A modest upward revision to the Eurozone manufacturing PMI has been the main news of note through the morning. The reading edged up to 46.7 from the flash estimate of 46.5, but is plainly still soft. The EUR ignored the news ahead of the upcoming ECB decision and press conference. EUR/USD dipped down to 1.3150 early in the session, but has since edged back up and remains comfortably in a 1.3150-1.32 range. Clearly the ECB meeting is centre stage today.
The majority of economists surveyed by Bloomberg now expect the ECB to cut the refi-rate by 0.25% to 0.5% at today’s meeting. In our view, there appears to be a greater possibility the ECB initiates further measures to improve the Eurozone monetary policy transmission mechanism via more direct bank lending (ECB balance sheet expansion) but we acknowledge a cut to the refi-rate is also a real possibility. The ECB announcement is at 07.45am EST/12.45pm BST, and the press conference at 8.30am EST/1.30pm BST. Ironically, EUR/USD may rally back to yesterday’s high if the ECB eases policy, because the ECB is supporting future growth. In contrast, if the ECB remains on hold, and appears indecisive at the press conference, we expect EUR to ease back below 1.3100.
The USD remained heavy in the wake of the FOMC statement. As expected, the FOMC kept its commitment to buy US$85 billion of assets per month. However, the FOMC inserted an extra sentence in its statement to indicate that it is prepared to increase or decrease its asset purchases. We think the FOMC inserted this sentence to counter some views generated earlier this year that it would taper its asset purchases soon, but also in response to the recent softening of US economic data, as fiscal austerity programs generate headwinds to economic growth. In our view, with inflation very low, economic growth soft and the unemployment rate high, the FOMC are likely to keep the current rate of asset purchases until at least early 2014. However, it is plausible US federal government austerity leads to another mid-year growth slump, repeating the economic pattern that occurred in both 2011 and 2012. The combination of tightening fiscal policy, while the US economic recovery remains fragile, means we do not dismiss the risk the FOMC increases its monthly asset purchases later this year, particularly if inflation continues to trend lower. The prospect of more FOMC policy stimulus risks keeping the USD heavy.
AUD/USD fell further in Asia trading after yesterday’s sharp fall. Weaker regional equity prices, a rally in regional bonds and the unexpectedly soft Australian March building approvals (-5.5%) have weighed on AUD. The softer building approvals have raised the prospect of a rate cut by the RBA on Tuesday. The OIS market is now pricing a 55% chance of a 0.25% rate cut by the RBA on Tuesday and 59bps of cuts over the next twelve months.
We would caution against getting bearish AUD and NZD because the major commodity export prices for both countries, namely iron ore prices, coal prices and dairy prices, still remain relatively high. Furthermore, there is unlikely to be any near-term easing of monetary policy in either Australia or New Zealand. By contrast, last night’s clear message from the Fed, which helped lower US ten-year bond yields to a fresh five-month low of 1.62%, was the Fed are prepared to increase their quantitative easing policy should the need arise. Australia-US and New Zealand-US interest rate differentials remain wide and supportive of AUD and NZD. We favour accumulating both AUD and NZD on these dips.
USD/JPY, USD/CHF and USD/NOK remained in relatively tight ranges, despite the large intra-day falls in AUD and NZD overnight, confirming to us it was not a major “risk off” move across global markets, and the selling in AUD and NZD was more related to model-selling. Despite the recent consolidation in USD/JPY, we still think USD/JPY can reach 100.00 in coming weeks. We retain our view that we have held since late 2012 that USD/JPY will lift because of the collapse in Japan’s current account surplus (to 0.0% of GDP in the three months to February), rather than the recent change in BoJ policy (which we judge will be unsuccessful in its ability to defeat deflation). For more details on our BoJ view, see the attachments.