Fed leaves the dollar in positive mood, euro at risk ahead of ECB

The Fed FOMC unsurprisingly left policy settings unchanged but the statement was perceived as less dovish, leaving a sour taste for risk assets. Crucially the statement did not validate market expectations that the Fed would hold off from tapering (reduction of Treasury and MBS purchases) until March next year, leaving the option of an earlier tapering on the table.

The bottom line is that the decision to taper will be highly data dependent, but the impact on markets was to leave the USD firmer and equity markets lower. The reaction is consistent with our view that a lot of dovishness was already priced into the market and that the risk / reward is for a more constructive USD environment.

Improvements in economic data, albeit from a weak level and a contracting balance sheet, have provided the EUR with support over past months. However, gains will not last and we suspect the EUR will be a casualty of relatively better US growth, Fed tapering and higher US yields over coming months. EUR has lost momentum this week and looks vulnerable to further slippage ahead of next week’s ECB meeting.

Soft inflation data out of Spain and German states yesterday highlights the room for the ECB to sound more dovish next week. Although firmer than expected October Eurozone confidence surveys limited some of the downdraft on the EUR overnight and highlighted further evidence of recovery, it is likely to do little to prevent further pressure on the EUR.

A couple of stronger than expected data releases helped the NOK to strengthen both against the USD and EUR. The August unemployment rate came in lower than expected (at 3.5%) while retail sales beat expectations in September (+0.7%). The NOK has been the only G10 currency to strengthen against the USD during October and after previous underperformance against the EUR, NOK looks set to make further gains against the latter.

One hurdle may be the announcement of Norway’s daily foreign exchange purchases for the coming month. Over September and October FX purchases were NOK 100 million per day and there is little reason to expect any change in November. Assuming that the October manufacturing PMI also registers some improvement tomorrow there is little to stand in the way of further NOK strength. We retain our long NOK/CHF trade idea.

GBP on a rollercoaster, NOK to bounce back

GBP has had a rollercoaster ride both against the USD and the EUR. On balance, it has fared better than the EUR vs. USD. News that Fitch ratings put the UK’s AAA ratings on negative watch had little impact although it may yet restrain GBP. If anything the news will likely help UK Chancellor Osborne formulate a relatively austere budget next Wednesday. Unlike the beleaguered JPY, GBP has not suffered from a widening in the yield differential with the US.

In fact 2-year UK Gilt yields have echoed the rise in US 2-year bond yields over recent days. This suggests that GBP ought to face less downward pressure compared to other currencies. Although I continue to see further GBP strength against the EUR over the medium term, the near prospects look volatile. Instead, I suggest playing a GBP positive view via the AUD.

It is worth commenting, albeit belatedly, on the outlook for the NOK following the surprise decision by Norway’s central bank, Norges Bank, which cut its policy rate by 25bps on Wednesday. Does it significantly change the outlook for the NOK? I believe it doesn’t and the recent drop in the NOK will provide a good opportunity to reinstate long positions.

Although the central bank may ease policy once again over coming months this will not undermine the NOK given that the influence of interest rate differentials on the currency is limited. Moreover, lower interest rates threaten to push already high property prices even higher suggesting that the Norges Bank may have limited room to cut rates further. Elevated oil prices continue to provide solid support for the currency and unless oil prices correct lower, the NOK will remain well supported versus EUR, with a drop to around 7.45 on the cards.

Posted in FX, Norway, UK. Tags: , , , , , . 1 Comment »

EUR capped, NOK strength overdone

The positive reaction to the Greek bailout deal failed to gain traction leaving risk assets under a degree of pressure. The fact that the deal was highly expected played a role in the unenthusiastic reaction but markets may also be cautious given the major tasks that still like ahead including a tough reform timetable for Greece, parliamentary approvals in various countries and implementation of the debt swap.

EUR looks stretched. The lack of follow through in terms of EUR upside suggests that the currency will struggle. The news of the deal came as a relief to markets but after so many days of negotiations failure to agree would have been inconceivable. However, the aftermath has seen renewed doubts creep into the market especially given the short time horizon (just nine days) for Greece to implement reform measures.

Market positioning suggests that there is still scope for some EUR upside but I doubt that the deal will be sufficient to prompt a big wave of short covering. Eurozone fundamentals remain weak and if anything the exercise in forming an agreement about Greece has revealed various splits within the Eurozone. Superior US growth expectations plus relatively higher US bond yields suggest EUR will struggle to extend gains in the medium term. Short term EUR/USD gains are likely to be capped at 1.3322.

EUR/NOK has dropped sharply over recent weeks, with NOK strength accelerating in February. The currency has been the second best performer versus EUR so far this year much to the chagrin of Norwegian officials who feel that the strength in the currency will weigh on the economy. Such concerns should be taken at face value. The NOK is highly overvalued according to various measures of ‘fair value’ but I do not expect the strength in NOK to persist over the short term.

Last week, warnings from Norway‘s central bank that they are ready to act to curb NOK strength may provoke some hesitation to enter long NOK positions especially as weakening economic growth will only strengthen the resolve of officials to prevent excessive currency strength. The NOK is sensitive to risk aversion and any correction in the recent rally in risk appetite could render the NOK highly vulnerable to renewed weakness.

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