bank leaning for a weaker ILS, USDILS should eventually move higher with the resumption of USD strength.
In Turkey (Tuesday), we expect the Central Bank of Turkey (CBT) to keep all policy rates unchanged. Inflation is running above the target, and the TRY weakened further with the contribution of political uncertainty after the elections. On the other hand, inflation has likely peaked, and the TRY should get some relief if a coalition government is formed, which seems a likely scenario at the moment. Overall, we think the CBT will keep its cautious monetary policy rhetoric and continue to highlight focus on inflation.
In Hungary (Tuesday), we expect one final cut of 15bp from NBH, bringing down the policy rate 1.5%. While there have been limited indications that NBH might be ready to stop, our economists think there are good reasons for NBH to call a halt to cuts. Inflation has risen sharply in the past months to 0.5% y/y from a low of -1.5% in January, and core also picked up to 1.3% y/y, although below the 2-4% inflation target. In addition HUF has depreciated since April, loosening monetary conditions.
Finally, we expect the Czech National Bank (CNB) to remain on hold and retain the exchange rate floor on Thursday. Inflation has accelerated considerably, to 0.7% y/y, while it remains below the 1-3% target. The CNB has signaled that it will not remove the CZK floor until inflation reaches the midpoint of the target, probably in mid-2016, in their view. Thus, we see no reason for the CNB to change its policies at this time.
LatAm: A hawkish BCB to support BRL
We expect the BRL to remain supported next week, particularly because of last week’s FOMC dovish bias and, in contrast, a hawkish central bank that seems to be committed to anchoring inflation expectations. The BCB may release its Quarterly Inflation Report this week, and markets will assess the distance of its models’ forecasts for 2016 inflation to the mid-point of the target in order to fine-tune forecasts of when the next hikes in the tightening cycle will occur. On Thursday, the National Monetary Council (CMN) will have its quarterly meeting, and local newspapers have recently commented on the possibility of its changing the inflation target of 2017, either reducing the mid-point (4.5%) or the tolerance range (2pp higher or lower).
Finally, on the fiscal front, on Wednesday, Congress could vote on the payroll tax break reversion, although local festivities during the week could risk insufficient quorum. In terms of data, focus should be on the labor market on Thursday; our forecast is consistent with the unemployment rate moving up to 6.1% in seasonally adjusted terms, reflecting the fairly weak outlook for the labor market in Brazil. In addition, we expect another negative growth number for real wages growth in this report.
In Mexico, the inflation number for the first half of June is scheduled for release, for which we forecast a 2w/2w increase of 0.05%, compared with the market consensus of 0.13%. Later in the week, we expect retail sales for April to show an increase of 0.4% after printing a 0.2% gain in March, while the unemployment rate probably will slightly improve in May from 4.3% to 4.2%.