Group Economics
FX Outlook for 2016
Macro & Financial Markets Research
26 November 2015
Breaking through parity Georgette Boele Co-ordinator FX & Precious Metals Strategy Tel: +31 20 629 7789 georgette.boele@nl.abnamro.com
Roy Teo
• Further US dollar strength in the coming months with EUR/USD to break parity… • …but 2016 should prove the peak for the US dollar, with declines to follow in 2017 • Brexit fears will weigh on UK growth and sterling in 2016…
Senior FX Strategist
• …followed by a strong recovery if Brexit is avoided
Tel: +65 6597 8616
• More weakness in dollar block FX in 2016 but a recovery in 2017
roy.teo@sg.abnamro.com
• Commodity EM FX to turn the corner in 2016… • …so will CEEMA FX versus the euro… • …but the recovery in Asia FX versus the USD will only arrive in 2017 US dollar to peak versus majors in 2016… We remain positive on the US dollar across the board and we expect new highs in 2016; parity in EUR/USD, 135 in USD/JPY, 1.25 in GBP/USD and 1.21 in USD/CHF. Monetary policy divergence and positive investor climate are the main ingredients that are likely to push the US dollar higher. We expect the US Federal Reserve to continue hiking interest rates in 2016 and 2017 reflecting the strength of the US economy, bringing the Fed funds rate to 1.25% at the end of 2016 and 2.25% at the end of 2017.
Fed rate hike expectations December 2016 Fed Funds in %
US Dollar index
2.00
105
1.50
100
1.00
95
0.50 Jan 15
90 Apr 15
Jul 15
Fed funds future Dec 2016 (lhs)
Oct 15 USD index (rhs)
Source: Bloomberg
Insights.abnamro.nl/en
2
FX Outlook for 2016 - Breaking through parity - 26 November 2015
Currently financial markets are expecting less Fed rate hikes. The Fed’s fund futures are only pricing in 0.82% and 1.35% at the end of 2016 and 2017, respectively (see graph above). It is likely that financial markets will catch up to our view of rate hikes for 2016 and 2017 in the course of 2016. At the same time, the ECB and BoJ are set to step up stimulus. The ECB is likely to set up QE and cut its deposit rate deeper into negative territory. We expect US dollar strength to mainly materialize in 2016. It is likely that the slow pace of Fed rate hikes will go hand in hand with an environment of positive investor sentiment. This way the US dollar will fully profit from monetary policy divergence in 2016. If general investor sentiment were to deteriorate, which is not our main scenario; the upside in the US dollar will likely be capped.
Calculated effective exchange rate US Effective exchange rate
170 150 130 110 90 70 75
80
85
90
95
00
05
10
15
Source: Bank of England
‌and to decline in 2017 2017 will be the year that the multi-year US dollar ascent (since 2011) will come to an end. At the start of 2017, most US dollar supportive factors will be reflected in currency markets in our view. In addition, other major central banks will end their quantitative easing programmes. As we have seen in the case of the US, the moment that tapering asset purchases comes to the fore, the currency will likely recover. Therefore, the euro will bottom out versus the US dollar and start its recovery. Central banks in Sweden, Norway and Switzerland will also end their monetary policy stimulus in line with the prospect of tapering by the ECB. As a result, growth differences will start to have a more dominant impact. We judge that the Swedish economy will outperform the eurozone economy in 2017. This should be supportive for the Swedish krona versus the euro, also because it is substantial undervalued. The Norwegian krone should recover strongly if oil prices are moving towards our forecast of USD 75 per barrel (end of 2017, Brent). In the case of USD/JPY the prospect that the Fed rate hikes are being fully reflected in the US dollar will likely stage a recovery of the yen versus the US dollar. According to purchasing power parity, fair value for USD/JPY is just below 90.
3
FX Outlook for 2016 - Breaking through parity - 26 November 2015
Brexit fears will weigh on growth and sterling in 2016‌ Sterling will be the weakest performing major currency in 2016 in our view. Fiscal consolidation, past sterling strength and the fear of a Brexit will weigh on UK growth and result in a later start of the BoE lift-off that currently is anticipated in financial markets. Therefore, we have added sterling short versus US dollar to our high conviction list. We expect that the UK government will hold a referendum on Brexit in the third quarter of 2016. It is unlikely that the BoE will hike before this referendum. Therefore, we pushed our first rate hike to November 2016 from August. Financial markets still expect a one rate hike of 25bp and a 50% probability of another rate hike in 2016. ‌followed by a strong recovery if Brexit is avoided Our main scenario is that Brexit will be avoided. As a result, we expect sterling to recovery strongly following this referendum outcome also because the focus will turn to the start of the BoE rate hike cycle. Compared to market expectations, we see less rate hikes for 2016 but more tightening in 2017. Therefore, we expect a rally of sterling in 2017.
Interest rate expectations important for sterling EUR/GBP
Yield spread Germany-UK
0.96
2.2 1.2
0.86 0.2 0.76 -0.8 0.66
-1.8 10
11 12 13 14 15 EUR/GBP (lhs) 2-year yield spread between Germany and the UK (rhs)
Source: Bloomberg
More weakness in dollar block currencies in 2016, but a recovery in 2017 We remain bearish on the Australian, New Zealand and Canadian dollars mainly because of monetary policy divergence and the continued drag on the economy from the correction in commodity markets. In 2017, we expect the Reserve Bank of Australia, Reserve Bank of New Zealand and the Bank of Canada to tighten monetary policy more than is anticipated by financial markets. This, the recovery in commodity prices and a weakening of the US dollar will likely strongly support these currencies in 2017. Commodity EM FX to turn the corner in 2016‌ Most currencies of emerging market commodity exporting countries have suffered considerably over the recent years. They have declined by between 20% to 55% versus the US dollar. Major emerging market currencies have hit new all-time lows, while others have come close. This sharp weakness was mainly the result of lower commodity
export revenues, weak domestic economies, soft investor sentiment and (geo) political challenges. This currency weakness will likely result in positive developments in the trade balances of these countries. In addition, a stabilisation and slight upward momentum in commodity prices should take away some of the negative sentiment in the currencies of commodity exporters. Moreover, the
4
FX Outlook for 2016 - Breaking through parity - 26 November 2015
slowdown in China will be gradual resulting in general in a constructive investor climate. The latter should lead to investors searching for global growth exposure and higher-yielding currencies. This is positive for currencies where central banks have stopped their easing cycle and the next step is to tighten. CRB and commodity FX CRB index
USD/Commo FX (inverse scale)
500
150
400 200 300 250 200 100
300 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 CRB Index (lhs)
USD/Commo (rhs)
Source: Bloomberg
However, there are also clear negatives for these currencies. Most of them remain vulnerable as interest rates in the US rise. Other headwinds could be the domestic political situation, the economy and possible downgrades. If we take all these positive and negative factors into account we see a recovery in Latin American currencies, the Russian ruble, South African rand because of stabilisation of commodity prices and some improvement on the domestic front. We expect this recovery to continue in 2017. Fed rate hike expectations Brent oil price
USD/Oil FX (inverse scale)
125
300
100
400
75
500
50
600
25 Jan 13
Jan 14 Brent oil price (lhs)
Jan 15
700 Jan 16
Oil FX index (rhs)
Source: Bloomberg
‌so will CEEMA FX versus the euro‌ Economic fundamentals for the currencies of central and Eastern Europe will continue to improve in 2016. The economies of Poland, Hungary and Czech Republic will profit considerably from stronger eurozone growth. Below the surface, inflationary pressures will slowly start to build making the case for monetary policy tightening in 2017 and the abandoning of the EUR/CZK floor at the end of 2016. In addition, the current account deficit of Turkey shows some tentative signs of improving, the central
5
FX Outlook for 2016 - Breaking through parity - 26 November 2015
bank will likely make monetary policy more transparent and the political uncertainty may decrease. In short, we expect most of these currencies to outperform the euro in 2016 and 2017. …but the recovery in Asia FX versus the US dollar will only arrive in 2017 Over the coming year, we expect the Chinese authorities to maintain their current policy of engineering a gradual depreciation of the yuan to support exports and inflate the economy. We also expect the PBoC to defend volatility in the yuan and narrow large discrepancies between the onshore and offshore yuan. As economic growth in China stabilises, capital outflows are expected to decline and this will reduce the need for the PBoC to intervene in the currency market. The IMF is expected to agree with inclusion of the yuan in the SDR basket on 30 November, which will take effect in the course of 2016. In our view, the effect on additional demand from central banks for the yuan as a reserve currency will be limited (the SDR quota represents less than 3% of total global FX reserves) and the role of the SDR as a reserve currency will rise only gradually. We expect the yuan to decline versus the USD 6.55 by the end of 2016 and followed by a stabilisation in 2017. We remain bearish on Asian currencies in 2016 as a weaker Chinese yuan, euro and Japanese yen will remain headwinds for Asian exports and monetary policy easing in Asia will also weigh. Asia ex China GDP will improve moderately in 2017. Inflation will rise across the board and hence central banks are expected to tilt towards a tightening bias. Growth and carry will come into picture in 2017. Valuation of Asian FX should also be more attractive by 2017. As a result Asian FX will recover in 2017. The Monetary Authority of Singapore (MAS) will likely steepen the slope of SGD NEER appreciation in 2017. This should support the Singapore dollar. In the case of Thailand, political stability should materialise in Thailand by 2017.
6
FX Outlook for 2016 - Breaking through parity - 26 November 2015
ABN AMRO major currency 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
26-Nov 1.0616 122.55 130.10 1.5100 0.7030 1.0239 1.0869 0.7226 0.6573 1.3305 9.2727 9.1929 7.4601
Q4 2015 1.05 125 131 1.50 0.70 1.05 1.10 0.70 0.64 1.33 9.50 9.50 7.46
Q1 2016 1.00 127 127 1.41 0.71 1.10 1.10 0.68 0.62 1.35 9.50 9.25 7.46
Q2 2016 0.95 130 124 1.28 0.74 1.18 1.12 0.66 0.60 1.37 9.50 9.25 7.46
Q3 2016 0.95 133 126 1.25 0.76 1.20 1.14 0.64 0.58 1.39 9.50 9.00 7.46
Q4 2016 0.95 135 128 1.27 0.75 1.21 1.15 0.62 0.58 1.41 9.50 9.00 7.46
Q1 2017 1.00 130 130 1.35 0.74 1.15 1.15 0.64 0.60 1.40 9.25 8.75 7.46
Q2 2017 1.00 130 130 1.37 0.73 1.15 1.15 0.68 0.62 1.35 9.00 8.50 7.46
Q3 2017 1.05 125 131 1.46 0.72 1.14 1.20 0.70 0.64 1.30 8.75 8.25 7.46
Q4 2017 1.10 120 132 1.57 0.70 1.09 1.20 0.72 0.66 1.25 8.50 8.00 7.46
Source: ABN AMRO Group Economics
ABN AMRO emerging market currency forecasts
USD/CNY (onshore) USD/CNH (offshore) 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
26-Nov 6.39 6.43 66.6 1,147 1.41 35.76 32.55 13,742 66 2.91 14.23 4.27 27.50 312 3.76 16.54 712
Source: ABN AMRO Group Economics
Q4 2015 6.40 6.40 66 1,190 1.43 36.80 33.00 14,300 60 3.00 14.00 4.20 27.00 310 3.80 16.75 700
Q1 2016 6.45 6.47 66 1,200 1.45 37.00 33.50 14,500 60 3.00 13.80 4.20 27.00 305 3.75 16.50 690
Q2 2016 6.50 6.53 67 1,220 1.47 37.20 33.70 14,800 60 2.95 13.60 4.15 27.00 300 3.70 16.25 680
Q3 2016 6.55 6.57 67 1,230 1.48 37.50 33.80 14,900 55 2.95 13.40 4.15 27.00 300 3.60 16.00 670
Q4 2016 6.55 6.57 67 1,240 1.50 38.00 34.00 15,000 55 2.90 13.20 4.10 26.50 300 3.60 15.75 660
Q1 2017 6.55 6.57 67 1,240 1.50 38.00 34.00 1,500 55 2.85 13.00 4.10 26.25 295 3.55 15.50 650
Q2 2017 6.55 6.55 66 1,220 1.48 37.50 33.70 14,700 55 2.80 12.80 4.05 26.00 290 3.50 15.25 640
Q3 2017 6.50 6.50 66 1,200 1.46 37.20 33.50 14,500 50 2.75 12.70 4.05 25.75 285 3.45 15.00 630
Q4 2017 6.50 6.50 65 1,200 1.45 37.00 33.20 14,200 50 2.75 12.50 4.00 25.50 280 3.40 14.50 620
7
FX Outlook for 2016 - Breaking through parity - 26 November 2015
Find out more about Group Economics at: https://insights.abnamro.nl/en/
DISCLAIMER This document has been prepared by ABN AMRO. It is solely intended to provide financial and general information on economics. The information in this document is strictly proprietary and is being supplied to you solely for your information. It may not (in whole or in part) be reproduced, distributed or passed to a third party or used for any other purposes than stated above. This document is informative in nature and does not constitute an offer of securities to the public, nor a solicitation to make such an offer. No reliance may be placed for any purposes whatsoever on the information, opinions, forecasts and assumptions contained in the document or on its completeness, accuracy or fairness. No representation or warranty, express or implied, is given by or on behalf of ABN AMRO, or any of its directors, officers, agents, affiliates, group companies, or employees as to the accuracy or completeness of the information contained in this document and no liability is accepted for any loss, arising, directly or indirectly, from any use of such n i formation. The views and opinions expressed herein may be subject to change at any given time and ABN AMRO is under no obligation to update the information contained in this document after the date thereof. Before investing in any product of ABN AMRO Bank N.V., you should obtain information on various financial and other risks and any possible restrictions that you and your investments activities may encounter under applicable laws and regulations. If, after reading this document, you consider investing in a product, you are advised to discuss such an investment with your relationship manager or personal advisor and check whether the relevant product 窶田onsidering the risks involved- is appropriate within your investment activities. The value of your investments may fluctuate. Past performance is no guarantee for future returns. ABN AMRO reserves the right to make amendments to this material. ﾂｩ Copyright 2015 ABN AMRO Bank N.V. and affiliated companies ("ABN AMRO").