Commonwealth Bank - FX Strategy - NY Open
The International Monetary Fund will release its quarterly Currency Composition of Official Foreign Exchange Reserves (COFER) at 2.00pm (BST). For the first time, the COFER will separately identify central bank reserves held in AUD and CAD. In December 2012, we estimated that AUD and CAD each accounted for about 2% of central bank reserves (see attached). We expect the COFER results to be close to our estimates.
The USD remained firm, despite comments from FOMC participants yesterday reinforcing Bernanke’s 19 June press conference where he stated that the FOMC is in no hurry to lift the funds rate. Three hawkish Fed officials speak today. Stein (a voter) is likely to warn discuss how an extended period of accommodative monetary policy poses risks of asset price bubbles and financial stability (1pm). Two non-voters, Lacker (2.15pm) and Williams (8.30pm), also speak on the economic outlook and monetary policy respectively. Next week’s non-farm payrolls report is likely to show a solid increase of around 170,000 and should not challenge the medium-term upward trend in US yields and the USD. The Fed is closer to the end of its easing cycle than is the remaining G4 and the RBA. The divergence in monetary policy cycles, and elevated real US bond yields suggests the trend of USD strength will remain.
EUR/USD is consolidating a little above 1.3000, having briefly dipped below the figure yesterday for the first time since early June. Dovish ECB undertones over the past week are acting as a EUR headwind. As we indicated over past weeks, the recent lift witnessed in EUR/USD back up towards 1.3400, appeared to have overshot the main fundamental drivers including the German-US yield differential. When combined with our firm USD view, we expect EUR/USD to remain heavy over the remainder of the week and in the run-in to next week’s ECB meeting.
GBP/USD shrugged off poor UK GDP released yesterday. A detailed look at the large downward historical revisions to UK GDP means the “output gap” may be larger than the BoE previously thought. A larger output gap implies less inflation pressures and raises the risk the BoE provides more policy support. The BoE holds its next meeting on 4 July. This is the first for new Governor Carney. We cannot rule out Carney delivers more policy support on 4 July, in the form of increased asset purchases and/or forward guidance on asset purchases or the Bank rate, next week (see attached note). Draghi surprised market participants at his first meeting as ECB President by cutting the refi rate. Carney may even break from tradition and issue a post-meeting statement next week to reaffirm the BoE’s dovish stance. We think that the mix of an ongoing easy policy stance by the BoE and the UK’s widening current account deficit (3.9% of UK GDP) suggests sustained medium-term gains in GBP/USD are unlikely.
AUD/USD traded mostly rangy today. Global equity markets are recovering from the recent sell-off indicating an easing in concern about global growth. Credit spreads are also beginning to ease after a modest widening. But the Australia-US ten-year bond spread is widening. In this environment, AUD/USD can continue to grind higher and our view remains that AUD/USD will end the year at 0.9600 before resuming its depreciation next year. AUD/USD faces the challenge of a strengthening trend in the USD.
A PBoC official indicated that the move to full renminbi convertibility is likely to be hastened. We believe market conditions are ripe for a further widening to the USD/CNY daily trading band. First, USD/CNY spot has retreated from trading at the maximum allowed 1% below the midpoint, pointing to some subsiding demand for CNY. Second, the morning fix has been weaker than expected because liquidity conditions have been more strained in recent weeks. Third, a firmer USD will ensure that even with a band widening, the USD/CNY will remain supported.
With the spot remaining supported also from subsiding inflows in coming months and money market rates starting to fall on improving liquidity condition, the forward curve is expected to flatten more significantly from the second week of July. As such, we recommend selling USD/CY NDF 1 x 12m spread, which has spiked to its widest since the GFC, surpassing even levels seen at the height of European sovereign crisis (see attached).
USD/JPY lifted through 99 for the first time since 10 June and has now clawed back almost half of the 10 big figures loss that started in late May (which saw our long CNH/JPY trade just dip below its stop). USD/JPY ignored the key Japanese economic data released today which showed industrial production surged by 2% in May and core CPI deinflation nudge up to 0.0%pa. We caution that Japan has recorded flat prices (in y-o-y terms) many times before in the past decade only to see deflation return. The large fiscal tightening scheduled for April 2014 risks a recession next year and the return of deflation. We have not changed our view that the BoJ will fail to meet its “2% inflation in two years” objective and that JPY is set for further weakness because of the steep narrowing of Japan's current account surplus, a firmer USD and higher US yields.
USD/CAD rose to as high as 1.0556 during the week, but has now dipped back below 1.0500. Over June, US 10-year yields have risen above Canadian yields, supporting the firmer USD/CAD. USD/CAD last traded above 1.0500 in late 2011, but could easily retest this level unless the USD unexpectedly softens, or April Canadian monthly GDP data (1.30pm BST) is stronger than market expectations centred on a 0.1% lift.