CURRENCY INSIGHTS Foreign Exchange Forecast and Analysis
June 2014
The Calm Before the Storm Navigating Through Today’s Currency Markets
www.yourcompanywebsite.com
CURRENCY INSIGHTS June 2014
06
USD
The Fed Chair continues to hold the line on the pace of monetary tightening, in large part because of the aforementioned downside risks to economic growth.
20
08
CAD
Rising inflation and higher oil prices have seen a drastic change in sentiment towards the Loonie – but will it be enough to prompt Poloz and the BoC to alter their stance towards monetary policy?
10
EUR
Yellen the dove, Carney the hawk, but what of Draghi?
12
GBP
The race to tighten is on – will the BoE be the first developed central bank to begin its campaign to normalize interest rates?
13
CHF
Lacklustre Swiss inflation and dovish SNB positioned to hold Franc back.
Emerging Markets
Investment is pouring into the emerging markets once again. Is history doomed to repeat itself?
04
2
Global Market Themes A storm is brewing in the wake of diverging central bank policies and the ECB accommodative monetary stance may be precursor to EUR volatility.
IN THIS ISSUE 14
NOK & SEK
Dovish Norges Bank in face of global export risks clip wings of NOK in Q2. Expectations of Riksbank rate cut in July hurts Krona in medium term. Global growth could be a late year saviour however.
16
18
JPY
AUD
Will Abe’s third arrow hit the mark – or will the promised structural reforms lack substance and force the BoJ to rely on further stimulus measures?
Fundamentals and the RBA suggest the currency should be lower, low volatility says otherwise.
19
NZD
Rate differentials continue to support. Market positioning prone to overstretched conditions.
22
INR
Soaring oil prices threaten to derail the Indian economy. But might there be gain in the pain?
13 12
23 18 06
CNY
Skepticism on China has risen to record highs. But has the fear gone too far?
10
08 14
23
19 16 22 3
CURRENCY INSIGHTS June 2014
GLOBAL MARKET THEMES - Mark Frey, SVP Sales and Trading, Chief Market Strategist
One could be forgiven for believing the usual summer trading doldrums have come a bit early in the northern hemisphere this year. Watching the overnight market for most currency pairs, which can sometimes be a wild affair, has been more like watching England in the World Cup, which is to say there has been shockingly little excitement to speak of. Indeed, one could perhaps blame the football that is unquestionably attracting more eyes to it than those being devoted to Bloomberg screens on trading floors the world over in recent weeks. The truth however, is that volatility has been in significant decline for months. Indeed, implied volatility levels, a measure of the market’s expectation of price variation in the coming period, are at generational lows across many currency pairs, touching levels not seen since the mid1990’s. From an overall trader sentiment perspective, markets certainly seem orderly, if not blissfully calm at present. While volatility has been depressed and trading volumes have already plummeted, markets in general have seen no shortage of big picture trends. Equities continue to move higher, propelled by seemingly immovably low interest rates and dovish central banks around the
4
globe. Banks appear to be taking on increasing levels of risk to expand lending and fight off competition from non-traditional sources of funding. Yield hungry hedge funds and investors are also seemingly taking on more leverage and risk as they chase returns in a low growth environment with already stretched asset prices. Energy markets are moving aggressively higher, though not because of growth in aggregate demand and business expansion but because of geopolitical risks across the Middle East and the Ukraine. While the market’s overall “risk on” appetite continues to build however, there are storm clouds gathering on the horizon. Economic growth in the developed world remains stubbornly anemic at best and broadly driven by private households, housing and ultimately, debt. Rising energy prices, optimistically viewed by most market participants as transitory given geopolitical tensions, are now threatening to drive second round wage inflation that will be decidedly less transitory. Further, some of those geopolitical issues, especially surrounding fighting in Iraq, don’t appear to be very fleeting at all and pose the risk of delivering longer-term inflationary effects. Indeed, the building price pressures that central bankers in London,
CURRENCY INSIGHTS June 2014
Washington and Ottawa have been largely shrugging off as non-factors in the long-term, may actually begin to morph into something that has to be addressed with monetary policy, an issue that really isn’t being priced into currency markets at all at this point, and certainly not where the Greenback is concerned. Even if we assume that markets have it right and that growth will slowly firm and return to the global economy without driving inflation skyward, it would at the very least be reasonable to believe that the expansion in economic activity wouldn’t be even. Those nations with comparatively firm growth prospects such as the USA, the UK and Canada should be expected to outperform the rest of Europe and Japan, regions which still require a steady drip of monetary morphine to dull the pain of moribund if not still slowing economies. Continued divergence in near-term growth prospects should then begin to be reflected by short-term currency valuations, meaning that the calm waters enjoyed by investors and business decision will likely become a bit more turbulent . Divergence in actual economic performance, rather than just expectations, would also likely translate a response from policy makers to tighten monetary conditions for
“
those nations further along in the business cycle, thereby serving to exaggerate growth driven currency strength. Despite the relative calm at present, there are a variety of ways that market participants could also have it wrong. Geopolitical tensions could build, energy prices could run and growth prospects could stall. Worse yet, geopolitically driven energy prices could increase risks of stagflation in derailing growth prospects at the same time spurring central banks to move on monetary policy with greater speed to counter increasing inflationary pressures. Regardless of whether markets have it right, and we’re headed for a straight line path back to economic prosperity, or they have it wrong and market conditions are about to get more challenging, it would be difficult under either scenario to foresee a continuation of the current levels of calm and depressed volatility. In simple terms, under almost any scenario that we can reasonably expect, we would argue that volatility is set to increase and that currency markets will become much more turbulent in the months ahead. In this view, certainty in the form of hedging protection looks not only historically cheap, but prudent as well.
Continued divergence in near-term growth prospects should then begin to be reflected by short-term currency valuations, meaning that the calm waters enjoyed by investors and business decision will likely become a bit more turbulent
5
CURRENCY INSIGHTS June 2014
USD
- Mark Frey, SVP Sales and Trading, Chief Market Strategist
Market pundits, most notably equity traders seeking a means by which to explain the seemingly euphoric optimism on display with respect to public share prices, have come up with any number of rational sounding excuses as to why we shouldn’t be concerned about the first quarter crash and burn for the U.S. economy. Delayed healthcare spending related to the launch of Obamacare and an unseasonably bitter winter have seemingly provided the required hall pass needed to avoid detention, or the sell-off that should have taken place. No matter the rationale, the simple fact is that economic growth remains weak, the recovery is uneven and the expected gains in employment have been less tangible than almost anyone expected. Though rising energy prices continue to spur inflationary pressures, the Fed Chair continues to hold the line on the pace of monetary tightening , in large part because of the aforementioned downside risks to economic growth. Above all else, Janet Yellen has made it abundantly clear that the Fed’s policy decisions will continue to be guided by the economic data, which has turned unquestionably soft of late, if not downright weak. With this in mind, it’s tough to foresee how the Fed could hasten the removal of monetary stimulus, thus withdrawing market support for the Dollar bulls in the immediate term who had previously positioned themselves for a run higher in the Big Dollar. Indeed, the Dollar longs have been trimmed significantly as have expectations for the potential near-term upside for the Dollar across the board. Though the Dollar bulls have pulled in their horns somewhat, the important fact to remember is that currency markets, unlike equities, are driven by relative economic expectations. While the outlook with respect to the U.S. economy has softened from the beginning of 2014, so too have expectations for the rest of the globe as well. Given that Europe and Japan continue to grapple with risks of deflation and the developing world contends with varying levels of domestic market chaos, the U.S. seems to be a picture of comparative economic stability and optimism. While comparative is indeed the operative word, it is after all what truly matters, thus leading us to believe that despite the recent economic
6
challenges, the U.S. is indeed still relatively well positioned in the global market place. Given that we can forgive the U.S. in its recent failings in terms of overall economic performance when compared to its relative peers, our focus must again turn back to the Fed. Though the timeline of future rate increases and a right-sizing of the central bank’s balance sheet remains uncertain, that path does indeed look much clearer than that of its international counterparts. The Fed’s anticipated policy tightening seems to be more a matter of when and not if, therefore it would still be reasonable to expect the Dollar to moderately outperform the market in the short-term, with an eye to even greater strength at some point in the not-too-distant future. In this sense, it matters much less whether the Fed raises rates in the second quarter of 2015 or the fourth, but that it will be raising rates at some point, thereby restricting the supply of Dollars available and driving their price higher. However, if the expectations for a rate increase in 2015 begin to slip into 2016, we may be required to materially re-evaluate even the relative economic merits of any expected USD strength.
CURRENCY INSIGHTS June 2014
“
USD daily
…the Fed Chair continues to hold the line on the pace of monetary tightening…
80.8000 Q3
81.0000 Q4
Expec te
d Targ
et
81.4500 Q1’15
Economic Indicators
-2.9 GDP
2.1 Inflation
6.3 Unemployment Rate
0 - 0.25 Central Bank Interest Rate
7
CURRENCY INSIGHTS June 2014
CAD
- Scott Smith, Senior FX Trader and Market Analyst
What a difference a quarter makes. The once beleaguered Loonie has seen market sentiment take an abrupt U-turn from the pessimistic start to the year, gaining roughly 5% from the lows registered near the end of March. A combination of external and domestic developments has the CAD bears slumbering in a hibernation haze. Navigating a global economic landscape that has been dominated by central bank policy has been one of the main focal points for currency markets so far in 2014. The accommodative stances of the Federal Reserve, European Central Bank, and Bank of Japan all have prompted investors to increase exposure to higheryielding assets, reducing volatility as equity markets melt higher, the summer doldrums appearing to have kicked in early. The lack of progress towards the normalization of interest rates south of the 49th parallel has kept the USD bulls at bay, and although yield spreads between the US and Canada have widened in favour of US treasury notes, the absence of urgency from the Fed in telegraphing a tightening of policy has left investors searching for yield elsewhere. The potential for oil supply disruptions as conflict in Iraq intensifies has also helped generate strong demand for the commodity-linked currency. With this we’ve seen hot money flowing into Canada as traders try to take advantage of the relative benefit higher energy prices will have on Canada’s resource sector. As such, the positive correlation between the Loonie and Brent has increased to levels not seen since Q1 2013, with movements by the CAD becoming more tightly intertwined with developments around the international price of oil. Domestically, a recent up-tick in inflation and retail sales has piggy-backed on the external developments witnessed abroad, adding to the Loonie’s strength as traders reposition for the possibility Poloz and the Bank of Canada will change their neutral stance towards interest rates. With the most recent headline reading on consumer prices well situated above the BoC’s target of 2%, participants are wondering how
8
long Poloz can continue with his dovish outlook towards inflation before warning a rate hike might be on the horizon. That being said, it is hard to see the latest CPI figures as anything other than transitory, given the presence of higher energy prices, a still insecure labour market, ongoing lack of business investment, and wavering momentum in the export sector. With implied volatility in the options market for USDCAD sitting at record low levels, it is hard not to think participants may be underpricing current risk factors, giving corporate hedgers that are naturally short USD attractive levels to enter into the market. While the short-term outlook for the Loonie could see momentum fuel further gains for the CAD, a number of external risk factors such as a de-escalation of conflict in Iraq, or a more hawkish than anticipated Federal Reserve, pose immense downside risks for a continuation of the Loonie’s stellar Q2.
“
...the positive correlation between the Loonie and Brent has increased to levels not seen since Q1 2013...
CURRENCY INSIGHTS June 2014
CAD daily
1.0800 Q3
1.1000 Q4
Expec te
d Targ
et
1.0900 Q1’15
Economic Indicators
1.2
2.3
GDP
Inflation
7.0 Unemployment Rate
1.0 Bank of Canada Rate
9
CURRENCY INSIGHTS June 2014
EUR
- Darryl Hood, Options Dealer
In the last 3 months we have seen Yellen the dove and Carney the hawk, but what of Mr. Draghi?
EUR daily
As we had expected in the previous addition, Mr. Draghi did reach into his tool bag for negative overnight deposit rates cutting to -1%, whilst at the same time cutting the base rate to 0.15% from 0.25%. In addition, we saw the introduction of the new TLTRO or for the cynical, a 4 year extension of the existing LTRO which banks need to pay back by February 2015. So what is the likely impact of these measures? In a nutshell the idea is that banks who are now being penalised for holding the common currency will use it to lend to the private sector and the man on the street will start to spend rather than save due to the virtual non-existent return on his savings. However, this was the apparent answer when the original LTRO and record interest rate cuts were previously introduced and it is difficult to see that the result will be any different. There likely won’t be enough to propel growth into flat lining economies in the short term, as there is every likelihood banks will take up the ‘cheap at the price’ cash but will then continue to hold it to grow their own balance sheets. However, what the above has done and I believe will continue to do, is weaken the Euro against its major counterparts, therefore allowing net exporters, such as Spain, Portugal and the other Mediterranean countries, to benefit. This will allow these countries to improve their GDP through to 2015, whilst the Euro continues to struggle due to the ‘carry trade’ possibilities that now exist as the interest rate languishes at record lows. Over in the US, June’s FOMC decision and following Q&A raised as many questions as it did answers. On the one hand, bullish intent was shown with another 10 billion USD slashed from
10
1.3400 Q3
1.3250 Q4
Expec te
d Targ
et
1.3000 Q1’15
Economic Indicators
0.9
0.5
GDP
Inflation
11.7
0.15
Unemployment Rate
ECB Rate
CURRENCY INSIGHTS June 2014
the QE programme and Janet Yellen stating that interest rate rises, once started, might be more aggressive than first thought. On the other hand, Yellen’s dovish rhetoric suggested any hope of a 2014 rate rise has been extinguished, unlike the hawkish comments of Mark Carney on the other side of the pond days before, and reduced the target rate forecast of 4% to 3.75%.
“
…the call is EURUSD lower throughout the year and into 2015...
With monetary policy for the Euro and USD going in opposite directions, the call is EURUSD lower throughout the year and into 2015, the pace of which will depend on rate rises in the US.
11
CURRENCY INSIGHTS June 2014
GBP
- Scott Smith, Senior FX Trader and Market Analyst
The outperformance of the Pound against most major currency pairs continued in the second quarter of 2014, though its gains were slightly less aggressive than earlier in the year as traders continue to evaluate the potential timeline for tightening of monetary policy from the Bank of England. Though both the Federal Reserve and the BoE are the two major central banks closest to normalizing policy, the relative trajectories and the timing of rate hikes from the respective banks will be the key influence on future price action of GBPUSD, with the pair set to continue its ascent as it is our belief the BoE will be the first to set the course of a gradual, steady climb in lending rates.
to buy a little more time with rates at rock bottom levels, though we do foresee some dissenters popping up on the MPC by the early fourth quarter, signaling a rate rise is in the cards for early 2015. Therefore, we anticipate the Pound to continue outperforming against currencies that have central banks with loose monetary policies (ECB, BoJ) while still being able to put in muted gains against the USD before the Federal Reserve plays catch up and begins to tighten policy after the BoE.
GBP daily
The momentum of Cable’s upward assault has abated as of late, largely due to the fact that the guidance deciphered from Governor Carney’s “…Governor Carney’s press conferences press conferences has has left market left market participants with more questions than participants with more questions answers.” than answers. At one juncture Carney is warning markets interest rate hikes could be coming quicker than anticipated, then at his next major event he is advocating more slack in the labour market needs to be absorbed before rates can begin their move higher. The reason for Carney’s double-speak is that the economic landscape in the UK is unfolding in a manner similar to his time spent at the Bank of Canada, where an over-heating housing market is propping up the economy and masking some of the weaknesses seen in other areas. With house prices in London outpacing the bubble-like housing industry in certain areas of China, Carney will want to do his best to transition away from the heavy reliance on consumer-based demand that comes from wealth increases as a result of a strong housing market, and focus on sopping up labour market slack by keeping borrowing conditions accommodating. The macro-prudential recommendations to cool the housing market should act as a stop gap for Carney
12
1.7100 Q3
1.7200
Q4 Exp ected Targe t
1.6800 Q1’15
Economic Indicators
3.1
1.5
6.6
0.50
GDP
Inflation
Unemployment Rate
Bank of England Overnight Rate
CURRENCY INSIGHTS June 2014
CHF
- David Starkey, Options Dealer and Senior Market Analyst
The local economic landscape in Switzerland hasn’t materially changed over the last 3 months. Deflation remains a concern, with inflation posting an anaemic annualised +0.22% in May. Meanwhile, GDP growth is showing signs of life and is on pace for expansion of approximately 2% in 2014. With inflation risks the primary concern, the SNB is unlikely to abandon “EURCHF looks content its accommodative in a range not much more policies, which than a big-figure or two include the EURCHF above the SNB floor.” floor at 1.2000 and extraordinarily low interest rates. In fact, deflationary concerns have led to speculation that the Swiss National Bank (SNB) may also be forced to adopt negative interest rates. Despite deteriorating inflation the Swiss Franc maintained resilience through Q2 against the Euro. In fact EURCHF looks content in a range not much more than a big-figure or two above the SNB floor. The primary reason the SNB adopted the floor was to counter safehaven flows tied to the risks of a Eurozone collapse. While these risks have by and large abated, the ECB’s decision in early June to ease monetary policy further has renewed downside pressure on the pair. Going forward, negative interest rates in the Eurozone are likely to continue weighing on the pair. Given the SNB’s commitment to (and capacity to defend) the floor, range trading in the 1.2000 to 1.2250 seems likely to define activity until such a time that the pair rallies higher. Be that either due to a Eurozone recovery or deflationary pressures in Switzerland forcing the SNB’s to adopt a negative interest rate policy. For the time being however, with the spotlight shining mostly on the Eurozone and the European Central Bank, the SNB appears happy to lurk in the periphery. Looking to the USDCHF, the 0.8700 area looks to have established itself as strong support, as the pair has twice (mid-March & early-May) bounced strongly off of that level. Expectations are that in the next 6 months the US Federal reserve will wind down its quantitative easing program. Furthermore, it’s generally held that at some point in the next 9-12 months the American benchmark interest rate will be hiked. This outlook of ever tightening
monetary policy in the USA is in stark contrast to the SNB’s deeply accommodative outlook and is positioned to guide USDCHF higher in the coming months. To the upside it’s worth being conscious of historical resistance at the 0.9155 and 0.9450 levels from January 2014 and September 2013 respectively.
CHF daily
0.9400 Q3
0.9600 Q4
Expec te
d Targ
et
0.9700 Q1’15
Economic Indicators
2.01 GDP
0.22
3.16
0.25
Inflation
Unemployment Rate
Swiss National Bank Rate
13
CURRENCY INSIGHTS June 2014
The Nordics: NOK & SEK - David Starkey, Options Dealer and Senior Market Analyst
The Norwegian Krone benefited from encouraging economic data through most of Q2, particularly inflation, which suggested that a recovery in Norway may be gathering momentum. This led the NOK to appreciate to its strongest value in 6 months against both of its two most commonly traded partners, the USD & EUR. However in June the Norges Bank conveyed a decidedly dovish “...a recovery in Norway outlook, noting that may be gathering growth in of exportmomentum...” oriented Norway’s trading partner’s remains restrained and is thus a significant risk. While no further easing is forecasted, Norges Bank is now expected to hold the key policy rate at 1.5% until early 2016 to help the domestic economy withstand any external economic setbacks. Inflation in Norway currently reads 2.3% against a target inflation rate of 2.5%. Given expectations of a gradual rise starting in 2016, in real terms interest rates in Norway could remain negative for the next few years. The Norges Bank action has led the NOK to give back all of its gains in the last 3 months in a matter of a couple of weeks. Looking forward this new theme is likely to continue against the USD, especially as the American recovery gains momentum. However, fresh easing from the ECB in June positions the Krone to gain at the expense of the common currency through the remainder of 2014 and into 2015. The outlook for the Swedish Krona remains bearish as CPIF, the Riksbank’s favoured inflation measure, deteriorated through Q2 printing in negative territory. Additionally, export activity in the first half of 2014 has lagged expectations, driven primarily by deteriorating economic conditions in the Eurozone. Through Q2 these two themes have led the Krona to its lowest value against the Greenback in nearly a year as well as 2-year lows against the Euro. As inflation continues stagnate there is a growing possibility that the Riksbank will announce another
14
NOK daily
6.2100 Q3
6.2400 Q4
Expec te
d Targ
et
6.3200 Q1’15
Economic Indicators
2.00 2.30 GDP
Inflation
2.7
1.50
Unemployment Rate
Norges Bank Rate
CURRENCY INSIGHTS June 2014
25 basis point cut to its Repo rate at its July meeting, which is likely to weigh on the SEK in the medium term. However one bright point in the Swedish economic landscape is that sentiment remains optimistic, especially in the retail and manufacturing sectors. Additionally, forecasted increases “...outlook for the in global demand Swedish Krona remains during the latter bearish.” part of 2014 and early 2015 position SEK to benefit against the Euro. Although forecasted momentum in the American economy is likely to outweigh that of Sweden, this imbalance could lead to further moderate losses for the Krona against the Greenback.
SEK daily
6.7500 Q3
6.8500 Q4
Expec te
d Targ
et
6.9000 Q1’15
Economic Indicators
1.90
-0.20
GDP
Inflation
8.00
0.75
Unemployment Rate
Swedish Central Bank
15
CURRENCY INSIGHTS June 2014
JPY
- Scott Smith, Senior FX Trader and Market Analyst
Compared to volatility the Yen saw in Q1, price action for USDJPY has been eerily stable for the second quarter of the year as the relative trajectories of central bank policies have not diverged at the pace we originally expected at the beginning of this year. From a technical standpoint, the pair looks ready to break out of its consolidative phase that has taken place over the better part of six months. Our fundamental view calls for a move higher as the Japanese government continues to struggle with the successful implementation of all three-arrows imbedded within ‘Abenomics’.
JPY daily
While the Federal Reserve has blunted any upward momentum in USDJPY by reaffirming their pro-growth bias towards interest rates, the Bank of Japan is still expanding their balance sheet at approximately twice the speed of the Fed. This divergence is set to continue throughout the remainder of the year as the BoJ keeps the printing press in overdrive while the Fed in constrast winds down their asset purchases. Promising signs of a pick-up in consumer prices, combined with stronger than expected growth in Q1, have raised speculation the BoJ may decide to forego any further policy accommodation in the foreseeable future. This has helped underpin Yen strength as the domestic currency settles into a comfortable range pivoting around the 102 handle. Japanese policy makers are hoping the contraction expected for GDP growth in the second quarter as a result of the sales tax increase implemented on April 1st can be recouped in an expedited fashion, the BoJ’s stimulus action dependent on economic performance in the penultimate quarter of 2014. The second attempt at Prime Minister Abe’s third arrow of economic reforms has already been touted as not packing enough punch, with many of the economic reforms to be fleshed out in later days with advisory councils and various ministries. We expect a cut in the corporate tax rate which will bring the Japanese tax structure closer to the rates seen in other highincome countries, spurring further capital expenditure and foreign direct investment.
16
103.5000 Q3
104.7500 Q4
Expec te
d Targ
et
Economic Indicators
5.9
3.4
GDP
Inflation
102.0000 Q1’15
3.6
<0.10
Unemployment Rate
Bank of Japan Rate
CURRENCY INSIGHTS June 2014
It will likely take much longer before the firing of Abeâ&#x20AC;&#x2122;s third arrow affects any substantial change in the corporate culture of Japan, leaving us to favour a bout of JPY weakness as growth struggles to pick up in the third quarter and the BoJ retains an accommodative stance towards monetary policy. While the domestic landscape has changed somewhat in the fact that the BoJ may choose not to inject any fresh stimulus if we see enough progress in economic performances for the third quarter, the risks are still to the downside for the Yen. This will be the case especially if the Federal Reserve decides to reign in expectations of when the first rate hike will take place.
â&#x20AC;&#x153;
...the Bank of Japan is still expanding their balance sheet at approximately twice the speed of the Fed...
17
CURRENCY INSIGHTS June 2014
AUD
- Richard Breen, Manager – Treasury and Risk Management
The AUD had a stellar second quarter as the run of encouraging local data continued, specifically labour market and Q1 GDP, and interest rate markets started to price in RBA hikes for 2015. All this happened despite Iron Ore plummeting below US$90/t for the first time since late 2012. If you need an example of how low volatility drives investors into carry trades, then look no further than the former Pacific Peso (AUD). However, it wasn’t all rosy as the recently elected Liberal Party handed down their first budget. Their concerns about the current and projected budget deficits, despite Australian debt/GDP amongst the lowest in the developed world, saw them introduce tough and controversial measures to rein in spending over the next five years. The tightening of fiscal policy amounts to 0.1% of GDP in 2014/15, 0.3% of GDP in 2015/16 and 0.6% in 2016/17. Some of the plans still have to pass the Senate which are likely to cause delays and amendments. The immediate reaction was a huge drop in consumer confidence to levels below those seen in the GFC. This caused immediate pessimism amongst many commentators and media outlets and since then we have also seen a continued decline in Aussie yields. We do note that business confidence has held up quite well since the release. With the AUD hovering above 0.9200 for some time, many had expected the RBA to resume their attempts to jawbone the currency lower. Their language remained the same “high by historical standards, particularly given falling commodity prices” in the June meeting statement. The minutes showed the Bank adopting a more dovish tone than most had been expecting, noting that they were unsure if low rates were enough to offset the decline in mining investment and fiscal tightening. These words have seen yields decline even further and are a marked change in the upbeat rhetoric we had heard from the Bank earlier this year. So we have a case where key commodity prices for Australia (Fe, Cu, C) remain under pressure, a continued decline in yields across the curve and a less upbeat central bank, yet the AUD remains well supported on the back of the low volatility environment we are currently in.
18
A reprice according to fundamentals may take place over the coming months and see the AUD closer to 0.9000, but exact timing is very tough to call. On the technical front, key resistance is not far away at 0.9460/70 and a break through that level may trigger some very large stops and allow for a potential 200 pip move to the upside. The market would more than likely attempt to fade such a move if seen.
AUD daily
0.9550 Q3
0.9235 Q4
Expec te
d Targ
et
0.9760 Q1’15
Economic Indicators
3.20 3.00 5.80 2.50 GDP
Inflation
Unemployment Rate
Reserve Bank of Australia Rate
CURRENCY INSIGHTS June 2014
NZD
- Richard Breen, Manager – Treasury and Risk Management
The New Zealand economy remains the outperformer of G20 nations and the desire of many politicians and central bankers the world over. The RBNZ in tightening mode has remained one of the key drivers of the NZD; the Bank followed up with another twenty five basis point hike in June to bring the OCR up to 3.25%, the highest among G10 central banks. RBNZ Governor Wheeler sounded decidedly more hawkish in the June statement than the market expected, citing continued acceleration in construction, high house price inflation and buoyant consumer and business confidence. The Bank also noted that while headline inflation “…RBNZ have no choice remains moderate, inflationary but to tighten monetary pressures are policy with the economy expected to running red hot.” increase. Wheeler also stated that the OCR at around five percent was the neutral level. The RBNZ is now in a very tough situation in that they would like a much lower currency but have no choice but to tighten monetary policy with the economy running red hot . The Q1 GDP figure showed the economy expanded at its fastest pace since 2007, unemployment at its lowest since 2009 and the Current Account deficit narrowing significantly over the past year. In an almost comical comment last week, Wheeler stated that that he would like to see a lower exchange rate and higher long term interest rates. Wishful thinking. Despite all the optimism around the New Zealand economy, we believe there are some difficult times ahead. Rate rises are going to hurt those overleveraged in the housing sector, while recent weakness in milk prices, if continued, will act as a drag on the economy. So what happens to the NZD going forward? Favourable interest rate differentials will likely keep the currency well supported as well as maintain a low volatility environment. However, in this kind of situation market positioning becomes even more important. With
much of the RBNZ tightening “already in the price” it may be hard for the Kiwi to make significant gains from current levels. 0.8842 was the post float high and the market will look to sell at those levels. If a technical break were seen, like any AUD strength, the market would also be looking to fade. The better strategy is to buy dips towards 0.8200-0.8400.
NZD daily
0.8800 Q3
0.8450 Q4
Expec te
d Targ
et
0.8000 Q1’15
Economic Indicators
3.60 1.90 GDP
Inflation
5.75 3.75 Unemployment Rate
Reserve Bank of New Zealand Rate
19
CURRENCY INSIGHTS June 2014
EMERGING MARKETS - Karl Schamotta, Director, FX Research and Strategy Sir John Templeton once said, “The four most expensive words in investing are ‘this time it’s different’”. Less than a year after the foreign exchange bloodbath now known as the “taper tantrum”, investors are once again pouring capital into the emerging markets. Convinced that this time is different and seeking to profit from yield differentials, Western asset managers are rapidly increasing their sovereign bond holdings in countries previously considered too risky for foreign consumption. Governments have rushed to profit from this, issuing a flood of debt, despite offering rates much lower than those prevailing prior to the 2008 financial crisis. Nations like Malaysia, Mexico, Hungary, Poland and South Africa have seen non-resident ownership soar to record levels, and exchange rates have risen correspondingly, with most major emerging market currencies seeing accelerating inflows as the year progresses. From Brazil to Indonesia, institutional investors are being joined by retail investors, causing
20
demand for exchange traded funds to leap over the past few months. There’s a problem however. This time really isn’t different.
“Less than a year after the foreign exchange bloodbath now known as the “taper tantrum”, investors are once again pouring capital into the emerging markets. ”
The global economy remains extremely fragile, with consumer spending patterns struggling to gain traction while wages remain depressed. With exports largely flat, many developing economies are increasingly reliant upon foreign capital for sustenance, and domestic imbalances are growing once more. Federal Reserve policymakers are becoming concerned about the damage that asset price bubbles might inflict on the global financial system, and are threatening an end to the easy money policies that have spurred cross-border capital flows for much of the past five
CURRENCY INSIGHTS June 2014
years. A number of voting members have warned that the punchbowl will be withdrawn sooner than later. Because the spread between developed — and developing — market debt has narrowed to such extremes, a relatively small spike in global yields could trigger a calamitous sell-off. With offshore ownership levels far above daily trading volumes in many emerging markets, the liquidity necessary to facilitate an easy exit is once again in short supply. Veterans who survived the dozens of currency crises in the latter part of the 20th century coined a saying to describe this sort of environment — “emerging markets are difficult to emerge from in an emergency”. In short, businesses with unhedged exposures could find themselves dealing with dangerous levels of currency volatility in the months ahead. The world is preparing to learn a very expensive lesson once again.
20
21
CURRENCY INSIGHTS June 2014
INR
- Karl Schamotta, Director, FX Research and Strategy
The honeymoon is over. India’s rupee had risen more than 6% on a tradeweighted basis between September and the end of May, and the country’s stock market posted an incredibly strong performance this year. With investors increasingly optimistic that Prime Minister Narendra Modi would bring stability and positive change to what has long been one of the world’s most complex economies, markets were looking positively bubbly. However, with conflict in the “The honeymoon Middle East spiralling out of is over. ” control, the rupee fell to a twomonth low in early June, and continues to fall as we go to pixels.
Modi’s government has come in with a strong mandate, and a solid majority in parliament. He has been given a historic opportunity to reduce energy subsidies, to trim spending on largely ineffective poverty-reduction programmes, increase infrastructure investment, and cut the corruption that has hobbled the economy for decades. Many of these areas have long suffered from a sense of apathy, with entrenched political interests repeatedly stalling progress. In other words, this crisis may be exactly what is needed to shock India’s ruling class out of its slumber and put the country on the path toward sustainable growth. Here’s hoping….
INR daily
India maintains one of the emerging world’s largest trade deficits, largely driven by its gargantuan appetite for energy products. As the fourth-largest oil consumer in the world, importing more than a third of its needs, the country is dangerously vulnerable to oil shocks. The country’s trade shortfall touched $11.2 billion dollars in May and is expected to widen, after Brent prices touched $115 a barrel during the middle of June. In an effort to shield the poor from price fluctuations, the Indian government heavily subsidizes fuel costs, meaning that the burden for price adjustment is likely to inflict significant damage on official coffers in the months to come – and could potentially endanger Modi’s reform agenda. Inflation pressures are also rising, with wholesale costs up more than 6% on an annualized basis in May. Consumer prices are up even more, having risen almost 8% over the last year, subtracting spending power from an economy that is already struggling to gain traction. Taken together, these factors could mean that India is facing a sovereign debt downgrade, a cut in growth forecasts, and a severe equity market correction in the months to come. All is not lost however.
22
60.1600 Q3
61.5000 Q4
Expec te
d Targ
et
Economic Indicators
64.0000 Q1’15
4.6
8.2
3.8
8.0
GDP
Inflation
Unemployment Rate
India National Bank Rate
CURRENCY INSIGHTS June 2014
CNY
- Karl Schamotta, Director, FX Research and Strategy
It’s an ironic twist of fate. The country which invented gunpowder now seems to have become one of the planet’s most dangerous powder kegs. For much of the past six months, market participants have increasingly sought to protect themselves against a hard landing in the world’s second largest economy. Offshore observers have become concerned about the rebalancing process underway, convinced that policymakers have lit a fuse that will inevitably result in an explosion. Fearful speculators have abandoned positions across the global commodity complex, while investors onshore have used almost any means necessary to deploy assets outside the mainland. As we’ve been warning, the Chinese growth miracle has long been fuelled by a dangerous expansion in debt, with local governments, state-owned enterprises, and private businesses bingeing on cheap credit. In combination with the artificial stimuli provided through currency intervention, depressed interest rates, and official backstops, economic activities have become dangerously distorted.
again. The Aussie and Kiwi could be poised for stronger performance to round out the summer, while the Japanese yen might see its safe haven appeal dulled. Commodity prices as well may see a sharp reversal upward in the event that the positive surprises keep coming. Of course, none of that is meant to reassure our readers that all is well. The longer that China continues on the current path without making the needed course adjustments, the worse the eventual correction will be. We would all do well to remember that market trends tend to take the escalator up, and the elevator down.
CNY daily
That being said, it isn’t clear that the current state of alarm is entirely justified. While lower growth rates can be expected in the years to come, it isn’t at all evident that the country’s leaders have truly lit the rebalancing fuse. Spooked by signs of an economic slowdown earlier this year, it appears that policymakers have launched a “stimulus by stealth” programme. The People’s Bank of China is intervening in the currency markets to push the exchange rate down while it eases monetary conditions through changes in reserve allocations and benchmark lending rates. Local governments have been instructed to ramp up infrastructure spending, while the banking sector increases lending activities. Fixed investment levels remain extraordinarily high, while the consumption share of output remains stubbornly low.
6.2300 Q3
6.2100 Q4
Expec te
d Targ
et
6.2400
Economic Indicators
Q1’15
In other words, while small adjustments have been made at the edges, it appears that it is business as usual at “China Inc.”
1.4
2.5
4.1
6.0
If so, last month’s surge in factory activity could presage a rebound in growth, wrecking bearish positions once
GDP
Inflation
Unemployment Rate
People’s Bank of China
23
CURRENCY CURRENCY INSIGHTS INSIGHTS June 2014 January 2013
About Cambridge Mercantile Group Since its inception in 1992, Cambridge Mercantile has been earning the trust and respect of leading companies around the world by providing efficient and customizable global payment services that are second to none. With offices strategically located across the globe, Cambridge facilitates the secure and prompt movement of over $23 billion dollars annually for thousands of clients of all sizes and niches. Whether you’re an independently operating business, a bank or a credit union, Cambridge provides a wide range of customizable solutions to meet the needs of your business and its customers or members. Powered by industry leading payments technologies with complete front to back end integration, Cambridge has become one of the world’s largest bank independent payments providers. Recently, Cambridge’s traditional business model has been complemented with an extensive enhanced suite of hedging and risk management products, as well as online payment solutions designed to effectively manage foreign exchange risk.
www.cambridgefx.com Global Offices Canadian Headquarters
US Headquarters
UK Headquarters
212 King Street West, Suite 400 Toronto, ON M5H 1K5 Phone: (416) 646-6401 Toll Free: (800) 374-8077 Toll Free Fax: (800) 982-4778 Email: info@cambridgefx.com
1359 Broadway, Suite 801 New York, NY 10018 Phone: (212) 594-2200 Toll Free: (866) 397-2837 Fax: (212) 918-0734 Email: info@cambridgefx.com
Cambridge Mercantile Corp.(UK) Limited Registered No. 05271222
Authorized MSB Registration Number 12199885 Payment Institution - Financial Conduct Authority (FCA) Reg. No. 504473 Registered Office: 71 Fenchurch Street, 10th Floor, London, England EC3M 4BS Phone: + 44 (0) 20 7398 5700 Fax: + 44 (0) 20 7398 5710 Email: info@cambridgefx.com
Disclaimer: This document is provided for informational purposes only. Some information provided in this document has been obtained from external sources. Cambridge Mercantile Group is not responsible for the accuracy, completeness, or currency forecasts of the information obtained from external sources. This document may include views, opinions and recommendations of individuals or organizations, and the recipient understands that Cambridge Mercantile Group does not necessarily endorse such views or opinions, nor is it providing any trading, investment, tax, accounting or legal advice. Any opinion expressed as to future direction of prices of specific currencies is purely opinions, and are not guaranteed in any way. In no event shall Cambridge Mercantile Group have any liability for losses incurred in connection with any decision made, action or inaction taken by the recipient or any party in reliance upon the information provided. Any currency rates/prices contained in or forwarded with this document are indicative and subject to change without notice. Prices quoted may vary substantially based upon the size of the transaction and market volatility.
15