CBA FX Strategy
2 June, 2014
New York Open
USD likely to remain within established ranges this week despite important US economic data.
Vol. may pick-up slightly as participants digest the incoming global economic data.
EUR has priced an easing at Thursday’s ECB meeting. But Draghi’s comments will be influential.
Further falls in iron ore prices likely to cap immediate AUD upside. But support for AUD is solid.
A lift in China’s Manufacturing PMI & a cut in the partial RRR ratio supportive for the economy.
USD is likely to remain within established ranges this week, despite a host of important US economic data, including US May non-farm payrolls data on Friday. Currency vol. may pick-up slightly given the amount of economic data this week, as well as the important central bank ECB policy meeting. Low US real yields will limit upside in the USD. So will another US$40 billion monthly trade deficit (due Wednesday).
In US rates, yields appear to have formed a base, and the next move could be a break higher. There is an abundance of US economic data due to be released this week. The ISM surveys (both mfg and non-mfg), the Fed’s beige book, and of course the usual data (ADP and jobless claims) leading into the monthly highlight, non-farm payrolls. That said, investors will be fixated on the ECB’s policy announcement Thursday. The ECB is unlikely to fall short of rising market expectations (of a 15bpts cut in the refi rate and 10bpt cut in the deposit rate to -0.1%). An outsized 25bp ECB cut in the refi rate and a suite of policy measures would induce a bond market rally that could be exacerbated by a downward surprise in payrolls (or partially reversed by a positive surprise). We see the balance of risks tilted towards higher US yields, especially relative to European yields.
AUD/USD fell after April building approvals and Q1 company inventories were weaker than expected. Our preliminary estimate for QI GDP is ¾%‑1% (3‑3¼%pa). We will finalize our forecast with tomorrow’s release of the balance of payments and public spending. Over the week, AUD will be influenced by a cross-current of factors. Locally, the RBA policy meeting (Tuesday) will provide an update of the central bank’s outlook on the local economy. Improving capital expenditure plans by the non-mining sector are likely to be welcomed. More evidence of a further narrowing in Australia’s current account deficit and the first estimate of Australian Q1 GDP (Wednesday) are likely to be AUD supportive. Internationally, the important US economic data and ECB policy decision will generate some impact. Iron ore prices have fallen to US$91.80 tonne, their lowest level since Q3 2012. There appears to be a combination of emerging excess-supply and seasonal factors weighing on the iron ore price. This will lower Australia’s terms of trade and over time weigh on the AUD. However, over the weekend, China’s May manufacturing PMI improved more than expected to a five-month high of 50.8. The PBoC also announced plans to cut the reserve requirement ratio (RRR) for some of the rural and smaller banks. We anticipate China’s demand for iron ore to remain firm, supporting Australian iron ore export volumes.
In Australian rates, investors will continue to take guidance from offshore markets. The two main events this week are the RBA announcement (Tuesday) and GDP report (Wednesday). There will be interest in any changes to the RBA’s statement. The local data released since last month’s meeting, have been on the high-side, with another strong employment report, and an upward revision to the CAPEX outlook. More importantly, the Australian Q1 GDP report (Wednesday) is expected to show a healthy gain. A steady hand from the RBA, and another strong GDP report Wednesday, should lead to an adjustment in investor appetite. The risk/reward this week is to be short duration (yields higher) relative to Europe, and the US. The 10-year AU-US 10-year spread may widen from here.
EUR/USD treaded heavy into European trading. The main focus this week will be the ECB policy meeting (Wednesday) and tomorrow’s May CPI is the last important data release before the policy meeting. On that note, today’s German regional numbers underwhelmed broadly market expectation, which point to a weaker than expected Eurozone May CPI reading of below 1% compared with the ECB’s inflation target of 2%. We and the market expect the ECB to announce a mix of policy measures, including a 10-15bpt cut in the refit rate to 0.10% and a 10bpt cut in the deposit rate to -0.10%. This would push the ECB deposit rate into negative territory for the first time. Given the move lower in EUR since the May ECB meeting, a lot appears to be priced in and the ECB simply “meeting expectations” may see EUR recover post the meeting in a classic “sell the rumor, buy the fact” scenario. In our opinion, further large declines in EUR/USD will require a more aggressive than expected policy announcement from the ECB and/or strong signals in the press conference that further policy easing is in the pipeline. This is because the Eurozone’s current account surplus is very supportive for the EUR. However, EUR is likely to remain heavy against GBP and AUD leading into the ECB meeting.
NZD/USD is likely to remain heavy this week because of a modestly firmer USD. NZD will be influenced by global factors this week because there are few New Zealand-specific events scheduled. A better than expected US non-farm payrolls could be the catalyst to push NZD through the 200 day moving average of 0.8356. AUD/NZD is likely to remain near its highest levels for 2014 and the 200 day moving average of 1.0989 but be capped by the heavy iron ore prices.
USD/JPY may lift slightly this week because of a firmer USD. Nevertheless, we expect USD/JPY to trade in a relatively tight range as it has for much of the past 8 weeks. We expect USD/JPY to be capped to the upside by the 200 day moving average of 102.38. The major catalyst for a big move in USD/JPY through this resistance level this week would be a better than expected US non-farm payrolls report. But we see another big surprise to payrolls (following last month’s positive surprise) as a low risk event given the lift in jobless claims in the reference week.
GBP/USD edged up off its lows in late May. The May UK manufacturing (Monday) and services (Wednesday) PMIs are the main data points this week. The BoE meeting on Thursday should be a non-event with no change or post-meeting statement expected. The UK PMIs rebounded in April and we think these levels can be sustained in May. By contrast, the market consensus is looking for a small decline. Firm UK PMI data will further illustrate the positive momentum in the UK economy and support GBP. The contrasting outlooks for the ECB and BoE, negative German-UK two-year yield spreads and relative outperformance in the UK economy should continue to dampen EUR/GBP. AUD/GBP is unlikely to break out of the range it has occupied since late March.
USD/CAD showed little reaction to the disappointing Q1 Canadian GDP data released on Friday. The Canadian economy grew by 1.2% (saar) in Q1. This was below the markets and the BoC’s forecasts. The composition of growth will also be discouraging from the BoC’s perspective, given exports and business spending was weak. The mixed performance in the Canadian economy should see the BoC reiterate that policy tightening is still some way off and the risk of further easing remains (Wednesday). The BoC may also stress that a lower CAD will help the Canadian economy rebalance, given the Canadian dollar has modestly strengthened since mid-March. Dovish rhetoric from the BoC is likely to weigh on the CAD and help AUD/CAD and NZD/CAD rebound from the seasonal weakness in May.
Upcoming Economic Calendar Highlights Important for Exchange Rates and Interest Rates
USD – ISM (today), Fed’s Beige Book (Wednesday), trade deficit (Wednesday), non-farm payrolls (Friday).
AUD – Retail sales, RBA policy meeting (Tuesday), current account deficit (Tuesday), Q1 GDP (Wednesday).
NZD – Q1 Terms of trade (Tuesday), Q1 building (Wednesday).
EUR – May CPI (Tuesday), ECB meeting (Thursday).
GBP – Manufacturing PMI (today), services PMI (Wednesday), BoE meeting (Thursday).
CAD – BoC meeting (Thursday), employment (Friday).