NZD outperforms

NZD has been the best performing major currency so far this year outshining other currencies by a wide margin. We expect further NZD/USD appreciation, albeit at a much more gradual pace over the coming months.

The kiwi has been propelled higher by a host of positive economic indicators including jobs data which has revealed an improving trend against the background of strengthening consumer and business confidence.

Economic growth is on track to reach our forecast of 3% this year. Additionally supportive of the NZD is the fact that NZ’s major commodity exports especially dairy products have remained high. NZD will also be helped by a likely healthy reading for Q4 GDP expected to come in at 3.7% YoY on Thursday.

NZD/USD looks set to target the 2013 high of 0.8676 as the next key target, a level that will provide strong resistance.

Why the JPY will weaken

While I continue to forecast JPY weakness over the coming months the JPY is currently being buffeted by various forces. Elevated risk aversion has limited the downside for JPY as the currency has once again found a safe haven bid although it has weakened as risk appetite improved slightly overnight.

Going forward, I expect US Treasury yields to move sharply higher as the US economy gains momentum and loses the shackles of bad weather, pressurising USD/JPY higher. Additionally likely further easing by the BoJ in April / May will contribute to downward pressure on the JPY.

Separately Japan has shifted from possessing a relatively strong broad basic balance surplus (current account + direct investment + portfolio flows) to a deficit, a factor that will undermine the JPY over the coming months.

Risk appetite firms

Despite the decision by Crimea’s parliament to formally request accession to Russia markets risk assets performed well overnight, with US and European equity markets registering solid gains. Consequently US yields rose overnight while the USD made gains against safe haven currencies.

Market relief probably reflected the fact that the referendum itself passed without violence while the reaction by the West in terms of sanctions was not seen to have a particularly detrimental impact on sentiment.

China’s decision to widen its currency band also passed with little fanfare given that such a move was largely anticipated. There will be some positive pass through into the Asian session from the gains in asset markets overnight although a degree of caution continues to be warranted given the still precarious situation in the Ukraine and ongoing tensions between Russia and the West.

What now for the CNY?

News that China doubled its currency band (to 2% from 1% in relation to its daily mid point) will have reverberations across markets but the reality is that China has been building up to this for several weeks and now that it has happened there may be little incentive to push for more currency weakness.

The net result will probably be less volatility after an initial knee jerk reaction and some relief in markets that the China has actually gone ahead with the move after so much speculation. The reaction of the CNY is set to follow the same script as April 2012, with volatility set to ease once the initial reaction fades.

The weakness in the CNY had been engineered to incite more two way risk to a currency that for many months had been on a one way path of appreciation. China had been forcing the CNY weaker over recent weeks in order to deter speculators who had taken significant long positions in the currency playing for further currency strength.

CNY depreciation versus the USD (around 1.5%) since mid February may also have been a reflection of weaker economic data, with China releasing a series of data releases that had missed consensus forecasts, especially recent trade data.

Already both implied and realized USD/CNY volatility has been trading well in excess of past moves (as reflected in statistical significant readings in our Z-score analysis). Additionally risk reversal skews (3 month, 25 delta) have been flirting with its 2 standard deviation band indicative of the view that the options market holds an extreme view of CNY downside risks.

The main imponderable is what China does now. The band widening is clearly a further step along the road of freeing up the currency on the road to capital account convertibility. However, the reality is that the Peoples Bank of China (PBoC) still sets the daily fixing and the movement in the CNY will still largely depend on where this fixing is set.

Ultimately a move towards a more market based currency will need to allow the market to determine the level and movements in USD/CNY. This may still be a long way off. In the meantime it seems unlikely that the authorities will intervene as aggressively to weaken the CNY as they have done in recent weeks, with a breach of USD/CNY 6.15 likely prove short lived.

China’s still healthy external position and likely resumption of capital inflows will mean that appreciation pressure on the CNY will return and a move back to around 6.00 by end 2014 remains on the cards.

No relief for risk assets

Perhaps unsurprisingly given the tumultuous build up to the poll the Crimean referendum resulted in an over 90% vote to leave Ukraine and join Russia according to Russian state media. Risk assets were already under pressure leading into the vote and the news is not going to help sentiment in any way, with the West already denouncing the result and Russia seeing it as a validation of its stance. Further sanctions and other punitive measures are likely to be announced leading to a heightening of tensions and increased risk aversion.

Our risk barometer is already well into “risk hating” territory highlighting the intensifying pressure on risk assets and demand for safe havens. Consequently expect the likes of the CHF, JPY and gold to remain under upward pressure and anything with high beta to be under downward pressure.

There is also plenty of data and events to capture the interest of markets this week, with the Fed FOMC meeting capturing top billing. Unsurprisingly no change in policy is expected, with a USD 10 billion taper set to be announced. Fed Chairman Yellen is set to highlight that the bar remains high to any slowing in the pace of tapering while more qualitative guidance is set to be announced.

On the data front US data will remain weather impacted but nonetheless, February industrial production is set to reveal a small gain today while manufacturing surveys will reveal some improvement in March. Additionally housing starts are set to rebound in February. However, Treasury yields are likely to be capped despite more encouraging data as safe haven demand intensifies, leaving the USD also restrained.

In Europe the data flow is less numerous and what there is will support the view that more action is needed by the European Central Bank (ECB) to ease policy. February CPI inflation is set for a downward revision while the German ZEW investor confidence index will slip further.

Talking the Euro down

It looks like the European Central Bank is finally waking up to the fact that belligerence over further monetary policy easing is resulting in a firming in the currency.

The fact that EUR/USD came dangerously close to breaching the psychologically important level of 1.40 must have triggered some panic within the governing council. To counter this ECB President Draghi noted that the currency’s level is becoming “increasingly relevant in our assessment of price stability”.

The problem is that words alone will not do the trick. Draghi believes that enhanced forward guidance will help to loosen monetary conditions by lowering real interest rates and this will weaken the EUR as real rates fall relative to other countries.

The market will expect action and not only words. If the Draghi really wants to weaken the EUR some form of monetary measures will need to be announced otherwise there may be little to stop EUR/USD testing 1.40 and beyond.

In the near term Draghi may have helped cap EUR/USD although technical support around 1.3825 (28 Feb previous high) will limit any downside.

Posted in ECB, eurozone. Tags: . Leave a Comment »

US dollar under renewed pressure

After hitting a multi month low at the end of last week the USD (index) failed to extend gains this week dropping overnight to 79.592 overnight in the wake of some slippage in US Treasury yields (10 year treasury yields fell to around 2.73%).

Conversely EUR/USD once again breached the 1.39 level despite attempts by European Central Bank officials to convince the markets that the message from last week’s policy meeting was in fact dovish. Markets have yet to be convinced (as do I), however, given that the ECB has yet to put its words into action in terms of further policy easing.

The key to a more sustainable EUR decline / USD recovery is to shake off the bad weather impact on the US economy. This is likely to take place soon although not quickly enough to be revealed in today’s release of US February US retail sales data, which will reveal that core sales remained pressured, leaving the USD without much support.

Posted in ECB, eurozone, US. Tags: , . Leave a Comment »
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