– Fed delivers, further USD weakness ahead; stay long AUDUSD
The Fed announced that it will continue to purchase long-term Treasuries after the expiration of Operation Twist at a pace of USD 45bn per month, implying a switch to a net balance sheet expansion at the pace of USD 85bn per month. The main surprise in the Fed announcement was the shift to numerical targets for unemployment and inflation in its forward guidance, which was not expected at this meeting. Specifically, the Fed said that rates will remain exceptionally low “at least as long as the unemployment rate remains above 6.5%” and inflation does not move more than 0.5% above the Fed’s 2% long-term target. Fed forecasts for unemployment and the fed funds rate were consistent with the previous guidance that most policymakers do not see tightening until 2015. The initial FX market reaction has been USD-negative but generally modest. We hold to the view that the Fed has fully delivered, and that the numerical targets set a high threshold for the eventual Fed policy exit. Given that the Fed is on course to expand its balance sheet substantially, this supports a weak USD regime. We think that market reaction could be been ‘suspended’ until the resolution of other uncertainties, namely the US fiscal cliff negotiations and the Greek debt deal, with the latter likely to be finalized at the eurozone finance ministers meeting today as Greece has met its target for the debt buyback. We maintain a bearish USD view and stay with our long AUDUSD trade recommendation, targeting 1.0850. Watch the annual Chinese central economic meeting over the weekend (December 15-16) which will set growth target and related macro policy in 2013; signals of a more optimist economic target coupled with pledge of proactive fiscal policy could lend support to the AUD.
– USDJPY following UST yields higher… for now
USDJPY extended its gains to 83.30 post-FOMC announcement and to high of 83.65 in Asian trading, standing in contrast to the general USD weakness. Nikkei reports that Bank of Tokyo-Mitsubishi UFJ plans to take a 20% stake (JPY 60bn) in VietinBank by purchasing shares held by the Vietnamese government, another M&A deal which is likely to lend some support to USDJPY. But in our view, the key factor for higher USDJPY currently stems from the UST curve steepening after the FOMC announcement, with 10y yields climbing above 1.70%. UST curve steepening is likely to be the result of i) the FOMC statement effectively announced a temporary increase in the Fed’s inflation tolerance to 2.5%; ii) the details suggest that the Fed will continue to target duration of 9 years, similar to Operation Twist, implying a shift to shorter-term maturities for the Fed’s UST purchases. At the same time, markets remain clearly focused on the BoJ policy in the context of the upcoming elections on 16 Dec. Although the JPY is likely to remain vulnerable for now, we still believe that Fed move clearly sets it on an easing path that the BoJ will struggle to match. Given that the financial market spill-overs are likely to be more significant for the Fed, the US should to remain the perennial winner in the ‘global currency war’. Hence, in our view, the USD, rather than the JPY that will be the main funding currency for carry trades as long as QE3 remains.
– SNB unlikely to surprise today; stay long EURCHF on declining Eurozone risks
The Swiss National Bank’s policy announcement today is likely to draw attention in the context of the recent moves by two of the largest Swiss banks to charge negative interest rates on cash balances of financial institutional clients. We do not believe that the SNB is likely to follow suit with a similar official policy, especially as the buying pressure on CHF has eased recently. We also do not expect any changes to the 1.20 ‘floor’ although we believe that a potential lifting of that floor cannot be completely ruled out, should the SNB wish to take advantage of current market conditions and surprise the markets. Ultimately, the EURCHF outlook hinges on the reduction in the eurozone risk. A successful completion of the Greece deal would be a positive for the cross and we maintain our current long trade recommendation, targeting a move to 1.25.
BNP Paribas