– Underlying USD weakness heading into FOMC
The USD has maintained an underlying weak tone, suggesting that investors are beginning to bet on a dovish FOMC today. Although the view that the Fed will shift to outright Treasury purchases is now very widely shared by market participants, we do not believe it has been fully reflected into markets or in positioning. Hence, USD weakness is highly likely should the Fed shift to outright UST purchase (USD 45bn). Our rates strategists pointed out that should the Fed continue to target the same maturities as under Operation Twist, the duration impact of the Fed operations would become larger. Thus, the Fed could maintain the USD 45bn allocation but move down the curve, steepening the curve from the belly (7y-10y sector) out to the 30y. In a less likely scenario, the Fed could reduce the headline purchases amount to USD 40bn per month keeping the purchase mix similar to Twist. While details will be important, we believe that ultimately for FX it is the switch to large-scale outright Treasury purchases that is going to have a large negative USD impact, just as it did during QE1 and QE2. Given AUD’s high beta to equity markets, we continue to position for the Fed via a long AUDUSD trade recommendation, established at 1.0390 and targeting 1.0850. We also believe that USDJPY is vulnerable to a dovish FOMC, which should overwhelm any JPY sell-signal provided by an expected weakening in Thursday’s Q4 Tankan (large manufacturer’s DI expected at -10 from -3 prior). Today’s release of BOJ’s domestic CGPI came in flat over Nov, after a 0.3% decline in Oct. Meanwhile, core machinery orders rebounded by 2.6%, but disappointed forecast of a 3.0% rose. But on the year, orders surprised with a 1.2% rise, against forecasts for a 4.4% decline after Sept’s 7.8% fall. The data had muted impact on USDJPY; we expect FOMC and domestic political news to remain dominant drivers of the pair.
– EURCHF higher as largest Swiss Bank decides to impose negative rates
EURCHF is back above 1.2100 after Switzerland’s largest bank announced it will start charging negative interest rates on cash balances of financial institutional clients, following a similar move by the country’s second-largest bank last week. As mentioned in the latest Global FX Plus, we believe easing euro zone stress will take EURCHF naturally higher — our target is 1.2500 H1 2013. However, speculation is increasing that the SNB either (a) raise the floor and/or (b) cut its 3m LIBOR target (now 0%) when they meeting on Thursday. On (a) we think that with eurozone stress easing and intervention having reduced, there is no incentive to raise the floor at this juncture as spot can naturally move higher anyway. On (b), while market pricing has increased for a negative 3m LIBOR (June 2013 euroswiss futures at -17bps from 0.0 a fortnight ago-see chart) we believe a cut in the SNB’s 3m LIBOR target is unlikely at this stage. Firstly, while CHF 1m LIBOR has turned negative recently, the more relevant 3m LIBOR has remained positive (at 0.014% and near SNB 0% target). We think that one may need to see 3m LIBOR fixings move to -0.10% or below on a sustained basis to even warrant any SNB response. Secondly and more important, with the SNB having shifted the policy focus from rates to the floor in September 2011 (a policy which served them well), reverting to changing rates could send the wrong signal.
– European currencies to trade firm; short EURGBP signal triggered by STEER
European currencies have been trading with a firmer tone. The EUR received a boost from a surprising bounce in the December German ZEW economic sentiment (+6.9 from -15.7) coupled with the positive news that Greece received offers worth over EUR 31bnn for its bond buyback. Today marks a busy day for economic data: Eurozone October industrial output (forecast +0.4% m/m) and UK November jobless claims (forecast +15K), but we expect muted market reaction to the data prints ahead of FOMC today. Of note, our STEER model suggests that EURGBP is vulnerable to a move lower, having not yet responded to the fall in the eurozone 2Y swaps. Accordingly, we have initiated a quant-based EURGBP short trade recommendation at 0.8065, targeting 0.7915 and with a stop at 0.8140.
BNP Paribas