Main interest in Europe through the morning has been the publication of the full CPI figures for April. The headline inflation reading was unchanged at 1.2% YoY, core inflation likewise at 1.0% YoY. Services inflation in particular dropped sharply to 1.1% YoY from 1.8% YoY. The EUR ignored the release, but the ECB Governing Council certainly will not do so given its current inflation forecasts and growing concern that inflation will undershoot the target. Further monetary easing remains a distinct possibility later in the year, although any further rate cut is not imminent. EUR/USD is trading in a 1.2850-1.2900 range this morning, but remains biased to the downside.
There has been no UK news of note this morning. GBP/USD has drifted sideways today, following yesterday’s volatility. Although the forecast changes in BoE’s Inflation Report were largely as expected, BoE Governor King’s comments that the use of negative rates “remains open to the Committee” if it wished to use them highlight that non-conventional easing measures remain a discussion point for the MPC. Should the incoming UK data disappoint rising expectations, expectations of further BoE easing are likely to build once again, particularly once BoE Governor-designate Carney takes the helm on 1 July. The minutes of the May BoE policy meeting are released on 22 May. Interest will be on whether the 6-3 voting pattern against further asset purchases has changed. As we have outlined previously, the underlying dynamics in the UK, such as negative UK real yields, a large UK current account deficit (3.7% of GDP), a relatively weak underlying UK economy and the ongoing risk of further Bank of England (BoE) policy stimulus suggest GBP should remain under pressure over coming months.
The other main news of note this morning has come from New Zealand. S&P has put 8 New Zealand banks on negative outlook on the grounds of rising economic risks. The banks involved are relatively small in absolute terms and also as a share of the New Zealand banking market. However, the news has fuelled the downward pressure on the NZD which has extended its move down under 0.8150 to a low for 2013 so far. As expected, the NZD showed little reaction the New Zealand Government Budget released today. The key takeout were: (a) The targeted 2014/15 surplus remains intact, though at $75 million, it is wafer thin. (b) Overall debt issuance is pared back NZ$3bn over the forecast horizon. (c) Meridian (electricity generator) has been confirmed as the next State owned enterprise (SOE) for partial privatisation. (d) A macro-prudential tool memorandum of understanding has been signed with the RBNZ. (e) NZ Sovereign credit ratings have been confirmed by Moody's and S&P.
Interestingly, the announcement by the NZ Debt Management Office that it will issue more inflation-linked bonds has implications for NZ's possible inclusion in the World Government Bond Index (WGBI). We recently indicated that the chances of NZ's inclusion had declined because RBNZ and EQC held bonds were deemed not to be eligible. Inflation linked bonds are also not included in the eligible pool of securities. By issuing more inflation linked bonds the chances of NZ being added to the WGBI have declined further, particularly given the assumed rate of issuance and the need for NZ to reach the market size thresholds by our estimated Jan/Feb 2014 cut-off period. While it is still possible, based on our assumptions, NZD/USD would need to rise by 4.5% from current spot by January, NZD/EUR by 7.5% and NZD/JPY by 2% (and hold these levels for 3 months). Nonetheless, non-inclusion in the WGBI would not be a NZD game changer. The capital flows story that has become an increasing source of support for the NZD over recent quarters is unlikely to be significantly impacted should New Zealand not be included in the WGBI. In terms of the capital flow outlook, we estimate that approximately NZ$10bn worth of offshore re-insurance flows have yet to flow into the NZD market. This equates to 22% of NZ’s annual merchandise exports. This also exceeds the amount of foreign purchases of NZ government bonds in the year to February 2013 (NZ$8.8bn). In addition, overall foreign demand for NZD denominated assets and NZ government bonds remains firm. This is being driven by NZ’s ongoing favourable relative macroeconomic dynamics, including New Zealand’s yield advantage. While NZ may not qualify for inclusion in the WGBI, there appears to be an increased chance that the rising issuance of inflation-linked bonds could make NZ eligible for inclusion in the World Government Inflation Linked bond index.
The USD continues to track near yesterday’s levels, despite the weaker than expected April US industrial production report and lower US bond yields. The USD’s recent strength has been driven by the US economy’s cyclical outperformance relative to the other G7 economies, and rising US yields brought on by increased expectations that the Fed may look to taper its asset purchase program. In our view, the US macroeconomic picture has not changed and so we expect the USD to re‑weaken, particularly against currencies linked to stronger performing economies. We expect a speech by Federal Reserve chair Bernanke on the US economic outlook and the FOMC minutes, both on 22 May, to dampen speculation the Fed will soon contemplate tapering its asset purchases. In the interim, FOMC voters Rosengren and Raskin are set to speak today (7.45am EST/12:45pm BST and 12.30pm EST/5:30pm BST respectively). Rosengren is typically dovish and if monetary policy is discussed, he may reiterate his dovish views. Interestingly, Raskin is set to speak on the “prospects for a stronger recovery”. Given she is viewed as being only mildly dovish, views that the outlook for the US economy have improved or that current policy settings could be adjusted could spark market interest. FOMC members Fisher (9am EST/2pm BST) and Williams (3.05 pm EST/8:05pm BST) are also set to speak today, but they are non-voters.
As we noted yesterday, we expect the AUD/USD to track back up towards 1.0310 over coming months given our views that the broader macro environment remain unchanged. In the near-term, movements in AUD/USD will continue to dictated by broader USD moves. AUD/NZD is very interest sensitive. Given the Australia-New Zealand two-year swap spread remains in New Zealand’s favour, we continue to expect AUD/NZD to remain under downward pressure and would look to sell on any rallies.
USD/JPY has edged back up over 102.50 in today’s European session. Overnight Japanese Q1 GDP came in slightly stronger than expected, up 0.9% (QoQ) or 3.5% (YoY). Q4 2012 GDP was also revised up from 0.0% to 0.3%. Although real GDP growth was higher, nominal GDP growth was weaker than expected, up just 0.4% (QoQ) in Q1. The GDP deflator was weaker than expected, contracting by 1.2% (YoY). Deflation remains an issue in Japan. As we have stated previously we do not expect the BoJ to reach its 2%pa inflation target. The BoJ holds its next policy meeting on 22 May. We do not expect the BoJ to make any policy adjustments, however we do expect some comment regarding the volatility and recent rise in JGB yields, and what (if any action) the BoJ could take. Irrespective, we expect the deterioration in Japan’s current account position to continue to push the JPY lower over the medium-term. Buying USD/JPY on dips remains an appropriate strategy.