CBA FX Strategy
14 April, 2014
New York Open
Tensions in the Ukraine have returned as a market focus. Earlier today Russia sought an emergency meeting of the UN Security Council. This comes after Ukrainian security forces battled pro-Russian gunmen in the eastern Ukrainian town of Slovyansk over recent days. An escalation of the violence, and/or more severe sanctions on Russia, may trigger a bout of market risk aversion. Typically this type of market reaction supports the USD, CHF and JPY.
USD pushed higher into European trading, while remaining near the bottom of its recent range. The USD may lift in the early part of the week as the US economic data rebounds from earlier poor weather. US retail sales are released today (8:30am). However, later in the week Fed chair Yellen is likely to reinforce the view that the FOMC will keep monetary policy very accommodative even after tapering is finished. Overall, we expect the USD to trade this week in the lower end of the range it has traded in the past year. We expect the USD to remain heavy until the real Fed funds rate turns positive in early 2016, or at the very least until the real US-G6 2 year swap rate differential turns positive in early-to-mid 2015.
In US rates, renewed investor caution pushed US Treasury yields lower. Equity markets fell on Friday as the US reporting season was mixed at best, and the large US bank JPMorgan under-delivered on expectations. The flow of money out of equities found a home in US Treasuries. The yield on the 10-year fell another 2.5bpts to 2.625%. This is the low end of the 2.6% to 2.8% trading range. We recommend going short duration at these levels. It is an eventful week ahead, with an array of key data indicators and eight Fed speakers hitting the podium. We continue to believe the US economy is on a firm footing. The time for the FOMC to normalise monetary policy will come toward the middle of 2015, in our view. A move to this view will support higher US yields and push the 10-year back towards 2.8%.
EUR opened the week lower following weekend comments from ECB President Draghi saying the strengthening of the euro “requires further monetary stimulus”. Concerns about the strength of the EUR remain at the front of policy makers minds. President Draghi was quite explicit, stressing that although the EUR is not a policy target, the EUR is an “important element” in its price stability framework and that “further EUR strengthening could trigger additional ECB easing”. These comments add to comments from other ECB policymakers. Late in Asian trade, the ECB’s Noyer noted that a “weaker euro is desirable”. The ECB rhetoric should dampen the EUR over the early part of the week. Eurozone Feb industrial production data had no surprise, conforming largely to market expectation.
AUD is likely to edge higher this week and may reach our short term tactical target of 0.9500. We see two factors supporting the AUD this week: (i) a sluggish USD; and (ii) RBA minutes that are likely to emphasise growing optimism that Australia can successfully transition from mining-led growth to other drivers of growth such as consumer spending, home construction and exports. In particular, the minutes are likely to comment on the strength of the investor housing market because mortgage interest rates are very low. We doubt the RBA will be overly concerned about the high $A because iron ore prices have lifted significantly since early March. A headwind to AUD this week is if the Chinese economic data, particularly Q1 GDP, continues to disappoint economists’ expectations (Wednesday).
In Australian rates, the rally continues and the market is looking very expensive. The US-led rally in rates pushed the 3-year bond future to 97.03. A sub-3% yield on the 3-year contract is far too low in our opinion. We expect the RBA to lift the cash rate to 3.5% by the middle of 2015. The 3-year futures contracts are screaming sells in our opinion. More importantly, the 3-year swap rate is just 3.14 (EFP ~16bps). The swap spread is trading tight around 16bps, compared to the 3m BBSW-OIS spread of 21bps. Outright paid positions on the short end, or steepeners in the 1 to 3 year sector of the curve, take advantage of this mis-pricing, in our opinion. The focus of the investor community this week will be on the RBA minutes, particularly how the RBA talks about the strength of the AUD currency and the housing market.
NZD/USD has tracked sideways through today’s Asian session. NZD/USD was modestly firmer last week, and is likely to remain firm this week. The major NZD catalyst this week is the Q1 CPI data. CBA’s NZ economists (+0.6%QoQ) see upside risk to the consensus (+0.5%QoQ). A firmer CPI would reinforce expectations that the RBNZ will hike rates on 24 April, and could move again as early as June. Results from the fortnightly GlobalDairyTrade auction on Wednesday BST could weigh on NZD late in the week, with strong end of season production keeping downward pressure on prices. Overall, we expect NZD to remain firm this week.
In Kiwi rates, rates have pushed lower through the course of the day, and flattened slightly. The 2yr swap rate is down 2.5bpts, with the US dragging the longer end of the curve down 4bpts (5, 7, 10, 15yrs). The CPI report on Wednesday has the potential to push the rates market around. A stronger than expected read will support the idea of a continued rate tightening in April AND June. The RBNZ has almost guaranteed another rate hike of 25bps to 3%. The question is whether or not the RBNZ moves again in June? We think it is a high probability. The market has this largely priced, but over the next two years we believe there is too much priced in the curve (contrary to Australia).
USD/JPY is likely to trade in a range with a bias to rise this week. Bank of Japan governor Kuroda is likely to emphasise his new message that the BoJ will provide more policy support if needed (Wednesday). While it is too early to see the full effects of the recent increase in the consumption tax on the Japanese economy, partial indicators suggest it is dampening the economy. We see high risks the BoJ increases its asset purchases at the 30 April or 15 July meetings.
USD/CNY midpoint was again higher than we expected at 6.1531. The USD/CNY fixing rate has held in a tight range around 6.15 since late March. Onshore USD/CNY traded sideways through today’s Asian session. The People’s Bank of China (PBoC) continues to sustain the spot at 1% above its midpoint, lifting USD/CNY in late trading session. The offshore USD/CNH has rallied off a softer start to the day and is trading mostly at par with its onshore counterpart on a firmer USD and continued uncertainty over the PBoC’s further actions. We think the PBoC is likely to continue to keep the midpoint around the 6.15 level. In our view, the short-term risk remains on the upside for USD/CNY, despite a sluggish USD. China’s key macroeconomic data is released on Wednesday. The Q1 2014 GDP data is expected to show that China’s economy slowed at the start of 2014, although March monthly activity data on retail sales, industrial production and fixed asset investment are expected to rise modestly following weaker than expected January-February outcomes. We see downside risk to market consensus.
Elsewhere in Asia, the Monetary Authority of Singapore maintained its current monetary policy stance. Singaporean GDP rose by 0.1%QoQ in Q1 2014, which was below consensus expectations for a 0.4%QoQ increase. SGD nominal effective exchange rate (NEER) dropped by a modest 20pts and remained largely unchanged for the rest of the Asian session. We continue to favour SGD underperformance against MYR, which commands around 15% of the NEER basket, as we expect MYR to lift on bond inflows and valuation support. As a result, we re-entered the short SGD/MYR one-month forward position on 2 April at 2.5990 with a target of 2.5500 and stop/loss of 2.6200 The recommendation has a positive carry of 2.30% p.a. (see attached note).
GBP/USD continues to hover around its recent highs. The key focus this week will be on the UK labour market data (Wednesday). The UK ILO unemployment rate is now at 7.2%. The BoE is forecasting the UK unemployment rate to fall below 7% in Q1 2014. The decline in the timelier claimant count unemployment rate in February suggests the ILO unemployment rate should ease lower in February. The market consensus is looking for the UK unemployment rate to ease from 7.2% to 7.1%. We think the risks are tilted to a larger than expected fall in the UK unemployment rate. A larger decline in the UK unemployment rate would support market pricing for the first BoE rate hike in early 2015 and GBP. The diverging outlook for the ECB and BoE policy and persistently negative German-UK two-year swap spread should continue to dampen EUR/GBP.
Upcoming Economic Calendar Highlights Important for Exchange Rates
USD – Retail sales (today), CPI (Tuesday), Industrial production (Wednesday), Beige Book, Jobless claims (Thursday). Fed speakers: Tarullo (today), Lockhart, Yellen, Plosser, Rosengren (Tuesday), Kocherlakota, Stein, Lockhart, Yellen (Wednesday).
AUD – RBA minutes (Tuesday), China GDP, retail, industrial production and investment (Wednesday), RBA FX transactions (Thursday). RBA Speakers: Debelle (Tuesday).
GBP – CPI (Tuesday), ILO unemployment, employment change (Wednesday).
EUR – ZEW, trade balance (Tuesday), CPI (Wednesday), Current account (Thursday). ECB speakers: Noyer (today).
NZD – CPI (16 April).
JPY – Industrial production (Wednesday). BoJ speakers: Kuroda (Wednesday and Thursday).
CAD – Bank of Canada rates announcement (Wednesday), CPI (Thursday).
Asian central banks – Bank of Thailand (23 April).