160322 fx watch by ABN AMRO

FX Watch

Group Economics Macro & Financial Markets Research

22 March 2016

The dollar rally is over Georgette Boele Co-ordinator FX & Precious Metals Strategy Tel: +31 20 629 7789 georgette.boele@nl.abnamro.com

 The dollar multi-year uptrend is over in our view  The uptrend rested on three crucial drivers:  Monetary policy divergence, rising EM risks and the collapse in commodity prices  Recently these three drivers have become less positive for the dollar  ECB and BoJ policies are not aggressive enough to pull down their currencies and the Fed will likely stay on hold…  ...as well the outlook for commodity prices is improving …  …and RM risks are priced in…  Political risk is rising in the US and the technical picture has turned Introduction The US dollar has seen a strong rally over the last few years. The US dollar index rose by 36% from September 2012 to February 2016. However, it is down by close to 7% since February of this year. The rally did not come in one straight line. The largest moves were in the following periods: September 2012 to May 2013 and July 2014 to March 2015. We have been positive on the US dollar since the end of 2012. We now think that the dollar’s upswing is over. Below we explain why and set out our key FX forecasts. In tomorrow’s FX Weekly we provide more details on the individual pairs.

Calculated effective Exchange rate US Index

130 120 110 100 90 80 70 00

Calculated Effective Exchange rate US Source: BoE, Bloomberg

Insights.abnamro.nl/en

FX Watch - The dollarr rally is ove er - 22 March h 2016

US do ollar strength h rested on th hree importan nt drivers The US S dollar bull ru n rested on thrree important drivers d namely monetary polic cy diverge ence (Septemb ber 2012 - May y 2013 and July y 2014 – Marchh 2015), the co ollapse in commo odity prices (Ap pril 2011 – mid d February 2016) and the risee in emerging market m risks which led to a collapsse in EM currencies (commod dity EM FX midd 2011 – Febru uary 2016). cember 2012 th he landslide ele ection victory of o Prime Ministeer Abe in Japan changed In Dec the ove erall outlook on n the yen. This s is because mo onetary policy would be gearred towards weake ening the yen. A As soon as exp pectations of su uch a policy staarted to surface, the yen was pu ushed aggresssively lower. In 2014 the ECB also shifted too a much more aggressive monetary policy. Thiss pushed the euro e sharply low wer as a result.. Meanwhile, th he Fed moved d into the oppossite direction by b preparing financial marketss for tapering QE Q in 2013 and the possibility off lift-off in rates thereafter. This monetary poolicy divergence e played a cruciall role in boostin ng the US dolla ar. opments that also a pushed the e dollar higher are the rise in emerging Two otther key develo market risks, with mu uch slower grow wth in most economies, and tthe collapse in commodity prices (these trends a are closely rela ated). Emerging market weakkness was mainly the result of o weak fundam mentals from growth g to high US U dollar-domiinated debt as well as fiscal and a current acccount dynamics. The prospec ct of the Fed taapering (in 2013 3) and afterwa ards the lift-offf (with speculattion building fro om July 2014 oon) weighed on n these countries because off the dependen nce on US dolla ar financing annd investors turrning to the US as destination forr their investme ent flows. The sharp fall in coommodity prices (since mid-20 011) had a dram matic impact on their econom mies while politiics in some countries took things from bad to wo orse (for example Brazil and South Africa). Recently, these three drivers have becom me less positiv ve for the US dollar. d

Balan nce sheet and d yen Index BoJ B balance sheett

TWI Japan

500

200

400

175

300 150 200 125

100 0

100 06

0 09

10 BoJ

12 2

TW WI Japan

Source: Bloomberg, ABN N AMRO Group Ec conomics

ECB and a BoJ polic cies not aggrressive enoug gh to pull dow wn their curre encies… The dy ynamics for mo onetary policy divergence d hav ve changed thiss year. For a start, the ECB and a the Bank off Japan will like ely continue mo onetary policy easing but their policies are not as effective in n generating cu urrency weakness anymore. In the case of the ECB, the foc cus is now on tthe credit channel rather than to take measuures that aim to o weaken the euro further (such h as deposit ra ate cuts). The Bank B of Japan may have com mmunicated that it is willing to cutt rates further into negative te erritory but alsoo here there seems to be a limit. Financial F marke ets have underrstood these lim mitations and hhave pushed the euro and

FX Watch - The dollarr rally is ove er - 22 March h 2016

the yen higher as a rresult. In additio on, QE may be e very successfful in weighing on the currency at the start but after some e time it also los ses some of itss impact. We have seen this with the Fed and d the US dollar and we are no ow also experieencing it with th he euro and the yen. In short, we expect that the e BoJ and the ECB will not bee aggressive enough e to push down d their curre encies.

Balan nce sheet and d euro Index ECB E balance sheeet

TWI eurozone

300

110 105

250 100 200

95 90

150 85 100

80 06

0 09

10 ECB

12 2

T EU TWI

Source: Bloomberg, ABN N AMRO Group Ec conomics

…and d the Fed like ly to stay on hold… Across s the Atlantic, tthe Fed has ha ad the tendency y to shift its ratee hike path tow wards the lower expectations e o of financial markets. The FOM MC decision on 16 March also o reflected this be ehaviour. We th hink it is unlikely that the Fed will surprise finnancial marketts by becom ming more hawkkish than expe ected in the futu ure because thee Fed will not be b happy with to oo much US do ollar strength, which w could dam mpen US grow wth & inflation as a well as creatin ng negative spiillovers for EM economies. Th hereby, a subsstantial driver of a possible US dollar strength fa lls away. Even n if the Fed werre to hike moree aggressively than t expectted this may no ot be dollar pos sitive. For insta ance, in a situaation where infla ation or inflatio on expectationss were to rise more m substantia ally than expeccted, this would d likely weigh on the US dolllar. In such a situation, financ cial markets woould believe tha at the Fed is behind d the curve, wh hich is negative e for a currency y. In addition, iff the pace of in nflation increas ses and/or rate e increases is higher h than tha at of growth, thiis would be outright negativ ve for the US d dollar.

...as well w the outlo ook for commodity prices and EM is im mproving… We think that commo odity prices and d currencies off commodity exxporting countrries have bottom med. Higher com mmodity prices s will initially im mprove the senttiment towards s commodity exporters and their ccurrencies. Late er on, this will be b felt in their eeconomies. On n the one n easing monettary policy (Cannada, Australia a, New hand, central banks tthat have been Zealan nd, and Norwayy) will likely need to be less accommodative a e. This will be supportive s for these currencies. On the other hand, h a further recovery in em merging market currencies will red duce inflation p pressures in co ountries such as Brazil, Chile,, Mexico, South h Africa and Russia a. As a result, ccentral banks in these countries could focuss more on supp porting growth h. This will be a positive deve elopment. As a result, the US dollar will likely y weaken versus s commodity cu urrencies. In sh hort, the monettary policy diveergence will like ely be smalle er-than-expecte ed or could eve en turn against the US dollar.

FX Watch - The dollarr rally is ove er - 22 March h 2016

USD versus CRB index 90-day rolling correlationn

1.0 0 0.5 5 0.0 0 -0.5 5 -1.0 0 07

1 12

USD vs v CRB Index Source: Bloomberg

Politic cal risk is risiing The po olitical risk in th he US is increa asing with the rise in probabiliity of Donald Trump becom ming to be the R Republican can ndidate for the Presidency. Hiis domestic and foreign policie es are unclear. Until this is cla arified this could d be negative ffor the US dolla ar.

…and d technical pic cture has turrned The US S dollar index a and several US S dollar pairs have h broken beelow their 200-d day moving averag ges. This could d be a false bre eak. But as sev veral pairs havee taken out this s level, the signal is quite strong . As a result, we w think that the e US dollar muulti-year uptrend has ended and a new trend has started. In the e near-term the behaviour couuld be volatile. Such a phase will likely be fo ollowed by a lo onger-term dow wn trend of the ddollar.

Calcu ulated Effectiive Exchange e rate US Index

130 0 120 0 110 0 100 0 90 0 80 0 70 0 00

0 04

Callculated Effective Exchange E rates US 2000-day moving averaage Source: Bloomberg, BoE

FX Watch - The dollarr rally is ove er - 22 March h 2016

ABN AMRO O major currency forecasts s 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

22-Mar 2 1.1267 111.68 125.83 1.4411 0.7837 0.9686 1.0913 0.7583 0.6758 1.3079 9.2565 9.4277 7.4543

Q 2016 Q2 1.15 113 130 1.40 0.82 0.96 1.10 0.76 0.68 1.30 9.25 9.25 7.46

Q3 2016 1.15 114 131 1.42 0.81 0.96 1.10 0.76 0.68 1.28 9.25 9.00 7.46

Q4 2016 1 1.15 115 132 1 1.48 0 0.78 0 0.96 1 1.10 0 0.76 0 0.68 1 1.26 9 9.25 8 8.75 7 7.46

Q1 201 17 1.1 15 11 14 13 31 1.5 50 0.7 77 0.9 97 1.1 11 0.7 77 0.6 69 1.2 25 9.2 25 8.5 50 7.4 46

Q2 2017 1.15 112 129 1.52 0.76 0.97 1.12 0.78 0.70 1.24 9.00 8.50 7.46

Q3 2017 1.15 110 127 1.54 0.75 0.98 1.13 0.79 0.71 1.23 9.00 8.25 7.46

Q4 2017 1.15 108 124 1.56 0.74 0.99 1.14 0.80 0.72 1.20 8.75 8.25 7.46

Q3 2016 6.60 6.60 67.0 1,165 1.38 3 35.00 3 32.80 13 3,400 64 2.80 14.75 4.30 2 27.00 310 3.55 17.00 660

Q4 2016 6 6.70 6 6.70 6 67.0 1,165 1 1.40 35 5.00 33 3.00 13,500 60 2 2.75 14 4.50 4 4.25 27 7.00 305 3 3.50 16 6.75 650

Q1 201 17 6.7 75 6.7 75 67.0 50 1,15 1.3 38 34.8 80 32.8 80 13,40 00 5 59 2.7 75 14.2 25 4.2 20 26.5 50 30 00 3.4 45 16.5 50 64 40

Q2 2017 6.80 6.80 66.0 1,140 1.36 34.60 32.50 13,300 58 2.75 14.00 4.15 26.25 300 3.40 15.75 630

Q3 2017 6.80 6.80 65.5 1,130 1.35 34.40 32.20 13,200 57 2.75 13.75 4.15 26.00 295 3.35 15.50 620

Q4 2017 6.80 6.80 65.0 1,120 1.35 34.00 32.00 13,000 55 2.75 13.50 4.10 25.50 290 3.30 15.25 600

Source: ABN AM MRO Group Econo omics

ABN AMRO O Emerging market m currency Changes in red/b bold

USD/CNY (o onshore) USD/CNH (o 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

22-Mar 2 6.48 6.48 66.5 1,164 1.36 34.89 32.40 13,152 68 2.86 15.27 4.26 27.04 311 3.62 17.38 679

Source: ABN AM MRO Group Econo omics

Q 2016 Q2 6.55 6.55 66.5 1,165 1.36 35.00 32.50 13,200 66 2.85 15.00 4.30 27.00 310 3.60 17.25 670

FX Watch - The dollarr rally is ove er - 22 March h 2016

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