Natixis: BoJ holds steady, will the Fed take action?

21 September 2016  •  Source: Nordine Naam, Forex Analyst, Natixis

Natixis: BoJ holds steady, will the Fed take action?The DXY dollar index increased towards 95.9 last week, despite mixed macroeconomic indicators from the US –including weaker retail sales and industrial production figures. This prompted the probability of a Fed funds rate hike to fall towards 18% as the market appears cautious in the run up to the Federal Open Market Committee’s (FOMC) meeting on 21st September.

Indeed, FOMC members remain divided over a potential rate hike, despite Lael Brainard, the Federal Reserve (Fed) governor’s best efforts to reassure the market that any tightening of monetary policy is unnecessary.

In our view, the Fed will maintain the status quo this month – though we’ll pay close attention to the tone of the FOMC’s statement. If dovish, the statement will place pressure on the US dollar, while any optimism on economic growth or a suggestion that monetary tightening may commence before 2017 is likely to benefit the currency.

This week, both growth and inflation forecasts will be published, alongside an updated dot plot – a projection for interest rates provided by each of the 17 central banks’ presidents. We expect the dot plot to show downward projections for 2017 and 2018 to reflect the US economy’s weakening growth potential, although this is unlikely to raise calls for a Fed Funds rate hike in December because inflation was stronger than expected last month.

Coupled with the declining crude oil price, these factors could see the DXY dollar index appreciating to test 96 – the upper bound of the 94-96 range in which the index has hovered since May.

EUR/USD: heading towards 1.104

The EUR/USD corrected towards the end of last week on the back of strong US inflation data for August, as well as the crude oil price’s downgrade towards $45/bbl. With both the European Central Bank (ECB) and the Fed offering few clues regarding any changes to their respective monetary policies, the EUR/USD’s three-month implied volatility remains low at 8.4%. That said, in the short-term, both the upcoming FOMC meeting and the current oil price slump are likely to bolster the greenback.

Meanwhile, the euro’s performance is likely to be dampened this week by weaker eurozone PMI data, which has prompted our unchanged EUR/USD target of 1.104.

GBP: buy six-month risk reversals

Sterling’s performance continues to rely heavily upon market expectations around the Bank of England’s (BoE) modifications to monetary policy. Last week, the central bank’s Monetary Policy Committee (MPC) held rates at 0.25%, while leaving the door open to an interest rate before the year-end. In light of the UK’s anaemic growth, we expect the BoE to cut the bank rate by 20bp to 0.05% this November.

The US dollar, on the other hand, will strengthen in the months ahead with Fed Funds rate hikes expected in December and throughout the course of 2017 – which will cause the GBP/USD to weaken towards 1.25 in the coming quarters. Meanwhile, the EUR/GBP is likely to hover within the 0.84 to 0.90 range.

As for the options market, six-month risk reversals (call-put options) have declined sharply, which suggests the market is predicting the sterling to fall against the euro. Indeed, the ratio between six-month 25-Delta risk reversals to six-month implied volatility has returned to pre-crisis levels – and with Brexit uncertainty showing no signs of relenting, six-month 25-Delta risk reversals appear to be an attractive purchase for investors seeking protection against the negative news flow.

JPY: USD/JPY at risk of correcting towards 100

The USD/JPY stabilised around 102 last week. Given the volatile European markets, characterised by a 3.5% decline in the EuroStoxx, investors reverted to the US dollar as their preferred safe haven to the Japanese yen. This follows the market becoming increasingly concerned by the idea of further measures being announced by the Bank of Japan (BoJ) during its monetary policy meeting. The BoJ’s Policy Board has been divided on quantitative easing (QE), with some members increasingly sceptical of its efficacy at stimulating both economic growth and inflation.

Given that the central bank has decided against pushing deposit rates deeper into negative territory towards -0.20% (to the delight of its banking sector), there is increasing speculation that the BoJ will begin to buy foreign bonds, which could yield better results for the yen. This practice, however, is likely to be viewed as an attempt to manipulate exchange rates on the global stage. In this respect, the USD/JPY may become more volatile – with the risk of a pullback towards 100.

CHF: EUR/CHF stable around 1.09

During its latest monetary policy meeting, the Swiss National Bank (SNB) maintained the status quo. The central bank acknowledged that growth has been stronger than previously anticipated, characterised by Q2’s GDP growth increase of 0.6%, following a 0.3% rise in Q1. Despite other positives, including exports rebounding after Q1’s decline, the SNB has stressed that the Swiss franc is overvalued and is willing to intervene in the foreign exchange market as a result.

Expanding the monetary base, however, seems unfeasible with the SNB’s foreign exchange reserves already totalling CHF 626bn. The SNB has accepted that the 0.75% deposit rate has been penalising the banking sector, which suggests that a further rate cut seems highly improbable.

All things considered, the EUR/CHF will continue to react to the evolving situation in Europe, while risk aversion remains a key consideration for investors. For instance, both Italy’s constitutional reform referendum next month and the US presidential election in November are likely to benefit the Swiss franc, as investors seek safer territory. With this in mind, we see the EUR/CHF holding around 1.09.

NZD: NZD/USD heading towards 0.71

This week, the Reserve Bank of New Zealand’s (RBNZ) rate meeting takes place, with the consensus predicting the monetary status quo to be upheld. As a result, the New Zealand dollar could struggle, while the accompanying RBNZ statement will be significant given the economy’s weak growth and inflation. With a dovish statement expected, such factors will weight heavy on the NZD/USD, which could pull back towards 0.71 in the short-term.

NOK: EUR/NOK on course towards 9.40

Norges Bank also meets this week and, similarly, the status quo is likely to withstand, despite Norway’s growth slowdown. The Norwegian economy is suffering from stagflation, with inflation hitting 4.4% year-on-year (YoY) in July. This creates a dilemma for Norges Bank in terms of whether to take action or not, but our view is that a neutral statement can be expected. And in light of the Brent price’s current bout of weakness, we expect the EUR/NOK to test 9.40.

CAD: USD/CAD heading towards 1.355

The Canadian dollar corrected sharply last week in reaction to both crude oil’s price slump and an invigorated US dollar. With economic activity weakening, the Bank of Canada (BoC) may decide to cut key policy rates in the coming months. In these circumstances, we have made an upward revision to our USD/CAD target from 1.33 to 1.35. Elsewhere, the USD/CAD three-month 25-Delta risk reversal has reached a high of 1.20 in order to reflect the USD/CAD’s potential to rise.

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