The European morning has again been fairly quiet. Main news-flow of note was in the UK. Headline inflation dipped more than expected in April falling to 2.4% YoY from 2.8% YoY in March. Core CPI inflation slipped back to 2.0% YoY. The numbers suggest that inflation may ease a little more rapidly than anticipated by the BoE in its latest inflation forecasts and open the door a little wider to more monetary stimulus in coming months. Indeed, had there not been the much talked about boost to inflation from administered prices which are beyond the influence of the BoE, headline inflation would be significantly lower. GBP took a hit following the print, GBP/USD has fallen down to 1.5170, EUR/GBP is up to 0.8480. There has been no Eurozone news of note through the morning, EUR/USD is still hovering in the 1.2850-1.2900 area. USD/JPY is hovering over the 102.50 area.
The USD has edged lower over the week so far. A number of factors combined to encourage the USD lower yesterday: (a) The Chicago Fed’s national activity index printed at a three-month low indicating still below-trend US GDP growth; (b) Chicago Fed’s Evans (FOMC voter) noted the US economy had improved a lot and is doing well, but fiscal headwinds are present. Evans added he believes the Fed has the right amount of monetary accommodation; (c) Rating agency Moody’s noted that the US Congressional Budget Office’s lower debt projections were a “positive development” but “more needs to be done on the policy front to address this rising debt ratio” post fiscal 2018. Later today, St. Louis Fed President James Bullard (voter) speaks on monetary policy in Frankfurt (11.30am EST/4.30pm BST). Bullard is known to be more hawkish than Evans, and his comments may generate some USD vol. ahead of New York Fed’s Dudley’s (voter) likely dovish speech titled “Lessons from the Zero Bound” (1pm EST/6pm BST). Less than 24 hours later, we get Fed Chairman, Ben Bernanke’s testimony to the Joint Economic Committee. As indicated in earlier comments, we believe Bernanke (and probably Dudley) will re-affirm the Fed’s current open-ended quantitative easing policy, and this should generate some softness in the USD.
AUD/USD showed minimal reaction to the May RBA meeting minutes released today. This was unsurprising, given the minutes revealed little new. The RBA Board continued to note that “the effects of the earlier reductions in interest rates were still working through the economy”. As indicated in the post meeting statement, the “board decided that some of the scope to ease policy should be used”. The use of the word "some" suggests that the RBA's easing bias remains in place. CBA economists continue to expect another 25bpt cut by the RBA in August. In our view, ongoing expectations of further RBA policy easing should continue to act as a headwind to any significant gains in the AUD. But as we have stated earlier this week, the key event for the AUD this week is Fed Chair Bernanke’s testimony. The risks around Bernanke’s testimony appear binary. If Bernanke re affirms the Fed’s current open ended quantitative easing policy (as we expect) the USD will soften and AUD/USD will lift toward 0.9900. However, should Bernanke signal an early end to the current open ended quantitative easing policy, the USD should lift pushing AUD/USD down towards 0.9500.
NZD/USD has lifted 1.4% off yesterday’s opening lows as the USD has softened. But like the AUD, the NZD is likely to be range bound ahead of the pivotal Bernanke speech on Wednesday. Today the RBNZ’s key measure of medium-term inflation expectations eased to 2.1% from 2.2% in the Q3 survey of expectations. NZ CPI inflation, at 0.9%, sits just below the RBNZ’s 1-3% target band. Inflation expectations are further confirmation that inflation pressures are not an immediate concern for the RBNZ. But over the next 9 months, the RBNZ must balance the impact of the elevated NZD versus the acceleration in house price and construction inflation. We continue to expect the RBNZ will leave the OCR on hold until March 2014.
USD/JPY is trading around 102.50 and may remain heavy ahead of Bernanke’s speech on Wednesday. Before Bernanke’s speech, Japan’s April trade balance and the Bank of Japan’s policy meeting are held. Japan’s trade balance (7.50pm EST/12.50am BST) will stay deeply in deficit. 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 trade and current account position to continue to push the JPY lower over the medium term. Our strategy is to buy USD/JPY on dips below 100.50. Our current forecasts predict USD/JPY will reach 110.00 in the second half of 2014, though the risks are for an earlier increase to 110.00, possibly as soon as the second half of 2013, because Japan’s current account surplus has collapsed.
USD/CAD has eased off its highs, in line with the softer USD. Today Mark Carney, delivers his final speech as Bank of Canada (BoC) Governor (12.45 pm EST/5.45pm BST). Given the BoC’s next meeting is only one week away, we don’t expect Governor Carney to say anything to significantly influence interest rate expectations. USD direction is likely to be the greater driver of USD/CAD movements this week, and in this vein, the Bernanke testimony will be pivotal. Nonetheless, looking ahead, the 29 May BoC meeting could prove to be an interesting one. Over recent meetings the BoC has moved to water down its tightening bias. Given the benign inflation, softening labour market and slowing momentum in both the Canadian and US economies, there is a chance that the BoC again moves to temper expectations regarding its interest rate outlook. This could weigh on the CAD, and prove to be the trigger for a repeat performance in AUD/CAD witnessed over recent years.
Since 1995, AUD/CAD has declined in 16 of the last 19 May months (if 2013 is included). Over the years it has declined, AUD/CAD has done so by an average 2%. Yet over June/July AUD/CAD has tended to rebound. Since 1995, the average rise in AUD/CAD over June/July has been 1.2%. Interestingly, if AUD/CAD declined in May (as it has in 15 of the past 18 years), it has failed to bounce back in June/July only 3 times.
RBA Minutes and AUD Rates
The May RBA meeting minutes contained few direct hints on the next policy move, but reminded the market that the policy outlook remains fluid. In deciding to cut in May, the minutes emphasised the lower than expected recent inflation outcomes, weak business conditions and an expectation that non‑mining business investment will remain subdued. The RBA’s emphasis on low inflation outcomes isn’t surprising in light of the Q1 CPI figures and the downgraded CPI forecasts in the SoMP.
In justifying a rate cut, the RBA also emphasised weak business conditions and an expectation for subdued non‑mining business investment. This view adds a dovish tone to the statement and is in line with anecdotal and survey evidence (such as the NAB survey). Business investment will remain a key local focus for the market, with the release of the Q2 Capex survey on the 30th. We think risks lie with a further downgrade in assumptions over business investment by forecasters (resources or otherwise), which could see the Aussie rates structure decline further.
We do, however, acknowledge that the May RBA meeting preceded the better than expected April labour force figures and the sharp fall in the AUD. Specifically, the AUD/USD is down 4.3% and the TWI is down 3.6%. As we said in last our last Swap Weekly, the fall in the currency isn’t at a point where we judge it to be an equal offset to the broader growth and disinflationary risks facing the economy. That said, the recent AUD weakness, does take some of the pressure off the RBA to follow up with another cut immediately.
To the extent that the high AUD has been a key driver of a low for longer rates structure, further falls in the AUD could lead to higher front end rates. But the manner of any further fall in the AUD is critical for the rates market. For instance, an orderly reallocation of portfolios outside of AUD assets on an improving global outlook (accompanied by a tapering of QE) presents some upside risk to Aussie rates. Of course, a fall in the AUD based on a lower growth outlook in Australia would drive a rally in Aussie rates.
AUD & NZD Today
Fairly wide 80–90 point ranges for AUD and NZD overnight giving both Exporter buyers and Asian Macro/Option account sellers opportunities to trade their business but overall they both open slightly weaker this morning than when NY left yesterday …. 14 year lows for RBNZ inflation expectations overnight kept NZD in check with H1 2014 looking the absolute earliest that the RBNZ will look to lift the OCR, 0.8120/0.8220 looks to easily contain this pairing ahead of tomorrow. AUD made session lows following the release of the RBA May minutes where the RBA revealed the 25bp cut earlier this month was needed to spur the economy and that inflation easily remaining in check. This morning we watch good buying interest from Exporters initially and then Real Money towards the lower end of the 0.9750/00 region … any moves above 0.9820 will draw out sellers and stops continue to sit above 0.9840/50. May Consumer Confidence data in Australia tonight.
Thoughts from our Trading Team
Aud/usd: dipped to a low of .9751 quickly overnight after the RBA minutes. It quickly recovered to .9775-80 where NY starts their day. Took out all weak shorts overnight making a high of .9842. Asian names were seen selling up here and Aud subsequently retraced. Looking to trade .9750-.9820 today.
Gbp/usd: down almost 1% off of overnight highs on the back of weaker than expected UK CPI. Broke Friday’s lows at 1.5160 and should remain heavy now. Look to sell rallies up towards 1.5160-80 with a s/l above 1.5215.
Other Points of Note
Amari clarified his comments- - I have previously said that the overly strong yen is in the process of being corrected- I will not say it has been corrected or where it will finish. Hopes the Yen will stabilize at a level that matches fundamentals.
Sgd weaker on story that DBS Bank buying a large stake in an Indonesian bank for $2.5bn
Zar weakness continues on mining violence -1.2% today and now -6.5% since early May
Senior Korean FinMin Official- I expect the second quarter economic indicators to show more effect from the weakening Yen