The dollar benefited only briefly last week when the US called off its partial government shutdown and raised the debt ceiling. Wednesday saw the DXY dollar index rebound to a high of 80.80 before the basket of currencies retreated on Thursday as the USD fell against most currencies.
Several factors can explain this correction. To start with, the budget impasse was a reminder to many investors that the US faces recurring problems in regards to its bipartisan political governance – a perception that will no doubt penalise the US dollar over the long-term.
Secondly, the agreement reached last week is a stopgap measure, as the financing of the administration will only be in operation until 15 January and another solution will need to be found before the debt ceiling is reached again on 7 February. Hence, Republicans and Democrats are due to meet on 13 December to decide on measures to achieve long-term fiscal consolidation. Certainly, there is a valid risk that another shutdown will take effect from 15 January if no agreement is made (notwithstanding the mid-term elections in November 2014 to renew one third of the Senate).
The USD has also been penalised by uncertainties over US growth. The latest Beige Book – a report by the Federal Reserve formally called the Summary of Commentary on Current Economic Conditions – was less upbeat than the previous report. We estimate that this month’s shutdown will knock 0.3 percentage points off GDP, while ratings agency Standard & Poor’s predicts a drop of 0.6 percentage points. On this basis, Q4 2013 growth could reach 1.9% instead of 2.2%. Yet the absence of reliable economic statistics will encourage a “wait-and-see” attitude in coming weeks.
In this environment, the Fed’s tapering of its QE3 programme could be further delayed until January 2014 – or later if there is another shutdown. Indeed, the greenback is no longer bolstered by prospects the central bank will scale back asset purchases. As a result, the DXY dollar index pulled down to 79.6 on Thursday, only one day after the deal for the budget was brokered.
In coming weeks, the US dollar will remain under pressure. This is bearing in mind the fact that economic growth was negatively affected in October and the same could happen again over the Christmas season if households anticipate another shutdown in January.
This week, keep an eye out for September’s employment figures and statistics for retail and home sales. If this data is disappointing it would no doubt lead to a further weakening of the DXY dollar index. That said, October’s Philadelphia survey – a business survey that tracks manufacturing conditions in the region – was reassuring, with sharp increases in employment and new orders.
In addition, it will be useful to keep tabs on the discussions between Republicans and Democrats who, it seems, want to reach an agreement on the debt ceiling before the 15 January deadline.
Finally, be attentive to any statements by members of the Fed, to better gauge their opinion on the current situation and determine the probability of tapering before the end of the year. In this environment, the DXY dollar index is likely to correct towards 78.60.
EUR: higher
Like most currencies, the euro benefited from the US dollar’s weakness, with the EUR/USD recovering back above 1.36 last week. The single currency also took gains from the news that Ireland will be able to refinance independently next year. There was also the fact that leading indicators – such as the ZEW manufacturing index in Germany – continued to turn around in October. This points to potential improvement for October’s Purchasing Manager’s Index (PMI) surveys in most European countries, due out this week.
Over the next few weeks the EUR/USD is likely to stabilise between 1.34 and 1.37, although the euro’s ascent is likely to be impeded by heightened expectations of an interest rate cut by the European Central Bank – given that the 1.1% inflation in September was low by past standards – and by renewed concerns over the European banking sector. Many peripheral banks will need to be recapitalised in the wake of the new stress tests that will be conducted in 2014. Finally, while the US dollar will remain under pressure in the very near term, the currency shouldn’t cave in, particularly if the September economic data is encouraging.
Last week’s relative stability of the EUR/USD (between 1.34 and 1.37) should contribute to a further decline in implied volatility towards historically low levels. Three-month implied volatility for the EUR/USD has pulled back below 7% to 6.90%, its lowest level since 2007. Furthermore, it looks set to decline towards 6.50 due to uncertainty around the Fed’s policy going forward, bearing in mind that three-month actual volatility is already at 5.85%.
What is the risk that the EUR/USD will go on to test 1.40? For that to occur, US indicators would need to be relatively poor, so doubts could be cast that the Federal Reserve’s tapering will be under way soon. As yet, our US economists are prudent and expect tapering to be postponed only until January 2014. Over three months, our 1.31 objective for the EUR/USD looks more challenging if the Fed does indeed delay tapering until January or later. All in all, however, we see the EUR/USD above 1.33 at the end of the year.
JPY: weaker
The Japanese yen was erratic last week as it reacted to news concerning the US debt ceiling talks. The currency fell in the lead-up to the deadline, and then rose significantly when a temporary deal had been reached. After testing 99, the USD/JPY went back on the retreat towards 97.7, which contributed to a sharp drop in three-month implied volatility below 10%.
At 97.60, we would be buyers of the USD/JPY, as this is an attractive level to pay a recovery towards 99.6. This is bearing in mind the fact that equity markets will pick up against the backdrop of relatively upbeat quarterly earnings in the US. It is also possible to play a further decline in three-month volatility over coming months by selling a “straddle” (a risky options strategy where the investor holds positions in both call-only and put-only, to cover stock-price movements in either direction).
GBP: higher
Sterling rebounded last week – not just on the back of a weaker dollar but also in reaction to an improvement in economic indicators. Retail sales, for instance, were up 0.6% month-on-month and 2.2% year-on-year for September. Similarly, encouraging British employment data was published, with a sharp decline in September’s claimant count (the number of people claiming Jobseeker’s Allowance). This week, watch out for the “Rightmove” property price index and the minutes of the last Monetary Policy Committee meeting, though the latter is unlikely to influence the market. With all of this in mind, the GBP/USD has upside to 1.6310.
CHF: trendless
The USD/CHF’s rebound to 0.9150 was short-lived. The announcement that US budget talks would resume in December rapidly undermined the US dollar against the Swiss franc, and the pair weakened to 0.902. The pair could correct temporarily as low as 0.896 this week. As for the EUR/CHF, it held above 1.23 and should stay there so long as there is no pick-up in risk aversion.
Commodity currencies: sharp rebound
Commodity currencies appreciated on the back of a weaker US dollar. The AUD/USD broke cleanly above 0.96 to its highest level since last May. The Australian dollar was hardly penalised by the correction of the equity markets, and the currency also benefited from the positive levels seen in the Q3 National Australia Bank survey. As a result, it still has some upside to 0.971.
The New Zealand dollar also appreciated, bolstered by positive economic data and a rise in property prices – stoking expectations the Reserve Bank of New Zealand will raise its interest rates in 2014. At 0.8525, the NZD/USD stands at its highest level since May. It still has upside to 0.865, but profit-taking remains a distinct possibility above this level.
Natixis