Contrasting Fed and BoE stance

A contrasting stance in the minutes of the Fed and Bank of England impacted FX markets. Firstly the Fed minutes revealed some unease among officials about maintaining current quantitative easing settings as the economic outlook improved. In contrast the BoE minutes revealed a more dovish than anticipated 6-3 vote in favour of further easing. Consequently GBP/USD dropped sharply while the USD made broad gains. It will take a move higher in US bond yields to reinforce USD strength and notably 10 year Treasury yields have yet to break the 2.0634 high reached on 14 February.

While the JPY is likely to continue to weaken over coming months I maintain the view that the bulk of its cyclical decline has already taken place, with the risks much more balanced. My models continue to show that the magnitude of JPY weakness is not justified by its usual drivers. Risks of a short term JPY correction higher notwithstanding I expect any further weakness to be much more gradual in the months ahead.

Consistent with my model output, the feeling on the ground in Japan is that the currency has indeed fallen too far, too quickly, while there is plenty of scepticism about the fact that so far there has actually been little in terms of actual policy measures to justify the drop in the JPY. In the meantime the new central bank governor will be scrutinised to determine whether he will be sufficiently aggressive to warrant the drop in the JPY. A decision may take place very soon. Whatever the decision USD/JPY looks set to struggle to break above 94.00 in the short term.

Markets will be very data-dependent in terms of determining AUD direction in the weeks ahead. A further batch of soft data will reinforce expectations of further RBA rate cuts and undermine the AUD further. I do not expect this to occur, with some stabilisation in economic data likely, an outcome which ought to restrain AUD bears. My quantitative model suggests that AUD/USD is now looking relatively cheap, with the regression estimate at around 1.07.

AUD’s drop against NZD has been particularly sharp. I do not believe the drop is justified and yesterday’s jump in AUD/NZD based in large part on comments by RBNZ governor Wheeler warning about FX intervention to weaken the kiwi in my view marks a shift in the fortunes of the currency pair. Such comments should not be surprising given the failure of the G20 to chastise Japan on its FX stance. Expect more FX jawboning in the weeks ahead from other central banks.

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