CBA FX Strategy - New York Open
The week has started very quietly in Europe. There has been no newsflow of note through the morning and currency markets have been fairly directionless. EUR/USD is still hovering under the 1.37 level, USD/JPY has inched back over 98. Bond and equity markets have also been fairly subdued to start the week.
USD sentiment remains poor. The majority of market participants now believe the Fed will delay tapering until 2014. We are clinging to a December start to tapering, but recognise the risks are heavily skewed towards a later start to tapering. We are not due to hear Fed Chairman Ben Bernanke’s FOMC driven views until the FOMC meeting next week (Wednesday October 29). The Fed will be guided by the economic data. US September non-farm payrolls is released tomorrow. Expectations centre on a stronger number (180k) than in August (152k). This week we also may also get the release of US September housing starts and building permits. Part of the reason the Fed delayed the commencement of tapering was because the recovering momentum in the housing market indicators is beginning to falter. A re-acceleration in the US housing data, consistent with consensus expectations, is necessary if the data is released on Wednesday (dependant on the returned US government workers data release schedule). The US ten-year swap rate at 2.70% remains consistent with a market that is re considering the timing of the Fed tapering and looking for a 2014 commencement. We anticipate the US ten-year swap rate would be closer to 3.0% and the US two-year rate would be above 50bpts at the time the Fed begins it tapering. If this week’s US economic data comes out at or slightly above expectation, we anticipate a modestly firmer USD.
AUD/USD direction will this week be driven by the USD and the swap market’s reaction to the Australian Q3 CPI (Wednesday). While the annual rate of Australian inflation is forecast to decline, the quarterly rate of inflation is due to be higher and we have clearly past the low point in the Australian inflation cycle. There may be an unusual amount of volatility in the Australian inflation numbers because the inflation data includes the quarter when the AUD dipped more than 8% but endured a quarterly decline of more than 4.0%. Having said that, the trend over recent years has been for a reduced amount of pass-through from currency movements into local inflation. A higher than expected inflation outcome would lift Australian swap rates and the AUD. It is becoming increasingly clear that while the RBA remains concerned about the economic growth transition from mining investment to non-mining investment, the RBA is also somewhat concerned about record low interest rates lifting local Australian house prices to elevated levels. The front-end of the Australian OIS curve remains very flat close to 2.50%. Our strategic view is that AUD can lift to the 200 day moving average of 0.9758.
NZD/USD is trading a little under 0.8500, and looks set to consolidate at this level over the week ahead. NZ data this week should capture two positive local themes, but the releases are unlikely to push the NZD too much higher, particularly if the USD firms somewhat this week, as we expect. New Zealand net migration flows have stabilised at around +2,000 a month over the last few months. The positive inflows are an encouraging sign for retailers, but also add to the demand in New Zealand’s tight housing market. We expect a slight narrowing in the September merchandise trade deficit. This partly reflects the recovery in dairy export volumes, following the sharp drop in August caused by the Fonterra contamination scare. The high level of milk production in recent months also points to a recovery in dairy export volumes. We expect NZD/USD will struggle to press too far beyond 0.8550 this week, unless the USD is much softer than anticipated.
USD/JPY has opened the week in the middle of October’s 96.50 – 99.00 range. This morning’s large September trade deficit undermined the JPY a little, USD/JPY has pushed back up over 98. But there is little else on the calendar in Japan in coming days, Friday’s Japan September CPI data are unlikely to have a lasting impact on USD/JPY either; we expect USD/JPY direction will be more a function of USD direction this week. Technically, USD/JPY appears to be in a narrowing range. As we mentioned last week, we anticipate USD/JPY can soften further in the short-term, down to the 200-day moving average of 97.18. But we anticipate a break higher in USD/JPY out of the current technical pattern and driven by both a USD recovery and a weaker JPY. A strategy of buying longer-dated (two-month) vol. in USD/JPY may prove fruitful if we are right about the eventual break higher in USD/JPY.
EUR/USD ended New York trading at its highest weekly close since November 2011, but just shy of the February 2013 intra-day high. The pair has been treading water just under 1.37 so far this morning. We expect EUR/USD will be largely determined by USD direction this week. Given our outlook for a slightly stronger USD, we expect EUR/USD to ease towards 1.3505 (30 day moving average). The advanced estimates of the October purchasing managers’ indices are the main Eurozone event this week (Thursday). We expect further improvement and convergence of economic conditions between the core and periphery Eurozone economies. However, the Eurozone PMIs will still lag the US equivalent (ISMs) by a large margin. A very weak recovery compared to the US will be the main message from the Eurozone PMIs. In our view, fundamental influences such as the negative German US two-year yield spread suggest further large gains in EUR/USD will be difficult to achieve.
GBP/USD will be determined by USD direction and UK developments this week. Bearing down on GBP will be a slightly stronger USD (see above). Providing a partial offset to these USD trends is likely to be further positive UK economic news. The NIESR economic growth indicator suggests UK GDP (released Friday) will show the strongest growth (of 0.8%) since Q2 2010. With expectations for UK GDP high, there is room for disappointment, adding to GBP downside. The minutes from the BoE’s 10 October policy meeting are likely to show little support for policy easing, greater optimism about the UK economy, but concerns about the-then US political developments and the elevated level of UK yields (Wednesday). The BoE Governor speaks at a Financial Times event, including a press conference (Thursday). The trends in GBP/USD and EUR/USD we expect are likely to see EUR/GBP ease below 0.8400 this week.
USD/CAD is now back trading around 1.0300, where it was for most of late September and early October before the US fiscal concerns intensified. Canadian CPI data last Friday showed core inflation pressures in Canada remain low, with the core CPI printing at 1.3%p.a. With plenty of slack still remaining in the Canadian economy, core inflation pressures are expected to lift only modestly over the year ahead. No change to policy settings is expected from the Bank of Canada at this week’s decision on Wednesday 23 October (1am Thursday AEDT). However, it will be interesting to see how the BoC views the recent period of weakness in Canadian growth, as well as the threats to US growth. The Bank also releases a full set of forecasts this week. We continue to expect the Bank of Canada will begin lifting rates in the second half of next year, but USD/CAD should lift back towards 1.0400 this week on both a firmer USD, and a cautious outlook from the BoC – particularly if it revises down its inflation and growth forecasts.
Upcoming Economic Calendar Highlights Important for Exchange Rates
USD – Non-farm payrolls (Tuesday); US building permits and housing starts (Wednesday); FOMC meeting (30 October); US retail sales (release date unknown).
AUD – Q3 CPI (Wednesday); China non-official October PMI (Thursday).
EUR – Advanced October PMIs (24 October).
GBP – Minutes from BoE policy meeting (Wednesday), Q3 GDP (25 October).
NZD – RBNZ Official Cash Rate review (31 October).
CAD – September CPI (today), Retail sales (Tuesday), BoC policy meeting (Wednesday).
JPY – BoJ policy meeting (31 October).