FX Convictions
Group Economics Macro & Financial Markets Research Georgette Boele, +31 20 629 7789
EUR/USD: new down leg
Roy Teo, +65 6597 8616
DISCLAIMER: This report has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead. This report is marketing communication and not investment research and is intended for professional and eligible clients only.
26 June 2015 We continue to expect US dollar strength Since our latest report on 19 May, we have kept in place our long conviction US dollar views versus the euro, the yen the Australian dollar and the New Zealand dollar. The weakness in the US economy is behind us in our view and economic data will strengthen in the months ahead. This will not only increase investor confidence in the US and the US dollar, it will also trigger a Fed rate hike in September. Currently, money market futures have not even fully priced in one rate hike. We expect two rate hikes this year. This and the upward adjustment interest rate expectations for 2016 should give a strong boost to the US dollar this year. However, this scenario should play out against the background of positive investor sentiment. If investor sentiment were to deteriorate, it is unlikely that the US dollar will profit unless there is market panic. We expect constructive investor sentiment and certainly not market panic.
Still strong conviction in a lower EUR/USD The recent surprising resilience in EUR/USD in the face of the Greek crisis has challenged our conviction of a lower EUR/USD this year. We expect investors to re-focus on monetary policy divergence. Indeed, with the strengthening of the US economy ahead, the spread in government bond yields will widen in favour of the US dollar. Furthermore, the ECB’s aggressive monetary policy easing will weigh on the euro. Given the divergence, it is likely that EUR/USD will test parity between the third and the fourth quarter.
…remain bearish in yen despite delay in BoJ increasing monetary stimulus… We now expect the BoJ to increase monetary stimulus only in early 2016 (from July 2015). However our bearish view on the yen remains as we expect interest rate differentials between the US and Japan to widen further. In addition, outward investments from Japan have accelerated by more than expected with a lower currency hedge ratio.
Dovish central banks to weigh on Australian dollar and New Zealand dollar We expect both the Reserve Bank of Australia and Reserve Bank of New Zealand to lower the Official Cash Rate by 25bp in the third quarter. Weak commodity export prices will also dampen sentiment in both currencies. In addition, the rebound in the US dollar will also push down these currencies.
2
EUR/USD: new down leg - 26 June 2015
Currency Forecasts majors Red/bold = change in forecasts
EUR/USD USD/JPY EUR/JPY GBP/USD EUR/GBP USD/CHF EUR/CHF AUD/USD NZD/USD USD/CAD EUR/SEK EUR/NOK EUR/DKK NOK/SEK
24-Jun 1.1197 123.83 138.66 1.5763 0.7103 0.9323 1.0439 0.7745 0.6881 1.2296 9.2149 8.7553 7.4620 1.0525
Q3 2015 1.00 125 125 1.47 0.68 1.05 1.05 0.73 0.69 1.27 9.50 9.00 7.46 1.06
Q4 2015 1.00 128 128 1.49 0.67 1.05 1.05 0.72 0.65 1.30 9.50 8.50 7.46 1.12
Q1 2016 1.05 130 137 1.52 0.69 1.00 1.05 0.70 0.65 1.31 9.50 8.50 7.46 1.12
Q2 2016 1.05 135 142 1.50 0.70 1.00 1.05 0.68 0.63 1.33 9.50 8.25 7.46 1.15
Q3 2016 1.10 135 149 1.51 0.73 0.95 1.05 0.67 0.62 1.34 9.50 8.00 7.46 1.19
Q4 2016 1.15 135 155 1.51 0.76 0.96 1.10 0.66 0.62 1.35 9.50 8.00 7.46 1.19
Q1 2016 6.35 65 1,140 1.42 34.50 31.80 13,800 48 2.85 12.20 3.85 27.40 320 3.20 15.25 635
Q2 2016 6.37 66 1,150 1.43 34.80 32.00 13,900 47 2.85 12.20 3.85 27.25 325 3.25 15.25 640
Q3 2016 6.38 66 1,150 1.44 34.80 32.20 14,000 46 2.85 12.20 3.85 27.00 325 3.30 15.00 645
Q4 2016 6.40 66 1,150 1.45 34.80 32.50 14,100 45 2.85 12.20 3.85 26.75 330 3.40 15.00 650
Source: ABN AMRO
Currency Forecasts major emerging markets Red/bold = change in forecast
USD/CNH USD/INR USD/KRW USD/SGD USD/THB USD/TWD USD/IDR USD/RUB USD/TRY USD/ZAR EUR/PLN EUR/CZK EUR/HUF USD/BRL USD/MXN USD/CLP Source: ABN AMRO
24-Jun 6.21 64 1,109 1.34 33.77 30.91 13,301 54 2.68 12.15 4.16 27.50 311 3.08 15.39 633
Q3 2015 6.26 65 1,130 1.37 33.80 31.30 13,500 52 2.85 12.20 3.95 27.50 315 3.15 15.50 630
Q4 2015 6.30 65 1,130 1.40 34.00 31.50 13,700 50 2.85 12.20 3.90 27.50 320 3.20 15.50 630
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EUR/USD: new down leg - 26 June 2015
Georgette Boele +31 20 629 7789 Roy Teo +65 65 978616
Performance and update of high conviction views • • •
Dollar has recovered, while the euro has been very resilient… …and the New Zealand dollar has been out of favour We expect more dollar strength ahead and keep our long conviction positions versus euro, yen, Australian dollar and New Zealand dollar
Dollar has recovered…
maintain leveraged overcrowded positions. From a US dollar
Since our previous FX convictions report released on 19 May,
point of view this would make sense, because currently the
the US dollar has recovered across the board. However, the
faith in the US dollar is closely tied to that of the state of the
move has been volatile and has lacked a strong direction. This
US economy and the prospects of Fed rate hikes. In short, it is
is mainly because US economic data have been mixed and
driven by cyclical factors and not safe-haven characteristics.
the FOMC has reiterated that the pace of rate hikes will be
We have seen such behaviour earlier in the year when
slow. Hence financial markets remain somewhat sceptical
investor sentiment deteriorated so did the US dollar sentiment.
about the magnitude of Fed rate hikes this year. Currently, the Fed funds futures have priced in less than one rate hike for
One could argue that the possibility of a Greek exit would still
this year.
make a euro position a risky proposition. So why would it then remain resilient? Investors have a variety of options to choose
Dollar recovers 18 May – 24 June
from in order to position for a lower euro. It can be done in the
Spot performance against the USD, in USD terms, in %
cash market, in the forward market or for example in the options market by buying euro put options. In an environment
1 0 -1 -2 -3 -4 -5 -6 -7 -8
of market panic or a strong momentum movement, investors are urged to position in the direction of the move. How they do this, is of a lower importance. In this situation net-short positions in the euro would increase and the bias for downside protection as well.
Short positions; EUR/USD 1m option bias Number of contracts
GBP
CHF
EUR
CAD
AUD
SEK
JPY
NOK
NZD
Source: Bloomberg
bias in the options market
-50,000
0.0 -0.5
-100,000
-1.0 -150,000 -1.5
…while the euro has been very resilient… A lot has been written by commentators about the resilience of the euro at a time that negotiations between Greece and its creditors were tough and Grexit risk escalated. Explanations have varied as follows. Some have stated that the euro has been resilient because the eurozone without Greece would be stronger. We judge this is very unlikely. A Grexit will likely be messy and painful and financial markets have not priced in this
-200,000 -250,000 Jul 14
-2.0 Oct 14
Jan 15
Apr 15
-2.5 Jul 15
CFTC CME Euro FX net non-commercial futures positions (lhs) 1M options market's bias EUR/USD (rhs) Source: Bloomberg
scenario. In the absence of market panic or strong directional Others have argued that investors have partly closed their
movement, investors are more selective on how they would
substantial euro short positions (see graph on the right),
like to position. For example, they recently have reduced their
because of the lingering Greek uncertainty. So if this case the
overcrowded short euro positions in the cash or forward
euro recovered because of a lower investor appetite to
market. But as they judged that the downside risks remain,
4
EUR/USD: new down leg - 26 June 2015
they have hedged the downside risk in the options market. In
verbal warning from BoJ Governor Kuroda that weakness in
such an instance, the net-short euro positions are reduced
the yen is not a one way bet.
while the downside bias becomes more negative. This has recently played out (see graph above). In short, investors have
…and the Russian ruble under pressure
closed euro short positions and/or partly switched some of
The Russian ruble was the weakest currency in our coverage.
their euro short positions from the spot/forward market to the
For a start, Brent oil prices have edged lower since 18 May.
options market. As a result, the euro has been very resilient.
The Russian ruble has a high sensitivity to oil prices so somewhat lower oil prices weigh on the ruble. In addition, the
Another major driver in our view has been developments in the
Russian central bank has reduced interest rates to support the
bond market, more specifically developments in the 10 year
economy. Working in the other direction, the Central Bank of
yield spread between Germany and the US. The more
Russia has signalled that it is comfortable with the ruble
substantial rise in German Bund yields than US Treasury
weakening to a certain extent. It has stepped intervention in
yields some weeks ago have given the euro (as interest rate
currency market to buy foreign currency at times that the ruble
sensitive currency) the upper hand. Therefore, these
was not very weak.
developments are another important explanation behind the
EM FX sharply lower 18 May – 24 June
rise in EUR/USD (see graph below).
Spot performance against the USD, in USD terms, in %
EUR/USD and 10y interest rate differentials EUR/USD
2
10y GE-US interest rate spread
0
1.25
-1.00 -2
1.20
-1.25
-4
-1.50
-6
1.15 1.10 -1.75
1.05
-8
EUR/USD (lhs)
10y GE - US interest rate spread (rhs)
Source: Bloomberg
RUB
CLP
PLN
TRY
BRL
ZAR
KRW
HUF
SGD
MXN
IDR
TWD
THB
Apr 15 May 15 Jun 15
CZK
Feb 15 Mar 15
INR
-2.00
CNY
-10
1.00 Jan 15
Source: Bloomberg
Since our latest report on 19 May, we have kept in place our long US dollar views versus the euro, the yen the
… and the Australian and New Zealand dollar out of
Australian and New Zealand dollars.
favour… The New Zealand dollar (NZD) was the worst performer sliding
Our open and closed high conviction 2015 views
more than 7% since our last update on 19 May. The main
High conviction views Open Position base currency EUR/USD Short since 20 November 2013 USD/JPY Long since 20 November 2013 AUD/USD Short since 3 July 2014 NZD/USD Short since 30 March 2015
catalysts were a more dovish central bank and weaker than expected GDP print in the first quarter of this year. Financial markets have priced in a 75% probability of 25bp rate cut in July. For more details, please refer to our FX Watch – NZD:
Japanese investors and stop losses being triggered. However,
Closed AUD/USD NZD/USD USD/CAD USD/CNY KRW/JPY EUR/GBP EUR/CHF EUR/SEK EUR/PLN USD/MXN USD/CHF CNH/JPY EUR/MXN GBP/USD
the yen losses were retraced after a more dovish FOMC and
Source: ABN AMRO Group Economics
more bearish, near term upside risk on 18 June 2015. The Australian dollar (AUD) was also out of favour as economic data disappointed and iron ore (Australia key commodity export) prices declined. …weak yen trend intact The Japanese yen declined to above 125 against the US dollar due to higher US Treasury yields, outward investment from
Closed short on 5 February 2014, re-opened on 3 July 2014 Closed short on 6 January 2014 Closed long on 5 February 2014 Closed short on 6 February 2014 on opening Closed long on 5 February 2014 Closed short on 16 June 2014 Closed long on 1 July 2014 Closed long on 3 July 2014 Closed short on 2 September 2014 Closed short on 30 September 2014 Closed long on 31 October 2014 Closed long on 10 November 2014 Closed short on 12 December 2014 Closed short on 19 May 2015 at 14.30
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EUR/USD: new down leg - 26 June 2015
Still strong conviction in a lower EUR/USD
0.62 (from 0.64). We expect the RBNZ to lower the OCR by
The surprising resilience in EUR/USD in the face of the Greek
25bp to 3.0% in the third quarter followed by another reduction
crisis has challenged our conviction of a lower EUR/USD this
by the end of this year. Weak key commodity export prices will
year. We expect investors to re-focus on monetary policy
also dampen sentiment in the currency. Furthermore, the
divergence. Indeed, with the strengthening of the US economy
exchange rate remains more than 10% overvalued against the
ahead, the spread in government bond yields will widen in
US dollar despite its more than 10% decline year to date. A
favour of the US dollar.
reversal of capital flows remains a risk as foreign investors’ government bond holdings remain high. Last but not least,
In addition, the weakness in the US economy is behind us in
narrowing interest rate differentials between New Zealand and
our view and economic data will strengthen in the months
the US will exert downward pressure on the NZD.
ahead. This will not only increase investors’ confidence in the US and the US dollar, it will also trigger a Fed rate hike in
Time to walk the talk RBA?
September. Currently, money market futures has not even fully
Since the RBA shifted from an easing to neutral bias in May
priced in one rate hike. We expect two rate hikes this year.
this year, the AUD has not materially weakened despite the
This and the upward adjustment interest rate expectations for
central bank’s reiteration that a weaker AUD is both likely and
2016 should give a strong boost to the US dollar this year.
necessary. A recent study by the central bank concluded that lower interest rates may not help to stimulate non-mining
However, this scenario should play out against the background
investment. However we still see merits of further rate cuts to
of positive investor sentiment. If investors’ sentiment were to
stimulate ‘animal spirits’. This is essential given that consumer
deteriorate, it is unlikely that the US dollar will profit unless
confidence and retail sales remain weak. In addition, inflation
there is market panic. We expect constructive investor
expectations and wage growth are also trending lower.
sentiment and certainly not market panic.
Furthermore, a lower OCR will help to weaken the exchange rate which is necessary to cushion the income effect of lower
Last but not least, aggressive ECB monetary policy easing will
commodity prices. A weaker AUD/USD towards 0.73 in the
weigh on the euro. Given the divergence, it is likely that
third quarter of this year is expected given that financial
EUR/USD will test parity between the third and the fourth
markets have not fully priced in a 25bp rate cut in Q3.
quarter. So we stick to our US dollar bullish positions. BoJ delay monetary stimulus; remain bearish on JPY Despite delaying our call on the timing of BoJ stimulus from July this year to early 2016 (see Japan Watch – BoJ to delay monetary easing to be published today), we have left our 2015 year-end USD/JPY forecasts of 128 unchanged. First, outward investment from Japan has been stronger than expected. Japan's total portfolio investment abroad in the first 4 months of this year totalled more than JPY 11.9 trillion, 7 times more than the historical average from 2005 to 2014. Second, there is some evidence that the currency hedge ratio of overseas investments has declined. Third, speculative short futures
Decline in AUD less than iron ore prices USD/metric tonne
190
1.1
170 1.0
150
0.9
130 110
0.8
90 0.7
70 50 Jan-09
0.6 Apr-10 Jul-11 Oct-12 Jan-14 Apr-15 Iron ore prices (lhs) AUD/USD (rhs)
positions in the JPY are not overcrowded. Last but not least, financial markets are still underestimating the magnitude of rate hikes in the US in our view. Widening interest rate differentials between the US and Japan will be positive for a higher USD/JPY. More bearish on NZD Since our FX Watch – Initiate short NZD on 30 March 2015, the position has yielded more than 8% despite its negative carry. We see even more downside. We have lowered our 2015 and 2016 NZD/USD forecasts to 0.65 (from 0.68) and
Level
Source: Bloomberg, ABN AMRO Group Economics
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FX Watch – NZD: More bearish but near term upside risks – 26 June 2015
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