CBA FX Morning Commentary
Volatility in USD/JPY and cross/JPY, triggered by a sharp reversal in the Nikkei stock market was the main story of today’s Asian trade. There has been no specific catalyst for the moves in the Japanese markets. In an address today, BoJ governor Kuroda stated that the BoJ had announced “sufficient monetary easing”, wished to “avoid increasing volatility in the bond market” and that he “doesn’t expect yields to jump”. Japanese 10-year bond yields are now close to 40bpts above their early April lows. In our view, as Japanese bond yields rise the chances of a BoJ policy response also increase. A key objective of the BoJ’s new policy is to keep JGB yields low. Kuroda next speaks on Sunday at the Japan Society of Monetary Economics (5:50am). Given our long held view that the deterioration in Japan’s current account is driving a structurally weaker JPY, we continue to favour a medium-term strategy of buying USD/JPY on dips, particularly below 100.50.
Following some volatility, the USD index is again tracking near yesterday’s lows. Nevertheless, the USD trade-weighted index is still up 2.4% so far in May. In our view a firmer USD should remain a theme in FX markets over the period ahead. Market participants appear to have shifted their expectations towards a possible tapering of asset purchases by the Fed. By contrast, expectations that the other major G4 central banks (i.e. the ECB, BoE and BoJ) will look to maintain or increase their policy stimulus continue to build. This relative divergence is one factor that should continue to be USD supportive. As a consequence, the incoming US data should have added importance, and suggests that the correlation between the US data and USD should remain. Furthermore, our preferred medium-term indicator of USD direction, the US-G6 two-year swap spread, is now near its least negative levels in a number of years. Relative outperformance in US bond yields should keep the USD firm.
EUR/USD has rallied this morning on the back of a stronger than expected German IFO survey. In line with the month on month improvement in the German PMIs, the German IFO has beat expectations. The business climate index has lifted, but remains below levels from March and February, while the current assessment reading in May is still below its 2013 high. Significantly, the expectations index was unchanged and remains at its lowest level since January. Although the IFO showed improvement, in absolute terms, the IFO indices remain way off their respective highs. The lack of substantial improvement in the Eurozone business surveys suggests the risk of further ECB policy action remains high. Given the recent dataflow, the ECB is expected to downgrade its economic outlook/forecasts when it meets in June. Expectations of additional ECB stimulus should continue to act as a EUR headwind.
GBP/USD is trading a little higher today, but we continue to expect GBP to underperform over the months ahead. We maintain our strategy of selling GBP/USD on rallies. In addition to a firmer USD, we think the mix of a weak underlying UK economy, large UK current account deficit (3.7% of UK GDP), negative real yields and renewed expectations of further BoE policy stimulus (should the incoming UK data underperform expectations) should help guide GBP/USD lower. The breakdown of the Q1 UK GDP data provided further evidence of the weak state of the underlying UK economy
We have lowered our AUD forecasts
We have revised down our AUD forecasts mainly due to USD strength and a decline in Australia’s terms of trade. Forecasts revised from 1.0400 to .9900 Jun-13, .9500 Sep-13, .9600 Dec-13.
Reasons for the downward revision
(1) Increased global commodity supply and a slowing in global commodity demand are generating downward pressure on Australia’s commodity export prices and Australia’s terms of trade.
All of the global base metal markets (except tin) are currently in surplus, which is placing downward pressure on global base metal prices. While Australia is an exporter of base metal commodities, the main driver of Australia’s terms of trade remains the prices of Australia’s two largest commodity exports; iron ore (26% of exports) and coal (18% of exports). The global coal market is in surplus and the global iron ore market is likely to be in surplus in the next six‑to‑twelve months.
Iron ore and coal prices have both experienced price declines over the course of this year. This has extended the decline in Australia’s terms of trade to 17% since it peaked in September 2011. The peak in Australia’s terms of trade from “excessively high levels” to “high levels” initially placed little downward pressure on the exchange rate. But the forecast further decline in Australia’s terms of trade from current “high levels” as commodity supply continues to come on‑stream, is likely to see the AUD/USD adjust lower.
(2) US GDP growth and the near‑term forecast for US GDP growth continues to significantly outpace the other G7 economies’ GDP growth, generating some broad‑based USD strength. While the US economy faces fiscal headwinds, we believe the US economy will continue to expand at a rate considerably greater than the G6 average.
(3) It has now become clearer that the Fed is near the bottom of their monetary policy easing cycle. We expect the Fed to taper their asset purchases in December 2012 and end the asset purchases in March 2014. We also expect the Fed to lift the Fed funds rate at the end of 2014. By contrast, the Reserve Bank of Australia (RBA) remains in an easing cycle. The divergence in the monetary policy cycles is driving downward pressure on the AUD/USD. Adding further broad‑based strength to the USD is the fact that the ECB, BoE and BoJ also remain in an easing cycle. We have also made some adjustments to our EUR, GBP, JPY as well as NZD and CAD forecasts.
(4) Reflecting the relative divergence in the easing cycles described above, most of the upward adjustment pressure on US interest rates relative to Australian interest rates is occurring through the ten‑year bond spread. The adjustments are greater at the ten‑year end of the bond curve because of the Fed’s current commitment to keep the Fed funds rate at exceptionally low levels. This is preventing a large relative adjustment at the short‑end of the US bond curve.
(5) Declining US core inflation has improved the attractiveness of US real yields. With the US nominal ten‑year bond yield now above 2.0% and US core inflation at 1.7%, US real ten‑year bond yields have turned positive and lifted to 35 basis points; their highest level since September 2011. While we believe it will take a larger rise in US real bond yields to generate a significant rise in USD, the lift in the US real ten‑year bond yield into positive territory is USD supportive.
(6) The lift in US real yields and the divergence in the relative monetary policy cycles between the US and the other G4 central banks is reducing the incentive for USD diversification into “other” reserve currencies including the AUD. Global central banks have bought the current dip in AUD, but not in the volumes they did during the AUD dips that occurred during 2011 and 2012. The diversification process into “other” reserve currencies is likely to have temporarily slowed as participant’s re‑assess the improved attractiveness in US real yields.
The slowing in reserve diversification into AUD is nevertheless consistent with a narrowing in Australia’s current account deficit. We forecast Australia’s current account deficit to narrow from its current 3.9% of GDP to 2.3% of GDP. The forecast narrowing in Australia’s current account deficit is a key reason why the AUD is unlikely to collapse.
(7) While China’s currency remains under strong appreciation pressure, the weakness in the JPY and the strength in the USD have led to a broad‑based decline in a weighted basket of non‑Japan Asian currencies. The AUD/USD is unlikely to diverge from the direction in Asian currencies because more than 76% of Australia’s merchandise trade goes directly to Asia. Our observations also indicate that since 1977, large directional moves in USD/JPY are consistent with large directional moves in the US trade‑weighted index.
(8) US offshore equity investment has turned negative for only the second time since 1973. It is likely the US equity market’s out‑performance, as well as the drawn‑out Eurozone recession, has encouraged offshore US equity capital to return back to the US. The equity capital inflow is supporting a firmer USD. This pattern is likely to continue over coming quarters as the US economy out‑performs its G7 peers and at least until the Eurozone bond market begins to price a Eurozone economic recovery.
AUD & NZD Today
Both AUD and NZD were sold down early-on in Asia back below 0.9700 and 0.8120 respectively with Real Money the stand-out sellers, some sporadic Exporter buying into 0.9650/60 and 0.8070 was evident and held the pairings from deeper corrections … AUD also weighed down by the second day of large falls in the ASX and front-page headlines in the newspapers highlighting the change in forecast by a number of banks for the AUD to 0.90c and lower for the end of 2013. We are still expecting any move on the day towards 0.9740/70 to find plenty of selling interest while buyers sit 0.9620/40 in good size. Weaker Trade data in NZ also weighed the pairing down overnight and accounts still are looking to sell rallies ideally as close to the key 0.8180 level as they can, buyers this morning into 0.8050/80. Q1 CAPEX data in Australia is the key release next week and will be watched very closely.