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FX Convictions – Time for Draghi to deliver - 04 March 2016
have come more into focus. In addition, news that London Mayor and Conservative political heavy weight Boris Johnson will campaign for UK exit from the EU was seen as increasing chances of a Brexit. As a result sterling fell sharply; GBP/USD dropped to even below 1.40 and EUR/GBP surpassed 0.79. Recently, sentiment has calmed somewhat resulting in a slight recovery of sterling. Although a Brexit is not our base scenario, we have been negative on sterling versus the US dollar since November 2015 because of a delay in BoE rate hikes, a weaker economy and fears about Brexit ahead of the referendum. As such our short sterling versus US dollar high conviction view has been our top-performing trade this year. We expect GBP/USD to move towards 1.35 ahead of the referendum. However, in the case of no Brexit, sterling could recover sharply as the risk premium is being priced out. Therefore, we have adjusted our end-2016 GBP forecasts. We have recently published a note on the impact of various Brexit scenarios (see Macro Focus – Brexit Scenarios).
We added long NOK versus euro on 19 February 2016 We have added a new high conviction call: long Norwegian krone versus the euro (short EUR/NOK) on 19 February 2016. For a start, our energy analyst expects a recovery in oil prices during the course of this year. This will give a boost to the sentiment for currencies of oil exporting countries such as the Russian ruble, Mexican peso and the Norwegian krone. Norway has relatively strong fundamentals compared to other oil exporting countries, as it has a fiscal surplus and current account surplus. In addition, although we expect the Norges bank to cut policy rates by 25bp in March, most of this is already reflected in the price. It is likely the last cut in the cycle and this would be an insurance rate cut. If oil prices recover as we expect, the Norges bank will likely become less dovish as inflation is close to target. The Norwegian economy is more geared towards the eurozone than the US. We have already in place positions with exposure to the US economy and to the US dollar. A new position in EUR/NOK will therefore diversify our calls as well as an indirect position for an oil price recovery. Last but not least, the Norwegian krone is cheap in terms of valuation. The Purchasing Power Parity level is around 8.15 in EUR/NOK. In short, we expect the ECB to be more dovish than the Norges bank this year and oil prices to recover. In addition, the Norwegian krone is relatively cheap. Therefore, we enter long Norwegian krone versus euro as high conviction view. We place our stop loss at 10.
Yen’s resilience to be temporary Since the Bank of Japan (BoJ) introduced negative interest rates on 29 January 2016, the Japanese yen (JPY) has defied gravity. A deterioration in investor sentiment pushed the yen to 111 against the US dollar. Afterwards the yen has eased to around 114 versus the US dollar. However, taking into account the overall improvement in sentiment, the yen has remained relatively resilient. One would have expected a much weaker yen versus the US dollar in the current environment. The reasons for this behaviour are a bit unclear. Therefore, we have raised our stop loss in USD/JPY from 110 to 112. Nevertheless, we expect the yen to weaken going forward because of an improvement in investor sentiment, more easing by the BoJ and Japanese investors turn abroad for higher return. Indeed, the Government Pension Investment Fund (GPIF) reported that in the quarter
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FX Convictions – Time for Draghi to deliver - 04 March 2016
ending December 2015, they have continued to reduce their holdings in domestic bonds and increased allocations to domestic equities and foreign assets. With domestic yields under pressure since the Bank of Japan (BoJ) introduced negative interest rates on 29 January, we expect the GPIF and other insurers to increase their purchases or overseas assets in search for higher yielding assets. Data from the Ministry of Finance also showed that domestic investors have increased purchase of overseas assets in the month of February after the BoJ introduced negative interest rates on 29 January. This will be negative for the yen as their foreign currency exposures are not fully hedged.
GPIF investment allocation shift
Outward investments from Japan have increased
%
JPY bn
50
3500
40
3000 2500
30
2000 1500
20
1000 10
500 0
0 FB FY 14 Q3
FS FY 15 Q3
DS Lower target
Jan-16
DB Upper target
Source: GPIF, *FB: Foreign bonds; FS: Foreign stocks; DB: Domestic bonds; DS: Domestic stocks
Jap purchase foreign bonds
Feb-16 Jap purchase foreign stocks
Source: MoF, Japan
Both the BoJ Governor and Deputy Governor have recently stated that they are unlikely to lower interest rates further in the next monetary policy meeting this month. This is priced in by financial markets. However, we do not rule out that other monetary stimulus including an enhancement of their qualitative and quantitative easing program will be announced. They are also likely to reinforce that even lower interest rates remains on the cards. In our view, lower deposit rates, further increase in the size of qualitative and quantitative easing program and ETF purchases will result in an indirect weakness of the yen.
RBNZ dovish bias to weigh on NZD We maintain our bearish view on the New Zealand dollar (NZD). The business confidence and outlook indicators declined in February that are weaker than when the RBNZ last cut the OCR by 25bp to 2.5% in December last year. In addition, consumer confidence and inflation expectations have also eased lower. Furthermore, key commodity export prices remain weak and the NZD is stronger than the RBNZ’s forecast by about 4%. However, we expect the RBNZ to keep the OCR unchanged this month as the unemployment rate in the last quarter of 2015 was surprisingly better than the central bank’s estimate. We also suspect that the RBNZ would want to wait for house price gains to slow further before easing again. As financial markets are pricing in about 20% probability that the RBNZ will ease next week, a relief recovery in the NZD is possible. However, we expect the RBNZ to strike a dovish tone next week and signal their discomfort on the exchange rate. Upside in the NZD is likely to be