Natixis: US dollar picks up again ahead of FOMC meeting

26 October 2016  •  Source: Nordine Naam, Forex Analyst, Natixis

USD picks up again ahead of November FOMC meetingLast week, the US dollar continued to appreciate against most currencies on the back of improving US economic growth – illustrated by both marked improvements in the Philadelphia Fed Business Outlook Survey and home sales. The positive news flow, however, has done little to increase the probability of a Fed Funds rate hike in December, which remains at approximately 67%.

Given the polls suggest that the appeal of Republican candidate, Donald Trump, is declining ahead of next month’s vote, the US dollar has enjoyed a period of strength. Indeed, victory for the Democrat candidate, Hillary Clinton, would guarantee the normalisation of the Federal Reserve’s (the Fed) monetary policy in the mid-term. We believe that nothing can stand in the way of the greenback’s appreciation apart from either a Trump victory or disappointing employment figures – i.e. less than 100,000 job creations in the coming months.

In the meantime, the market’s focus turns to next week’s Federal Open Market Committee (FOMC) meeting, during which we expect numerous hawkish speeches calling for a monetary policy normalisation – especially since inflation is set to increase on the back of rising oil prices. As a result, long positions on the US dollar rebounded sharply last week and can be expected to increase further before both the FOMC’s meeting on 2nd November and the Employment Situation Report’s publication on 4 November.

Elsewhere, the US’ Q3 GDP growth is expected to total 2.6% – up from 1.4% in Q2. In this environment, the greenback has further upside potential, especially if US equity markets are encouraged by a positive news flow during Q3 ‘reporting season.’

EUR: EUR/USD heading towards 1.078

Last week, EUR/USD broke below our first target of 1.09 and went on to test 1.086. This has been, in part, spurred by divergent monetary policies in the Eurozone and the US European Central Bank’s (ECB) president, Mario Draghi, dismissed rumours that an early tapering of asset purchases had been discussed, but fell short of ruling out a quantitative easing (QE) extension.

The ECB will struggle to justify QE’s extension, given both economic growth and inflation are strengthening. Our view is that Draghi may have little choice but to approve a QE extension in order to ease the strain on long rates in southern Europe (notably Italy and Portugal).

This has, however, placed significant pressure on the euro at a time when the US dollar has been buoyed by promising macroeconomic data.

This week, EUR/USD’s performance will be influenced by the next raft of macroeconomic indicators, particularly Eurozone inflation figures. In the short-term, we expect Eurozone inflation to remain weak – 0.8% compared to 2.2% in the US. That said, a marginal increase can be expected for two reasons: firstly, the base effects linked to the oil price’s recent upturn; and secondly, the improvements to Eurozone Purchasing Managers’ Index (PMI) Survey in October following a post-Brexit referendum lull during the summer.

In short, EUR/USD still has some downside, but the main driver of its performance will be the Fed’s intentions for tightening monetary policy in 2017. In the short-term, EUR/USD could test 1.0780 in the run-up to the FOMC meeting, while over the mid-term, we keep with our 1.05 target – which is significantly below the 1.10 consensus.

GBP: Sell GBP/USD on any rebound above 1.24

GBP/USD has stabilised at around 1.22 in the absence of negative Brexit-related news, despite the government’s hazy stance on trade negotiations.
What is certain, however, is Prime Minister Theresa May’s resolute views on ending free movement of people between the UK and EU, even though French president, François Hollande, has confirmed that such a move will have severe consequences for the UK economy.

At present, UK macroeconomic indicators are mixed, best demonstrated by improving employment data yet sluggish inflation figures. Even so, we remain negative on sterling’s prospects because economic growth is likely to falter. With Q3 GDP growth expected to slow towards 0.3% (from 0.7% in Q2), the British Banker’s Association (BBA) has hinted that many banks may relocate part of their operations early next year. 

Unless the political climate deteriorates or Theresa May pushes for a ‘harder’ Brexit, the rate of GBP/USD’s correction will begin to slow in the mid-term, given the market is already short on the pound. With this in mind, it would take a raft of unforeseen market developments to accelerate sterling’s slide once again. In the coming months, our GBP/USD target remains at 1.18, especially before the activation of Article 50, which is expected in March 2017. But, given the pair’s decline is also being steered by the greenback’s appreciation, we recommend selling GBP/USD on any rebound above 1.24.

JPY: USD/JPY heading towards 105Natixis

The USD/JPY has stabilised between 103.5 and 104. The pair remains under the influence of external factors, notably the performance of the US markets. In particular, the stabilisation of both the US equity markets and long rates has helped to steady the ship.

Our view is USD/JPY may briefly rise towards 105 before the FOMC’s meeting and the publication of October’s Employment Situation Report next week. The Bank of Japan (BoJ) is hoping the Fed’s actions will indirectly weaken the yen against the greenback, given the central bank’s failure to do so via its ultra-accommodating monetary policy.

CHF: EUR/CHF around 1.08

EUR/USD’s decline has placed pressure on EUR/CHF, causing the pair to head towards the unofficial floor rate of 1.08 – the benchmark the Swiss National Bank (SNB) has been defending for more than a year.

We suspect that the SNB has intervened in the foreign exchange market once again in order to dampen a sharp rise in the Swiss franc, although such interventions are not sustainable in the long-term due to the central bank’s large balance sheet. In the short-term, expect EUR/CHF to hold around 1.08.

CAD: USD/CAD heading towards 1.35

Last week, the Canadian dollar appreciated sharply following the Bank of Canada’s (BoC) meeting. While the central bank maintained the status quo for key policy rates, the BoC is seeking ways to stimulate growth – particularly in light of declining oil sector investment and weak household consumption.

However, concerns are mounting that the BoC seems unfazed by the country’s weak inflation figures (1.3% in September), and is pursuing a markedly different approach to monetary policy compared to the Fed. Such divergence is likely to weigh heavily on USD/CAD, which we expect to test 1.35 ahead of the forthcoming Organisation of Petroleum Exporting Countries (OPEC) meeting on 30th November.

NOK: EUR/NOK on course towards 8.85

Despite Norway’s weakening economic growth, we expect Norges Bank to maintain the status quo following its meeting on 27 October. Currently, the Norwegian krone is significantly undervalued, but its nominal effective exchange rate value has recovered during 2016 in tandem with crude oil prices.

Although the Norwegian krone has outperformed the Swedish krona for several months, Norges Bank is now tasked with contending high inflation, which stood at 3.6% year-on-year (YoY) in September. Despite this, we forecast that the crude oil price should bolster the krone in the short-term – causing EUR/NOK to pull back towards 8.85.

Sell AUD/USD on any rebound above 0.77

Recently, the Australian dollar has proved resilient against the US dollar, and has drawn strength from reassuring macroeconomic indicators out of China. Indeed, Chinese GDP growth reached 6.7% during Q3, supported by the upturn in iron ore prices towards $59 per ton has benefitted the Australian economy.

That said, we remain cautious about the Australian currency, given the fragility of both the Chinese and Australian economies in the longer-term. Following the disappointing Labour Force Survey, the Reserve Bank of Australia (RBA) may be comforted by Q3 inflation to be released next week, which we predict will be 1.1%. Should this occur, we expect the RBA to maintain the monetary status quo during the central bank’s meeting next week. All things considered, we recommend selling the AUD/USD on any rebound above 0.77.

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