In reaction to the a series of indicators that confirmed the strengthening of US growth, the US dollar extended its rise against most G10 and emerging currencies. In particular, the labour market is continuing to improve. Furthermore, all of the losses incurred by the equity markets in October have been retraced, with the S&P 500 now standing above its September high.
In other words, there is nothing standing in the way of a monetary tightening by the Federal Reserve come mid-2015. The US 2-year rate is back at its highest levels of September at 0.54%, and can be expected to extend its rise. And although the US 10-year rate has also risen, it is only at 2.40%, which is 20bp below its September high. Furthermore, the Federal Reserve looks set to raise the Fed Funds rate just when the European Central Bank (ECB) and Bank of Japan (BoJ) embark on another round of monetary easing, and when some emerging countries begin cutting monetary policy rates – which might unravel in 2015.
In short, the overall environment remains favourable for the US dollar. That can be seen in the significant positions held by speculative accounts, to the point in fact when the currency is starting to be overbought. The DXY dollar index has broken above 88 and we see it appreciating further to 90-91 in coming months.
EUR: EUR/USD heading lower towards 1.23, then 1.2135
EUR/USD broke below 1.24 after statements by ECB president Mario Draghi confirmed that the ECB’s balance sheet could be expected to increase by EUR 1,000bn following the measures already announced (TLTRO, ABS and covered bonds). Draghi indicated that the Governing Council is unanimous in its commitment to use additional unconventional instruments if needed, in addition to existing measures, to expand the balance sheet by EUR 1,000bn – or if inflation expectations were to weaken further. Lastly, Draghi stressed that ECB staff have been tasked with ensuring the timely preparation of further measures to be implemented – raising the question of what type of measures could be announced.
Certainly, purchases of corporate bonds would fail to do the trick, but would earn the central bank a respite. The only way to really increase the balance sheet is to purchase sovereign bonds. As yet, however, this is unlikely to happen in the short-term.
At its December meeting, the central bank will adjust its growth and inflation forecasts, but we doubt this will trigger the decision to purchase sovereign bonds. Indeed, we believe the ECB will want to wait for the effect of recent measures, notably the TLTRO. Furthermore, it is likely that inflation will stabilise, especially after the euro’s fall.
Under these conditions, the EUR/USD’s slide accelerated to 1.2365, not far off our short-term target of 1.23. The pair could end up rapidly testing our medium-term objective 1.2135, particularly if European economic activity continues to disappoint.
JPY: Buy USD/JPY on any correction, with a target at 117.9
The yen extended its correction in the wake of the BoJ’s decision last week to increase asset purchases. The USD/JPY and EUR/JPY pairing have broken above our short-term targets of 115 and 143, respectively. The BoJ has announced that it will increase asset purchases to JPY 80trn from JPY 60- 70trn given the risks overhanging growth. Concurrently, Japan’s Government Pension Investment Fund (GPIF) has announced it will increase the proportion of foreign assets held on its portfolio. In this respect, weekly data shows a sharp increase in purchases of foreign bonds by Japanese investors, up to JPY 800bn from JPY 40bn the previous week. Lastly, the strength of the US dollar also played a hand in the USD/JPY’s appreciation above 115. Although the pair is overbought, we estimate that, in the short term, it has upside to 117.9.
GBP: GBP/USD heading towards 1.55
Despite some relatively promising macroeconomic data, sterling could not resist the strength of the US dollar. As a result, the GBP/USD is currently testing 1.58. Given the low inflation in September (1.2% year-on-year), sterling does not have much support, especially as the trade deficit is continuing to increase (it reached GBP 9,821m in September, compared with GBP 8,950m in August). While the announcement of a further improvement of the labour market could bolster the currency, the BoE’s Quarterly Inflation Report will be more of a market mover. If this report reveals that the central bank has revised downwards its inflation forecasts, due to the fall in crude oil prices, it will support expectations that the first interest rate hike will be delayed until the end of 2015 – especially if the growth forecast is also trimmed. Under these conditions, the GBP/USD could correct in the short term towards 1.55.
CHF: USD/CHF on course towards 0.984 before parity
USD/CHF has broken above our 0.97 target and remains bullish given the strength of the US dollar, notwithstanding the improvement in Swiss economic indicators. The manufacturing PMI increased to 55.3 in October from 50.4 in September, while inflation recovered to 0% year-on-year in October compared with an expected -0.1%. The EUR/CHF has held near the Swiss National Bank’s 1.20 floor rate given the correction of the single currency and is likely to hold at this level given that the Swiss National Bank stands ready to intervene in the currency market. In the short term, the USD/CHF can be expected to extend its uptrend towards 0.984 and then parity given the US dollar’s appreciation.
AUD: Sell AUD/USD on any rebound to 0.848
Given the deterioration of the Chinese PMI, the strength of the US dollar and the extreme caution of the Reserve Bank of Australia, the AUD/USD corrected sharply to a 4-year low of 0.854 – no longer far off our 0.85 short-term target. The Australian central bank reiterated its intentions to keep monetary policy rates on hold for a prolonged period given the uncertain economic outlook. It also indicated that the Australian dollar could be held at an abnormally high level following the measures announced by BoJ, which could see Japanese capital switch into Australian assets – which offer higher returns.
NZD: NZD/USD heading towards 0.758
In the face of an invigorated US dollar and weak prices for dairy products (New Zealand being a major exporter) NZD/USD’s downturn also accelerated, the pair breaking below our 0.77 target.
Natixis