FX Watch
Group Economics Macro & Financial Markets Research
05 July 2016
Resilient Commo FX Georgette Boele Co-ordinator FX & Precious Metals Strategy Tel: +31 20 629 7789 georgette.boele@nl.abnamro.com
Roy Teo Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com
• Brexit will have a modest negative impact on Commo FX… • …while expectations of Fed rate hikes in 2017 will also hurt • But investor sentiment should give some support… • …as well as higher commodity prices • Domestic central banks continue to dampen the impact of large currency swings • Overall, we therefore expect Commo FX to remain resilient
Introduction Since the result of the Brexit referendum, sterling has dropped by more than 10% versus the US dollar to levels below 1.33. EUR/GBP has also rallied sharply to above 0.8450. We expect sterling – and to a lesser extent the euro – to be weaker than in our pre-Brexit scenario. In particular, sterling looks likely to fall further – to a low of 1.20 against the dollar – given the risks related to the UK’s huge current account deficit and the capital flows necessary to fund it as well as anticipation of weaker UK economic growth and BoE monetary policy easing. Our base case sees lower economic growth, especially in the UK, where the uncertainty and hence corporate retrenchment will be more severe. These effects will also impact the eurozone economy. In this FX Watch we examine these effects on currencies of commodity exporters as well as the impact of expected higher commodity prices and Fed rate hikes next year.
Exports to UK and eurozone % of total exports
Mexico Brazil Chile Australia Russia South Africa NewZealand Canada 0
25 eurozone
50 UK
Source: Thomson Reuters Datastream, IMF DOTS
Insights.abnamro.nl/en
75
100
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FX Watch - Resilient Commo FX - 05 July 2016
Modest negative impact via the export channel… Overall, the exposure to the UK via the trade channel of commodity exporting countries is relatively small. What is more, our base view is that a Brexit will also have a negative impact on the eurozone economy. Even though this is modest, this will have a more substantial impact on these countries as they have a larger exposure to the eurozone (see graph above). So the slowdown in the eurozone growth will have a modest negative impact on exports from these countries to the eurozone. This will also weigh on economic growth and on the outlook of these currencies.
…and expectations of Fed rates hikes will also hurt later in the year Our base case is for the Fed to remain on hold this year, but to hike a total of 75bp next year. We expect this to happen in an environment of more constructive global growth and more positive investor sentiment despite the UK political and economic uncertainty. In the past, Fed rate hikes have unnerved financial markets and/or reduced sentiment in financial markets. There is a risk that this will happen again when financial markets start anticipating Fed rate hikes. The reason behind the rate hikes is crucial for its effect on the US dollar. If US growth is moderate and inflation is picking up, triggering the Fed to hike rates, this would not be a very positive situation for the US dollar as real rates will unlikely move higher. If the Fed were to hike rates because of above trend-growth then this would be a positive for the US dollar. A combination of strong growth and higher rates is positive for a currency. We think it will be modest US growth and three rate hikes. So not a major bull-case scenario for the US dollar, however the dollar could be supported somewhat.
But investor sentiment should give some support… The days following Brexit referendum result, investor sentiment in financial markets deteriorated sharply. Moreover, financial markets have become more constructive again. The slide in sterling came temporary to a standstill. In addition, financial markets have anticipated more accommodative central banks including the pricing out of Fed rate hikes for 2016 and most of 2017. This has supported investor sentiment. Although UK political and economic uncertainty will remain, we do not expect a sharp deterioration in sentiment on global financial markets. This will support currencies of countries that are more cyclical in nature (leverage to global economy or leverage via commodity exposure) such as the one in this FX Watch.
…as well as higher commodity prices will be supportive This year we have been positive on commodity prices. The rise in these prices directly supported the related currencies (see graph below). We see more upside for oil prices and therefore we increased our year-end target to USD 65/bbl. For the second half of this year we also expect higher metal prices as well as higher dairy prices. The latter is supportive for the New Zealand dollar in particular. We also remain positive on commodity prices for 2017. Our energy analyst forecasts Brent oil price to reach USD 70 per barrel at the end of 2017. Firmer commodity prices are expected to improve the terms of trade of commodity exporting countries. This should not only support economic growth but also the outlook for commodity currencies.
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FX Watch - Resilient Commo FX - 05 July 2016
Commodity FX moves with commodity prices %
300
150 200
250
250 200 300 150
350
100
400 10
11
12
13
USD/Commo (lhs)
14
15
16
CRB Index (rhs)
Source: Bloomberg, ABN AMRO Group Economics
Central banks’ monetary policy driven by currency movements Up to recently, domestic central banks’ monetary policy in commodity exporting countries has strongly diverged. The reason for this divergence is the growth/inflation trade-off. The sharp weakening of the Brazilian real and the South African rand in 2015 and the Mexican peso in 2015 and 2016 resulted in a tightening of monetary policy to dampen inflation. In Mexico, inflationary pressures have continued to build on the back of further weakness in the Mexican peso in 2016. As a result, the Banxico hiked interest rates by 50bp to 4.25% last week. The central bank will likely remain hawkish as long as the peso remains weak. As the Brazilian real and South African rand recovered strongly so far this year, there is room to stimulate the weak economy in these countries. Therefore, we expect lower interest rates in Brazil, and there could also be a rate cut in South Africa to support growth. In addition, the central bank in Brazil has intervened in currency markets to even dampen the upside in the real. In Australia, New Zealand and Russia inflation remains weak. The Australian dollar, the New Zealand dollar and the Russian ruble are likely also stronger than forecasted by the respective central banks. We expect more monetary policy easing in Russia (-50bp), Australia (-25bp) and New Zealand (-25bp) later this year. Looking further ahead, we expect both the RBNZ and Bank of Canada to raise interest rates late next year. The New Zealand dollar (NZD) and Canadian dollar (CAD) are expected to strengthen as these rate hikes are not priced in by financial markets. On the other hand, an appreciating Australian dollar (AUD) could hinder the rebalancing of the Australian economy towards the non-mining sectors. Hence, the Reserve Bank of Australia may shift towards a dovish bias during periods of sustained strength in the AUD.
Commo FX to remain resilient If we take all the above into account, currencies of commodity exporters will likely remain resilient. A majority of currencies of commodity exporters could weaken somewhat in the coming quarters because of uncertainty in financial markets in the near-term. Subsequently, the prospect of Fed rate hikes next year (to be anticipated at the end of this year) should weigh on these currencies as well. However, we expect higher commodity prices to dampen the impact of expectations of Fed rate hikes if investor sentiment does
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FX Watch - Resilient Commo FX - 05 July 2016
not deteriorate sharply. We expect of currencies of oil exporters to outperform this year and next year as they closely track oil prices.
Our Commo FX forecast Changes in red/bold
AUD/USD NZD/USD USD/CAD USD/RUB USD/ZAR USD/BRL USD/MXN USD/CLP
05-Jul 0.7508 0.72 1.2886 63.86 14.56 3.24 18.41 661
Q3 2016 0.72 0.70 1.27 64.00 14.75 3.30 18.50 670
Q4 2016 0.74 0.70 1.27 64.00 15.00 3.35 18.50 670
Q1 2017 0.75 0.70 1.27 64.00 15.25 3.40 18.50 680
Q2 2017 0.75 0.70 1.27 64.00 15.50 3.50 18.50 680
Q3 2017 0.75 0.72 1.25 62.00 15.00 3.30 17.50 660
Q4 2017 0.75 0.75 1.20 58.00 14.50 3.20 17.00 640
Source: ABN AMRO Group Economics
Find out more about Group Economics at: https://insights.abnamro.nl/en/
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