CBA FX and Rates Strategy
24 Marc, 2014
In US rates, the Treasury curve was victim to some sort of “jiu-jitisu move” overnight (to steal a quote from Dallas Fed President Richard Fisher). The front end of the Treasury curve sold off (yields higher), out to the 7-year point. By contrast, the long end of the Treasury curve rallied (yields lower) beyond the 7 year bonds. The US Treasury curve flattened sharply as a result. The 2 to 5-year sector of the curve has sold off (yields higher) 10 to 20bps since the FOMC delivered a more hawkish outlook last week, implying a faster and more assertive normalisation of monetary policy than many in the market has positioned for.
The US 2s10s curve fell 3bps to 229bps overnight, and is down 15bps since the FOMC’s policy announcement last week. The 5s30s curve spread has collapsed to 183bps from 207bps last week (before the FOMC announcement) and is now at the lowest level since October 2009. The 2 to 5-year sector of the curve has plenty of room to move yields higher still. Investors are likely to demand higher yields as the US economic data improves. Continued Fed tapering, which impacts the 7 to 10-year sector of the curve, is likely to see a more parallel lift higher in rates than that witnessed overnight.
USD weakened suddenly (and inexplicably) late in the New York afternoon because of a surge in the EUR. The sudden weakening in the USD is probably flow-related and should reverse today. The Fed’s commitment to continue tapering asset purchases and updated guidance about a lift in the Fed funds rate in 2015 will encourage a lift in US two-year swap rates and marginal strength in the USD. However, we don’t anticipate strong upside momentum in the USD until the real Fed funds rate gets into positive territory in mid-2016.
AUD/USD reached our short term target of 0.9139 overnight. AUD was supported by a weaker USD and news that the credit rating agency Fitch affirmed the Australia government’s AAA rating with a stable outlook. RBA deputy governor Phil Lowe delivers a speech to ASIC today on financial regulation (3.45pm). However, given the audience and topic, Lowe is unlikely to touch on monetary policy or the currency.
In Australian rates, participants in the 3-year and 10-year bond futures have taken lead from the US Treasury market. The 3-year bond futures contract is up 1bp in yield, whereas the 10-year bond futures contract is down 1bp in yield. Phil Lowe’s speech today is unlikely to have a material impact on market pricing, in our opinion. And we expect a relatively quiet day in the markets, although this may be famous last words. At least there won’t be much on offer in the way of economic data releases. We expect AUD to drift lower today if the USD rebounds in line with our expectations.
EUR/USD remains resilient, shrugging off slightly weaker German and Eurozone aggregate March flash PMIs, and a more narrower nominal and real German-US two-year yield spread to bounce back in the New York session. The moves in NY in EUR/USD appear flow related. In terms of the data, despite the consolidation the Eurozone composite remains close to its highest level since mid-2011. Both French PMIs moved back into expansionary territory for the first time since Q1 2012. Conversely the output price components of the PMIs remain weak and point to sustained low inflation in the Eurozone. The German IFO is released today (8pm AEDT). Given the weaker than expected March German PMIs we see downside risks to the consensus already looking for a moderation in the IFO. In addition, ECB President Draghi speaks today (3am AEDT). Should policy be discussed, Draghi is likely to reiterate the ECB’s easing bias and/or negative impact of the high EUR on Eurozone inflation. A softer German IFO and dovish comments from Draghi may take the gloss off the EUR and see it reverse the overnight spike. This may also see AUD/EUR continue to grind higher.
GBP/USD has consolidated just above the 100-day moving average (1.6435). Today, February UK CPI is released (8:30pm AEDT). UK CPI has drifted lower over the past year, and in January pushed below the BoE’s 2% target for the first since November 2009. Given the persistent shop price deflation we think the risks are tilted to UK CPI coming in below the market consensus looking for 1.7%pa. A lower CPI print could see market expectations for future BoE policy tightening be pared back and weigh on GBP intra-day. Barring an increase in risk aversion, AUD/GBP should remain firm in the near term.
Upcoming Economic Calendar Highlights Important for Exchange Rates
USD – durable goods orders (Wednesday), GDP Q4 (Thursday). FOMC speakers: Lockhart, Plosser (Tuesday), Pianalto (Thursday).
AUD – RBA Board meeting (1 April). RBA Speakers: Lowe (today), Stevens and Lowe (Wednesday), Stevens (3 April).
EUR – CPI (31 March). ECB speakers: Draghi (today).
GBP – CPI (today), retail sales (Thursday), GDP, Current Account (Friday). BoE speakers: Dale (Friday).
NZD – Trade balance (Thursday).
JPY – CPI (Friday).
CAD – GDP (31 March).