Natixis commentary: Sterling exposed in post-ref climate

12 July 2016  •  Source: Nordine Naam, Forex Analyst, Natixis

Over a fortnight after the post-ref Brexit result, the DXY dollar index has risen to 96.1, up from 93 in the days prior to the referendum. Since 23 June, the US dollar has appreciated against all emerging currencies (with the Chinese yuan falling towards 6.70), as well as all G10 currencies bar one – the Japanese yen. That said, with commodity prices firming, the Australian, Canadian and New Zealand dollars – deemed “commodity currencies” – began to make up some of these losses against the US dollar last week.

Natixis commentary: Sterling exposed in post-ref climate

Indeed, both the greenback and the yen’s safe-haven role have been employed since the post-ref turbulence began. In the past week, however, the US dollar has been unable to make any further gains, despite renewed fears for the UK real estate industry. Given these fears, Scandinavian currencies have also depreciated because of the region’s exposure to the UK economy.

A stronger USD

In the short-term, we expect the US dollar to strengthen on the back of any poor indicators from London, as investors head for safe territories. On the whole, the greenback will benefit from the pound’s losses from Brexit-related fears in the long-term. Of course, in this new environment, any indication of US strength will be hugely detrimental for both the GBP and the EUR.

Domestically, the US employment report should reflect June’s labour market improvements following a bout of weakness in May. This week, we will pay close attention to numerous statements by Federal Reserve members that may shed light on the outlook for US growth in the post-referendum era. We also hope that the Fed’s intentions regarding its planned monetary normalisation will also emerge this week, given US equity markets have shown signs of buoyancy, even before the start of Q2 reporting season.

With US growth set to outstrip that of the UK, we expect the Fed to continue its monetary normalisation strategy in December. With this in mind, the dollar will be bolstered by increasing capital flows from investors hunting for higher returns, given the emergence of increasingly negative interest rates in some markets. Accordingly, the dollar is likely to appreciate against most G10 currencies (with the exception of the JPY) and emerging currencies (including the CNY).

A weaker EUR/USD towards 1.05

Since the UK’s referendum on European Union (EU) membership, the EUR has corrected against all but one of the G10 currencies – the pound being the sole casualty, of course – and against the Scandinavian currencies due to their exposure to the UK economy.

The EUR has tumbled significantly against the JPY and the USD. Indeed, Brexit fears will remain burdensome on the EUR as the negative effects on EU economic growth may force the European Central Bank (ECB) to extend its asset purchase programme well beyond March 2017.

More generally, Brexit will cause uncertainty about the entire European project, which will heighten concerns for the EUR’s long-term performance. In this context, we have identified six political factors that spell danger ahead for the EU project: the rise of populist political parties; calls for similar referendums across Europe; Italy’s referendum on institutional reforms in October; as well as crucial elections in France, Germany and the Netherlands. Of course, these developments may have significant effects on the EUR depending on their respective outcomes.

Turning to economic factors, rising caution around the performance of Italian banks is yet another potential hazard for the EUR. With this in mind, we expect the EUR/USD to fall gradually towards 1.05 at the year-end.

Continued correction of the GBP

Last week, sterling resumed its downward route as the GBP/USD tested 1.2798 – its lowest level since 1985. This followed news that six real estate investment funds will close amid fears of a Brexit-fuelled collapse of UK property prices. In this respect, we expect the presence of extreme political and economic risks to continue a GBP/USD correction towards 1.20 at year-end – with sterling’s fall gathering pace from August following the release of the first flurry of post-referendum indicators. By August, we see the pound depreciating further on the back of the real estate sector’s troubles and the likely effects of any interventions taken by the Bank of England (BoE) – including the cutting of key intervention rates, which may come during this week’s monetary policy meeting.

Be wary of a USD/JPY correction

The JPY has remained resilient on the back of Brexit-related risk aversion and the troubles for the Italian banking sector. And, following the Bank of Japan’s (BoJ) failure to react to these exogenous factors, the USD/JPY tested 100. It seems, therefore, that the BoJ is playing a waiting game in the hope that lower-than-expected inflation figures will prevent the Japanese currency overheating.
In the immediate future, Japan’s Liberal Democratic Party’s (LDP) victory in the upper house elections will give prime minister, Shinzo Abe, room for manoeuvre to implement a fiscal stimulus. If a fiscal stimulus announcement is not made, however, expect the USD/JPY to test levels of 99.

EUR/CHF: the 1.08 level is likely to hold

The Swiss National Bank (SNB) has successfully held the EUR/CHF above 1.08, thanks to its currency reserve interventions. Indeed, the SNB increased its foreign currency reserves to an historic-high 608.8bn CHF – up 6.6bn CHF in June. We suspect the SNB has intervened once again since the beginning of July, in the wake of the UK’s real estate investment troubles. With this in mind, the central bank should defend its EUR/CHF levels of 1.08 in the short-term.

AUD/NZD lower towards 1.02 and USD/CAD higher towards 1.33

The Australian, New Zealand and Canadian dollars – known as the “commodity currencies” – are displaying diverging trends.

Despite the risk-averse market conditions, the NZD and, to a lesser extent, the AUD have appreciated against the USD. The NZD has reaped the rewards of the Royal Bank of New Zealand’s (RNBZ) indication that further cuts to key interest rates may pose a risk to financial stability. Indeed, this suggests the RBNZ is unlikely to pursue further key interest rate cuts in the short to mid-term. Elsewhere, the NZD has benefited from the rebound in dairy product prices.

As for the AUD, the currency has held firm in the aftermath of the latest Reserve Bank of Australia (RBA) meeting – notably due to iron ore prices rising towards US$55 per tonne. This week, we will keep one eye on the latest employment figures.

Lastly, the CAD has depreciated following the correction to Brent oil prices. This week, we will pay close attention to the Bank of Canada’s (BoC) latest employment figures. Against this backdrop, we expect the AUD/NZD to fall towards 1.02 and a rally from the USD/CAD towards 1.33 to continue.

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