Natixis: Fed moves to restrict dollar volatility
Posted: 24 August 2016 | Nordine Naam, Senior Forex Analyst, Natixis | No comments yet
The US Fed will be considering their options very carefully when it comes to regaining control of dollar volatility ahead of the Jackson Hole summit…
Following a post-Brexit referendum flurry, the US dollar has been in retreat. In their July meeting, The Federal Open Market Committee’s (FOMC) supposed caution has been confirmed, as the minutes published last week revealed that many FOMC members believe waiting for more economic data is necessary before tightening monetary policy further. This comes despite the equity markets’ sharp rebound since the Brexit vote, which has done little to convince the FOMC that the US economy is undergoing a robust recovery.
In many respects, this lack of confidence has been warranted given the disappointing Q2 GDP growth of just 1.2% – which had been expected to eclipse the 0.8% Q1 growth spectacularly – and the weak inflation figures slowing to 0.8% year-on-year (YOY) from 0.9% in June. With inflation expectations well below the 2% target and fears of eroding growth, FOMC members such as John Williams have revived calls to cut interest rates and a monetary policy rethink. For Williams, the neutral rate – the interest rate required to maintain trend-rate economic growth and stable inflation – is much lower than it was three years ago which, in turn, justifies his calls for the Fed Funds rate to hold at its current low levels.
That said, this bearish outlook is far from unanimous. At a recent press conference, New York’s Federal Reserve (The Fed) president, William Dudley, suggested a Fed Funds rate hike in September was preferable, quoting recent promising employment figures as a key indicator of economic improvement.
In our view, a rate hike looks unlikely, however, as the Fed seem committed to their wait-and-see approach as to whether future economic data confirms a growth and inflation rise or not. A Fed Funds rate hike in December seems more likely following the US presidential election – especially if markets become volatile on the back of opinion polls swinging towards a vote for Donald Trump.
Yet, even with other leading central banks pursuing a course of monetary easing – including the Bank of England (BoE), the Bank of Japan (BoJ), as well as the European Central Bank (ECB) – the Fed’s efforts to maintain a stable US dollar against other leading currencies have prevailed. Indeed, the overarching caution from the Fed has been successful in restraining DXY dollar index volatility – keeping the index camped in the 93 to 100 range, where it has hovered since Q1 of 2015.
This week, expect the US dollar the hold steady before Janet Yellen’s speech at the Jackson Hole Symposium on 26th August. Here, we anticipate the Fed chair will prepare the markets for monetary tightening before the year-end. In terms of a mid-term forecast, we now expect the greenback’s value to firm, especially if monthly job creations remain above 200,000. Should this occur, calls for a Fed Funds rate hike may intensify, but for now, a rate hike in December remains a 50/50 scenario.
EUR: sell EUR/USD at 1.135, with a target at 1.11
The euro has appreciated against most of the G10 currencies apart from the US dollar and sterling. Against a backdrop of widespread central bank easing from the BoE, BoJ, and the Reserve Bank of New Zealand (RNBZ), European investors have had fewer alternative destinations, with long rates now firmly in negative territories in the UK, Japan and Switzerland to name a few.
Under these circumstances, the euro has gained from the ECB’s lack of activity with regard to new measures. Indeed, with a consensus forming that the ECB has no more ammunition to fire, capital outflows from the eurozone have fallen, which has proven to be good news for the single currency. Elsewhere, the encouraging macroeconomic indicators out of the eurozone, such as the sharp rise in August’s German ZEW index – a measure of economic sentiment in Germany – is assisting the euro’s surge.
In the mid-term, the single currency will remain bearish against the US dollar considering the ECB is likely to extend its asset purchase programme beyond March 2017, while inflation remains below its official 2% target. All things considered, we recommend selling the EUR/USD around 1.135.
EUR/GBP: turn buyer on any pullback towards 0.855
Sterling has enjoyed a rebound following the sharp 1.5% month-on-month increase in July’s retail sales, when the consensus predicted a mere 0.1% rise. Indeed, the referendum outcome has not curbed household consumption, although a future Brexit has already hit both the UK property and labour markets.
With future trade relations between the UK and the European Union (EU) in disarray – particularly around the financial sector’s ‘passporting’ capabilities, and single market access, UK business survey results are deteriorating amid an expected slowdown in UK GDP growth in the next few quarters. Of course, the delay in invoking Article 50 is only heightening doubts around the economic outlook – prompting firms to scale back their UK investments. In other words, we are sceptical that sterling’s recent rebound is permanent.
With this in mind, alongside this week’s Confederation of British Industry (CBI) survey results, take advantage of any pullbacks towards 0.855 to buy the EUR/GBP in anticipation of a short-term recovery towards 0.87, followed by 0.90 in the mid-term.
JPY: USD/JPY likely to be relatively stable around 100
The yen’s recent appreciation comes at a time when GDP growth has slowed to just 0.2% in Q2, and YOY inflation stands at 0.4% – a source of heightened concern for the BoJ. Indeed, slight alterations to the BoJ’s monetary policy left the markets disappointed as the central bank’s pledge to almost double exchange-trade funds purchases from ¥3,300bn to ¥6,000bn was dampened by the decision not to increase bond purchases (which remain pegged at ¥80,000bn).
Similarly, the government’s quantitative easing (QE) programme is expected to have negligible effects on Japan’s GDP growth as the latest stimuli mark a miniscule growth in public spending. Under these conditions, the market may anticipate a BoJ intervention to steer the course, however, we believe this is unlikely as other central banks would treat a move with suspicion. In fact, with the yen currently in a period of subdued volatility (although three-month volatility for the USD/JPY has recently picked up from 11.3% to 13%), we believe only a colossal spike in yen volatility would spark a BoJ intervention in the foreign exchange market.
In the short-term, the USD/JPY’s performance will be influenced for the most part by the greenback. Ahead of Janet Yellen’s speech at the Jackson Hole Symposium this week, we expect the US dollar to remain firm – meaning the USD/JPY should remain stable around 100.
By year-end, exogenous political risks such as Italy’s constitutional reform referendum in October, the US presidential election in November, as well as fears of equity market corrections, could mean the yen’s safe haven status is confirmed. Should this unfold, the USD/JPY could begin to test 98 – or even lower.
CHF: EUR/CHF set to test 1.08
The Swiss franc has remained strong against the euro, with the EUR/CHF camped between 1.08 and 1.09 since the UK endorsed a Brexit in June. The Swiss National Bank’s (SNB) ongoing foreign currency market interventions have strengthened the Swiss franc, which remains bolstered by Switzerland’s current account surplus that stands at more than 9% of GDP.
Despite the negative 0.75% deposit rate and fears that this may cause vast capital outflows, deposit volumes in Switzerland remain high – further confirming a period of Swiss franc strength. That said, with foreign exchange reserves at a staggering CHF 615bn, the sustainability of the SNB’s monetary practices will be called into question – especially as risk still remain around its deflationary pressures and growth potential.
In the short-term, however, the EUR/CHF should hold above 1.08, but brief spells below this benchmark cannot be ruled out before the year-end.
AUD and NZD bolstered by the keener risk appetite
Commodity currencies have staged a recovery since June thanks to a weaker US dollar and rising commodity prices. For instance, the Australian dollar benefitted from an iron ore price recovery towards the US$60 per ton mark, while the New Zealand dollar has also benefitted from the rising milk price.
As a result, the AUD/USD has recovered back above 0.77 following positive employment data emerging from Australia, while the NZD/USD tested a record-high of 0.73 despite the Reserve Bank of New Zealand’s (RBNZ) decision to cut interest rates.
In the run-up to Fed chair, Janet Yellen’s speech this week, the AUS/USD may appreciate towards 0.783, while the NZD/USD could test 0.746.