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Further declines in USD/JPY remain the likely short-term outcome

Posted by Marge Maresca on Oct 7, 2013 9:19:00 AM

CBA FX Strategy - NY Open

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The USD has eased lower through the European morning as nervousness over the latest fiscal impasse in Washington transmits to markets. European equity indices are lower across the board, bond yields have pushed down and the CHF is rallying in classic, albeit modest, “risk off” pattern. There was no meaningful progress from politicians in Washington over the weekend, markets are adjusting expectations to the likelihood of another stand-off potentially running down to the wire. Mr. Boehner’s stance appears to have hardened a touch. “The nation’s credit is at risk because of the administration’s refusal to sit down and have a conversation.” He added “we are not going to pass a clean debt limit” as “the votes are not in the House to pass a clean debt limit.” Meanwhile President Obama continues to indicate that he will not negotiate with the Republicans over funding the government or raising the debt ceiling. Plainly the stalemate is still entrenched, although both leaders have also indicated that they expect the debt ceiling to be raised and default to be avoided. Developments in Washington will continue to dominate currency markets from now on until the debt ceiling has been raised in a couple of weeks time, particularly given that the week ahead is a relatively quiet one in terms of economic news flow. The US government remains partially closed for a 7th successive day, non-farm payrolls has not been published and the deadline for agreement on the debt ceiling is October 17th.

AUD/USD is holding up well despite declines in global equity markets and base metal prices and has held mostly over the 0.94 handle so far this morning. Participants dislike the uncertainty of the US government politics. But as yet, there is no need to undertake a large downward revision to US or global economic growth that would impact the valuation of AUD.  AUD cross-rates remain range-bound. We continue to believe AUD/NZD can grind a bit higher as the Australia-New Zealand swap spread narrows somewhat. This week’s release of the Australian September labour report (10 October) will be instrumental in driving near-term direction in the AUD/NZD cross.  Last month, Australian August employment fell by 10.8K, which was well shy of market expectations.  As a result, the unemployment rate edged up to 5.8%.  We expect to see a reversal of August’s numbers and a lift in Australian employment of around 20k in September.  That would be enough to leave the unemployment rate unchanged at 5.8%, and should help provide a boost to Australian swap rates, and the interest-rate sensitive AUD/NZD cross rate.

NZD/USD movements over the week ahead, like other currencies, will largely be a function of US developments. However, we expect the local data to offer a degree of support. We are not expecting a lift in business confidence in the NZIER’s quarterly survey of business opinion (8 October), because confidence is already at a high level.  But we will be looking for continued improvement in sectors other than construction and further advances in the proportion of firms intending to hire or invest.  The survey should provide confidence that New Zealand GDP growth will lift from the drought-affected 0.2% (QoQ) growth in Q2.  Ongoing confidence in the New Zealand economy is supporting New Zealand interest rates, and helping to keep the NZD in a firm trading range centred on 0.8300.  As long as vol. remains contained, early next week NZD/USD should continue to respect its 0.82-0.8400 range of recent weeks. 

USD/JPY remains heavy, indeed dipped back below 97 early in the European session.  In addition to the US political situation keeping USD/JPY heavy, the decline in US-Japan interest rate differentials is also contributing.  Since early September the US-Japan two-year bond spread has narrowed from over 0.33% to 0.22%, while the US-Japan ten-year spread has narrowed from 2.15% to 1.97%.  We expect the US-Japan bond spread narrowing to reverse once the market switches from US political concerns to the eventual timing of Fed tapering. But for now, the narrowing in the US-Japan bond spread remains a headwind for USD/JPY, and
further declines in USD/JPY remain the likely short-term outcome.  Today the BoJ made no change in policy (as expected) and USD/JPY showed little reaction.  The BoJ made very minor changes to the description of the economy with no real consequence.  We think that if the BoJ are thinking of changing policy, it will happen at the next meeting on 31 October.  That is when the BoJ produce new economic forecasts.  Over the coming week USD/JPY movements are likely to remain a function of US developments.  We continue to expect the US government shutdown to be short lived and the economic consequences to be small. Accordingly, our base case is currencies remain within established ranges, albeit at the bottom of the range in USD/JPY’s case. If the partial US government shutdown persists, volatility will begin to increase, and USD/JPY could decline below the 200-day moving average of 96.63. 

EUR/USD continues to hover near its highest levels since early February although continues to hover just below the 1.36 level.  In the short-term, while the US political uncertainty persists, the highly liquid EUR looks set to be a beneficiary of the US government uncertainty, and a generally softer USD.  The Eurozone’s record current account surplus (2.2% of GDP) is a contributing factor in this outcome. EUR/USD could re-test its 2013 high (1.3711), which is less than 1% away.  But we don’t expect ECB President Draghi to talk down the currency unless EUR/USD trades up towards 1.400, around a 6% deviation from ECB forecasts.  The European data calendar is light over the week ahead.  A lift in German industrial output is expected in August (due 9 October) following the unexpected fall in July. The improving Eurozone survey data suggests the gradual recovery should continue.  This is our own and the ECB’s baseline assumption.  According to the ECB, it will take a better than expected recovery to change its forward guidance and easing bias.  The risk of further ECB policy action over coming quarters, particularly to temper any further rise in Eurozone market interest rates, remains significant.  The various ECB speakers this week could reiterate this message.  President Draghi speaks on 9 and 10 October (BST).  While EUR/USD may be supported in the near-term by the softer USD, over the medium-term fundamentals suggest EUR/USD should ease back down.  The German-US two-year yield spread is currently suggesting EUR/USD should be down closer to 1.3300. 

GBP/USD held above the 1.60 level despite Friday’s sell-off and has edged back up to 1.6070
through the morning. There was no particular catalyst for the GBP sell off on Friday suggesting something of a position unwind instead. A dose of profit taking should be little surprise given GBP’s outsized gains over the past 3 months. It remains to be seen whether the rally is now over, but we certainly expect GBP to remain firm over the week ahead, boosted by ongoing improvement in the UK data, and a more sanguine Bank of England.  August UK industrial production data (9 October) should show production growth continuing to lift, mirroring the improvement in the UK manufacturing PMI which is up near 2-year highs.  No change to monetary policy settings is expected at the 10 October BoE meeting. New BoE Governor Carney appears to have become more tolerant of higher UK market interest rates compared to earlier in his term.  Accordingly, it is unlikely there will be any statement following the meeting.  The UK economic recovery has been stronger than we expected, and we expect GBP to remain firm. 

USD/CAD remains range bound within a narrow band centred on 1.0320. We expect this to continue over the early stages of this week.  The uncertainty of the timing of US data releases means USD/CAD vol. is likely to remain low while the US data (particularly non-farm payrolls) remains on hold.  But by the end of the week we will at least receive the September Canadian labour market report (11 October), and will possibly have received the US labour data as well.  In isolation, we expect CAD should receive a boost if Canadian jobs growth of around 15K is recorded, and the outsized 59.8K gain in August is not revised lower.  The underlying trend is one of gradual jobs growth, but the unemployment rate is expected to remain around 7.1%.  USD/CAD vol. may pick up at the end of the week, given the unpredictable nature of the Canadian labour market, as well as the fact that US non-farm payrolls may be released around the same time.  But in the absence of a significant labour market surprise (in either report), we expect USD/CAD will remain trading within its recent range. Firm labour market data in both the US and Canada should keep USD/CAD towards the bottom of the range.

EUR/USD continues to hover near its highest levels since early February although continues to hover just below the 1.36 level.  In the short-term, while the US political uncertainty persists, the highly liquid EUR looks set to be a beneficiary of the US government uncertainty, and a generally softer USD.  The Eurozone’s record current account surplus (2.2% of GDP) is a contributing factor in this outcome. EUR/USD could re-test its 2013 high (1.3711), which is less than 1% away.  But we don’t expect ECB President Draghi to talk down the currency unless EUR/USD trades up towards 1.400, around a 6% deviation from ECB forecasts.  The European data calendar is light over the week ahead.  A lift in German industrial output is expected in August (due 9 October) following the unexpected fall in July. The improving Eurozone survey data suggests the gradual recovery should continue.  This is our own and the ECB’s baseline assumption.  According to the ECB, it will take a better than expected recovery to change its forward guidance and easing bias.  The risk of further ECB policy action over coming quarters, particularly to temper any further rise in Eurozone market interest rates, remains significant.  The various ECB speakers this week could reiterate this message.  President Draghi speaks on 9 and 10 October (BST).  While EUR/USD may be supported in the near-term by the softer USD, over the medium-term fundamentals suggest EUR/USD should ease back down.  The German-US two-year yield spread is currently suggesting EUR/USD should be down closer to 1.3300. 

Upcoming Economic Calendar Highlights Important for Exchange Rates

USD – US Congress developments;  Non-farm payrolls (release date unknown).

AUD – September labour report (10 October); Chinese monthly data (trade balance 12 October, Q3 GDP 18 October); RBA meeting minutes (15 October), RBA Governor Stevens speech (18 October).

JPY – Current account (8 October). 

EUR – German (and other Euro nation’s) industrial production (9 October), Draghi speaks (9 & 10 October) EZ aggregate industrial production (14 October).

GBP – BoE policy meeting (10 October).

NZD – NZIER Business Opinion (8 October), CPI (16 October).

 

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