– Expecting substantial USD weakness by year-end
The broad USD index has now been rallying for two consecutive months and has strengthened by over 3% during this time. We expect this USD rally to reverse towards year-end as investors concerns around the fiscal cliff, the euozone and China fade and as the Fed moves from Operation Twist to outright Treasury purchases at its meeting on 12 December. The recent economic data flow supports the case that the Fed is likely to ease policy further – Thursday’s November Philly Fed survey fell to -10.7. Meanwhile, the Empire manufacturing survey rose slightly to -5.22, but the employment component was particularly weak at -14.6. Even accounting for the volatile weather effects, it is clear that recent data remains consistent with ongoing Fed policy easing. There were few surprises from Fed Chairman Bernanke on Thursday who said that weak housing was “a powerful headwind” to the recovery. Given our view of Fed QE3 expansion in December, our updated FX forecasts continue to see broad-based USD weakness into year-end and in 2013. Acknowledging the recent price action we revised our end of December EURUSD forecast slightly lower to 1.33 but still see the pair reaching 1.35 in Q1 2013. Taking into account the recent developments in China, notably the pick-up in high-frequency activity data and an acceleration in CNY gains, we have also lifted our end-2013 AUDUSD target from 1.05 to 1.10.
– Weak news flow restrains EUR and GBP in the near-term
The Eurozone economy officially slipped into a recession in Q3 as the region-wide GDP contracted by 0.1% q/q, in line with expectations. The underlying picture was somewhat mixed, with 0.2% q/q gains in Germany and France, a smaller-than expected 0.2% q/q contraction in Italy, but larger than expected declines in the Netherlands (-1.1% q/q), Austria and Portugal. Our European economists point out that soft PMI readings at the start of Q4 imply an accelerating contraction. However, in our view the growth readings will gradually likely become less of a restraint for EURUSD, especially if a decision on Greece is reached at the Eurozone finance ministers’ meeting on Tuesday of next week. Meanwhile, UK retails sales disappointed on Thursday with ex-auto retail sales declining 0.7% m/m (-0.1% expected). GBPUSD is trading around its 200 day-ma, currently 1.5852, and there continues to be a risk of unwind of long GBP positions on a break below this– our FX positioning analysis suggests that investors continue to hold moderate long Sterling positions. Over the week ahead we may see position clearing dominate sterling price action, but beyond this we view that a move higher in GBPUSD will be driven by broad USD weakness and we continue to expect substantial GBPUSD appreciation by year-end.
– Japanese politics may continue to push higher USDJPY, for now
USD/JPY has stabilised but likely political headlines are likely to keep the pair supported ahead of the lower house election on December 16. Even though the LDP leader Abe’s comments are do not reflect the consensus among the LDP partly and hence final policy action is likely to be less aggressive, the strength of his statements is likely to cause investors to remain short JPY ahead of the vote. However our fundamental metrics for USDJPY indicate that the scope for further USDJPY gains is likely to be limited. Our favoured US-Japan 2-year yield spread indicator continues to signal downside risk, suggesting that a level around the high 78s is justified (see chart). BNP Paribas STEER also indicates that USDJPY has been overbought. Furthermore, our BNP Paribas FX Positioning indicates that the market is already holding substantial short JPY positions (see chart), which may limit scope for aggressive JPY selling to continue to take place. See USDJPY’s Rise Not Sustainable in this week’s Global FX Plus for further details.
BNP Paribas