The week in FX: Euro and ECB in focus as Catalan risk rumbles on
Euro resilience most likely down to this week’s ECB Governing Council meeting as Catalan risk continues to prove disruptive…
The US dollar appreciated over the course of last week, with the DXY dollar index above 93.5. The greenback was bolstered by a number of factors, particularly by the rather hawkish speeches from several Federal Open Market Committee (FOMC) members. As a result, the likelihood of a December hike in the Fed Funds rate now stands at 80%. In fact, progress pushing through Donald Trump’s tax reform mainly bolstered the US dollar, notably with the Senate passing a 2018 budget resolution. Certainly, this is seen as a first step towards the adoption of the tax framework.
Of course, the market’s attention was on the upcoming appointment of the next Federal Reserve Chair. There are now three favourites in the markets: Jerome Powell, Janet Yellen and Kevin Warsh. Jerome Powell is clearly a dove – much like Janet Yellen – while Kevin Warsh is less of a dove. But the impact on the US dollar will depend on the final pick. If Jerome Powell is chosen, the US dollar could correct a touch in reaction, whereas the appointment of Kevin Warsh would be more favourable to the greenback. Over the next few days, there will be a number of macroeconomic publications, notably the first estimate of Q3 GDP.
EUR: towards 1.1680
The EUR/USD held firm despite the Catalan risk. Article 155 has been activated and must soon be validated by the Senate, imposing a direct rule on Catalonia ahead of the organisation of the upcoming regional elections – the outcome of which is uncertain. The market appears to be shrugging off the Catalan risk, which suggests that it anticipates a resolution of the crisis. Even so, there are still considerable uncertainties, especially if demonstrations escalate. The Euro’s resilience probably stems from the European Central Bank’s (ECB) upcoming meeting of the Governing Council. While the market has priced in a 9-month recalibration of the Asset Purchase Programme, there are still uncertainties as to the level of monthly asset purchases (€40bn over 6 months then €20bn over 3 months, or €25bn-€30bn over 9 months). In addition, M. Draghi will accompany these changes with a very “dovish” speech. All in all, we remain bearish on the EUR/USD, particularly since the market is already very long on the single currency and the uncertainties over Catalonia. The EUR / USD can correct to 1.1680.
GBP: still bullish on EUR/GBP towards 0.91
Sterling corrected in the face of the deadlock in Brexit negotiations. Indeed, The European Council is expected to take the view there has been insufficient progress over the UK’s financial commitments. It will therefore not give the go-ahead to move to phase two of the negotiations concerning the new trade agreement, but suggested that this could be possible in December. Sterling was also penalised by the deterioration in retail sales in September, in turn heightening uncertainties concerning the Bank of England’s (BoE) monetary policy. The probability of a hike in the bank rate during the 2 November Monetary Policy Committee (MPC) meeting remains elevated at 78%. In the coming days, the market will focus on the Q3 GDP publication; weak growth would stoke uncertainties as to an eventual interest rate hike, in turn penalising sterling. Under these conditions, we remain bullish on the EUR/GBP towards 0.91 in the short term and 0.95 over the medium term.
JPY: USD/JPY heading towards 114.5
The Swiss franc and Japanese yen – two stable currencies – corrected in the face of an invigorated US dollar and a low volatile environment. Last week, the Japanese yen recorded the second biggest decline after the New Zealand dollar in reaction to the upturn in US long interest rates, which are closely correlated with the Japanese currency. What’s more, Japan’s general elections confirms Shinzo Abe’s grip on power and the current policy framework – based on a durably accommodating monetary policy –, meaning a monetary normalisation is unlikely before Q2 2018. Under these conditions, we remain bullish on the USD/JPY towards 114.5.
CHF: EUR/CHF on course towards 1.17
The Swiss franc also weakened significantly, with the EUR/CHF currently testing 1.16 – which is not far off our target for 2018. In light of the decline in sight deposits at Swiss commercial banks, it is possible that capital flows have at long last increased slightly. What is more, it is likely that the Swiss National Bank will intervene in the market to counter the Catalan risk. In the very near term, the EUR/CHF should therefore stabilise around 1.15.
NZD: AUD/NZD heading towards 1.138
The New Zealand dollar corrected sharply after the formation of a populist coalition government by the NZ First and Labour parties. The new Prime Minister wants more state intervention in the economy and a modification of the Reserve Bank of New Zealand’s mandate. This environment is clearly negative for the New Zealand dollar, which lost more than 2.5%, taking the NZD/USD to 0.6992. The pair could extend its correction towards 0.685, while the AUD/NZD could appreciate towards 1.138.
EUR/SEK could rise temporarily towards 9.70
This week the market will focus on the Riksbank’s monetary meeting, which closely follows the ECB’s policy – indeed, it will not end its asset purchase program until after the ECB announcements. We will follow its new inflation forecasts as well as the risks underlying its macro scenario, especially on the real estate market, given that the latest indicators – industrial production and unemployment, for example – were disappointing. All these elements can reduce expectations of rate hikes by the Riksbank and thereby weaken the SEK punctually. In this context, the EUR / SEK may temporarily test the 9.70 level, because of a reduction in accumulated long positions. However, in the medium term we remain positive on the SEK, which will be supported by the Riksbank rate hikes, with a EUR / SEK return around 9.30.