160216 fx watch by ABN AMRO

FX Watch

Group Economics Macro & Financial Markets Research

16 February 2016

New forecasts: USD upside capped by on-hold view Fed Georgette Boele Co-ordinator FX & Precious Metals Strategy Tel: +31 20 629 7789 georgette.boele@nl.abnamro.com

Roy Teo Senior FX Strategist

 We have revised our FX forecasts  Sharp deterioration in investor sentiment leading to…  …reflation efforts by central banks  We now think the Fed will be on hold in 2016…  …which should overshadow impact of more ECB and BoJ easing  We therefore now see limited upside for the US dollar

Tel: +65 6597 8616 roy.teo@sg.abnamro.com

Sharp deterioration in investor sentiment leading to… A number of factors explain the deterioration in market sentiment: 

Fear of a global economic recession (with concerns focusing on the US, China, and emerging markets more widely)



Worries that central banks are not willing or able (out of ammunition) to support growth



Fall in oil prices leading to selling (due to outflows from sovereign wealth funds and FX reserves of oil producing countries)



Lower oil prices hurting energy sector assets (equities and high yield debt securities)

Speculative net positions In contracts

300,000 200,000

100,000 0 -100,000 -200,000 -300,000

12 EUR

13 USD

Source: Bloomberg

Insights.abnamro.nl/en

14 JPY

15 Gold

FX Watch - New forecasts: USD upside capped by on-hold view Fed - 16 February 2016

Volatility in equity markets, such as the VIX and VStocks, has risen substantially. In addition, credit default spreads on banks and Southern European countries have increased considerably, prices of US Treasuries and German bunds have rallied sharply and so have gold prices and the Japanese yen. Against this background, the US dollar has performed badly mainly because of the pricing out of Fed rate hike expectations. In short, the deterioration in investor sentiment has resulted in the unwinding of carry-trades and the closing of substantial open speculative positions. Most positions are quite neutral now. But the surge into the yen has gone too far, signalling fear of another crisis in the making, which we think is overdone.

…reflation efforts by central banks in 2016… We expect major central banks to take measures to support growth and improve investor sentiment. As a result, we now think that the Fed and the Bank of England will refrain from tightening monetary policy this year. In addition, we expect the ECB and the Bank of Japan to cut interest rates further into negative territory (see our Global Daily Insight Downgrading our forecasts: less growth, more stimulus 16 February 2016). FX intervention by Japan’s Ministry of Finance is also likely if the JPY strength persists towards 110 against the USD. We also expect the Norges bank, the Reserve Bank of Australia, the Reserve Bank of New Zealand, the Bank of Canada and Central Bank of Russia to cut interest rates in the coming months to support their respective economies. We expect the PBoC and the Chinese government to proactively stimulate growth and smooth the volatility in the Chinese yuan in the near-term. Asian central banks will also support and re-inflate their economies by easing monetary policy further. We expect more monetary stimulus in Indonesia, India, Taiwan and possibly also in South Korea. The risk of the Monetary Authority of Singapore shifting its modest appreciation of S$NEER to neutral in the next monetary policy meeting in April is also increasing. Moreover, the central banks of Denmark, Switzerland, Czech Republic and Sweden will likely intervene in FX markets to arrest any strengthening of their currencies versus the euro. The central banks of Turkey, Mexico, Brazil, and South Africa will try to stay on hold as long as inflation does not set out of control.

…resulting in lower volatility All in all, central banks around the globe will be forced to support domestic and global growth. These actions together will likely support sentiment in financial markets as well. However, they will all try to lower their currencies and therefore it will be less effective. As a result their policies will likely converge resulting in lower volatility in currency markets. As a result, panic-like moves in the yen, in commodity and EM currencies will fade, especially if commodity prices finally start to recover. Meanwhile, there will be a lack of a strong direction in the yen, US dollar, euro, Swiss franc, Swedish krona, Polish zloty, Hungarian forint and Czech Koruna.

FX Watch - New forecasts: USD upside capped by on-hold view Fed - 16 February 2016

Less supportive central banks in 2017 If in 2016 a solid foundation is set for a revival of global growth, the US Federal Reserve and the Bank of England will hike at a modest pace in 2017. The Norges Bank and the central banks of Denmark, Australia, New Zealand, Canada, Hungary and Poland will also likely start tightening. The SNB, CNB and Riksbank will likely stop intervening in FX markets which is also a form of tightening. Meanwhile, we expect the ECB to end asset purchases during 2017. Against this background the euro will likely experience some upward pressure. The relative performance in the end comes down to the relative impact of the measures. For example the US dollar recovered when the Fed did not ease further and rallied strongly after the tapering. A similar reaction is likely with the euro, the yen and the krona. However, the Fed rate hikes will offset this effect on EUR/USD.

Fed Balance sheet and the USD TWI Index

TWI US

600

110

500

100

400

300 80

200

100 0

Fed

TWI US

Source: Bloomberg, ABN AMRO Group Economics

ECB Balance sheet and the USD TWI Index

TWI EU

300

110 105

250 100 200

95 90

150 85 100

10 ECB

TWI EU

Source: Bloomberg, ABN AMRO Group Economics

FX Watch - New forecasts: USD upside capped by on-hold view Fed - 16 February 2016

Changes to our FX forecasts Our new forecasts reflect the above-mentioned dynamics of central banks’ behaviour, global growth outlook and investor sentiment. Originally we were of the opinion that the US dollar would still have a last leg of substantial strengthening. We no longer hold on to this view. There may be some dollar upside versus majors in the near-term if sentiment improves and other central banks ease monetary policy further. However, we don’t expect the US dollar to reach new highs anymore. This is because also Fed is forced to take into account the negative effect of a strong US dollar on the US economy. As a result of these opposing forces, our forecasts look quite flat especially in EUR/USD where we expect weakening towards 1.05 but not beyond. In 2017, expectations of tapering by the ECB will be seen by financial markets as a prelude for subsequent tightening and will hence exert and upward pressure on the euro at a time that the Fed is tightening. We remain negative on sterling, because we expect the Brexit referendum to weigh on sterling for the coming months pushing GBP/USD towards 1.35.

2y Spread Germany- US, EUR/USD 2y spread in %

EUR/USD

0.0

1.40

1.30 -0.5 1.20 -1.0

1.10 -1.5

1.00 12

2Y spread Germany-US (lhs)

16 EUR/USD (rhs)

Source: Bloomberg, ABN AMRO Group Economics

We have kept our 2016 year-end USD/CNY forecasts unchanged. Our view that China policy makers’ objective of a gradual depreciation of yuan has not changed. Since August 2015 the yuan TWI has declined by about 6-7%. In our view most of the necessary depreciation has been front-loaded and a relatively stable yuan TWI is likely this year. This will help support risk sentiment in yuan and reduce capital outflows. In 2017 a 6.80 USD/CNY rate would imply about 1-2% depreciation of yuan TWI based on our FX forecasts. We remain negative on Asian FX because of monetary policy easing of Asian central banks, a slowing Chinese economy and weaker currencies of major trading partners (Japan, eurozone, China). We have become more bearish on the Indian rupee (INR) as the Reserve Bank of India is likely to tolerate some depreciation in the INR to maintain competitiveness and stimulate exports which have contracted for longer than expected.

FX Watch - New forecasts: USD upside capped by on-hold view Fed - 16 February 2016

ABN AMRO major currency forecasts Changes in red/bold

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

16-Feb 1.1176 114.19 127.62 1.4498 0.7708 0.9861 1.1021 0.7162 0.6598 1.3758 9.4736 9.6217 7.4642

Q1 2016 1.10 116 128 1.45 0.76 1.00 1.10 0.70 0.65 1.40 9.50 9.60 7.46

Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 1.05 1.05 1.05 1.05 1.05 1.05 1.05 117 118 120 122 124 122 120 123 124 126 128 130 128 126 1.36 1.35 1.38 1.40 1.42 1.44 1.46 0.77 0.78 0.76 0.75 0.74 0.73 0.72 1.05 1.05 1.05 1.06 1.07 1.08 1.09 1.10 1.10 1.10 1.11 1.12 1.13 1.14 0.68 0.66 0.65 0.63 0.62 0.64 0.65 0.63 0.62 0.61 0.60 0.58 0.60 0.62 1.40 1.38 1.36 1.38 1.40 1.42 1.44 9.50 9.50 9.50 9.25 9.00 8.75 8.50 9.20 9.00 9.00 8.75 8.50 8.25 8.00 7.46 7.46 7.46 7.46 7.46 7.46 7.46

Source: ABN AMRO Group Economics

ABN AMRO EM currency forecasts Changes in red/bold 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

16-Feb 6.52 6.52 68.3900 1,217 1.40 35.64 33.16 13,395 77 2.96 15.77 4.41 27.03 310 4.00 18.79 701

Q1 2016 6.50 6.50 68 1,200 1.40 35.50 33.40 13,400 74 2.90 15.80 4.35 27.00 310 4.00 18.75 700

Q2 2016 6.55 6.58 69 1,230 1.42 36.00 33.80 13,700 72 2.85 15.80 4.30 27.00 310 4.00 18.50 700

Source: ABN AMRO Group Economics

Q3 2016 6.60 6.63 69 1,250 1.44 36.50 34.20 14,000 70 2.80 15.60 4.30 27.00 310 4.00 18.25 700

Q4 2016 6.70 6.73 70 1,260 1.46 37.00 34.50 14,300 68 2.75 15.40 4.25 27.00 305 4.00 18.00 700

Q1 2017 6.75 6.78 70 1,260 1.48 37.50 34.70 14,500 66 2.75 15.40 4.20 26.50 300 3.95 17.75 685

Q2 2017 6.80 6.83 70 1,270 1.50 38.00 35.00 14,700 64 2.75 15.20 4.15 26.25 300 3.90 17.50 680

Q3 2017 6.80 6.80 70 1,270 1.50 38.00 35.00 14,700 62 2.75 15.20 4.15 26.00 295 3.85 17.25 675

Q4 2017 6.80 6.80 70 1,270 1.50 38.00 35.00 14,700 60 2.75 15.00 4.10 25.50 290 3.80 17.00 670

FX Watch - New forecasts: USD upside capped by on-hold view Fed - 16 February 2016

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