CBA FX Strategy
30 March, 2014
USD risks are to the upside this week. There is a large amount of US economic data due this week, including US non-farm payrolls (Friday). While we envisage the seasonally improving weather in the US will be reflected in the US economic data, we don’t expect a strong USD reaction to the US economic data. Neither the FOMC’s higher end-2015 and end-2016 interest rate forecasts, or selected upside US economic data surprises have been able to generate a firmer USD. In fact, the USD is some 3.0% lower today than when the Fed first muttered they could begin tapering some twelve months ago. We believe it will take a lift in the real Fed funds rate to generate sustained USD strength.
In US rates, investors in Treasury notes pushed yields higher into week’s end. The 10-year Treasury note, currently 2.72%, has been trading between 2.6% and 2.8% over the month of March. We continue to look for a gradual move higher in US yields as the data improves and investor sentiment returns. We see the US 10-year yield testing the top of this range in coming days. This week, newly-minted Fed Chair Janet Yellen speaks again tonight. Yellen is likely to reiterate the US economy is on a firm recovery path and the Fed remains committed to withdrawing (or unwinding) the extraordinary monetary stimulus. We believe the ISM manufacturing survey, Tuesday, is due to snap back from the severe weather affects, as the regional surveys (Empire State, Philly Fed, Chicago Fed, and Markit PMI) have picked up recently. Finally, the payrolls report this week will be watched closely. The market consensus is for 200k, and we are on consensus. A 200k report would meet expectations, no more. A significant print above 200k would fuel “risk on” sentiment and see the 10-year US Treasury yield break through the high-side of its recent range of 2.8%.
AUD/USD is likely to remain firm this week. AUD has been the best performing major currency over the last two-weeks and the factors driving AUD higher over recent weeks have not changed. This Tuesday’s RBA board meeting is likely to repeat the view the Australian economy is coping well with the economic transition from mining-led investment to other forms of economic activity. The board meeting is also unlikely to deviate from the published observation that the AUD is “high by historical standards” but neither we nor the market, perceives this as an effort to talk the AUD lower. Other important Australian and Chinese economic data released this week may affect AUD’s intra-day direction, but AUD should close the week higher for a third consecutive week. Today, we should get some further month-end activity in AUD hedging, but the relatively flat monthly performance of the global MSCI stockmarket index suggests only a mild pick-up in vol.
In Australian rates, swap rates are likely to grind higher this week in line with the US. The local data has the potential to lift rates later in the week, however. The initial focus in the market will be the RBA announcement on Tuesday. The RBA statement is unlikely to break any new ground, however. The rates market is likely to be on high-alert leading into the announcement, but ultimately look through the “on hold for a period” commentary. Further out, the Australian retail sales and the trade balance reports have the potential to push yields higher. CBA internal indicators suggest a strong pick up in household consumption, and our economists are forecasting 0.5% (consensus 0.3%) for retail trade in February. The trade surplus is likely to remain in February (with a CBA forecast $850mn) following the bonanza A$1.43bn surplus in January. The upbeat data is likely to support sentiment towards the next move in monetary policy being a rate hike in Australia. And this should be reflected in pulling forward hike expectations in the rates market.
USD/JPY should trade in a range with a slight bias to lift this week. Following a 3.8% surge in January, we expect Japanese industrial production to ease; our view is more pessimistic than consensus looking for a modest 0.3% increase (10.50am). The Q1 2014 Tankan survey of Japanese businesses is widely expected to paint a strong picture of the Japanese economy (Tuesday). We agree Q1 will be strong for Japan though warn much of the strength in Q1 may reflect a “bringing forward” of spending ahead of the 1 April consumption tax increase (as occurred in 1997). We expect a large fall in consumption spending after the tax is increased and see high risks the Bank of Japan increases monetary policy support that pressures Japanese swap rates lower, supporting an increase in USD/JPY and AUD/JPY. AUD/JPY should continue to grind higher this week in line with a stronger AUD and end the quarter very close to our forecast of 95.23.
EUR/USD continues to hover just above its 50-day moving average (1.3725). There are a number of EUR event risks this week including the flash estimate of March Eurozone CPI (today) and the ECB policy meeting (Thursday). The slowdown in German CPI in March, released on Friday, should see Eurozone CPI ease down from 0.7%pa to 0.6%pa in March. A larger than expected slowdown would raise expectations the ECB could announce further stimulus later in the week. While we do not expect the ECB to adjust its policy settings in April, the ECB’s ongoing easing bias, weak Eurozone inflation and credit dynamics suggest there is a risk particularly if March Eurozone inflation is weaker than expected. Irrespective, we think the ECB will stress that its options remain open, in an effort to keep a lid on the EUR and its negative impact on Eurozone inflation. While EUR/USD may remain contained given the lacklustre momentum in the USD, EUR should underperform the AUD, NZD and GBP.
GBP outperformed at the end of last week, helped along by data that showed momentum in the UK services sector picked up in January. Focus this week will be on the UK manufacturing PMI (Tuesday) and UK services PMI (Thursday). While we think both UK PMIs are likely to moderate slightly on the month, they should remain historically high and indicative of positive momentum in the UK economy. The firm momentum in the UK economy and ongoing market expectations that the BoE could begin to tighten policy later this year should keep GBP firm against the USD and EUR.
USD/CAD bounced up from 3 week lows on Friday, receiving support at the 1.10 level. Canadian monthly GDP data for January is released tonight (11:30pm AEDT). A solid 0.4%MoM rise is expected, though this will only partially unwind the 0.5%MoM fall in December. A better than expected outcome would see a further lift in Canada’s economic surprise index, which has become less negative thanks to stronger than expected Canadian manufacturing sales, retail sales and CPI outcomes. Improved Canadian economic data could see USD/CAD remain under pressure this week, although the less-negative US-Canada two-year swap spread could limit any weakness in USD/CAD.
USD/CNY closed trade largely unchanged on Friday, after rising through the week. Comments from Chinese Premier Li Keqiang that China can’t ignore the dangers of increasing downward pressure on the economy and there are “difficulties and risks” have added to expectations of supportive policy action, either through looser monetary, or fiscal policy. China’s official purchasing managers manufacturing index is released on Tuesday, and is expected to ease modestly lower but remain above the key 50 level. A weaker than expected outcome will add to pressure for a policy loosening in China.
Elsewhere in Asia, the next Asian central bank meeting is the Reserve Bank of India (Tuesday 1 April). We expect rates to remain unchanged at 7.0%, with new RBI Governor (ex IMF Chief Economist) Raghuram Rajan, focussed on reducing still high wholesale and retail inflation. Nevertheless, we anticipate further near-term strength in INR, with USD/INR likely to head toward 59.50.
Upcoming Economic Calendar Highlights Important for Exchange Rates
USD – ISM (Tuesday), ADP (Wednesday), ISM non-manufacturing (Thursday), payrolls (Friday). Fed speakers: Yellen (Monday), Lockhart, Bullard (Wednesday), Fisher (Friday).
AUD – RBA Board meeting, China manufacturing PMI (Tuesday), Retail sales, trade balance (Thursday). RBA Speakers: Glenn Stevens (Thursday).
EUR – Eurozone CPI (Monday), PMI composite, ECB meeting (Thursday). ECB speakers: Draghi (Thursday).
GBP – PMI Manufacturing (Tuesday). BoE speakers: Bailey, Carney, Andresen (Monday), Bailey (Tuesday), Cunliffe (Wednesday), Haldane (Friday).
NZD – CPI (16 April).
JPY – Tankan (Tuesday).