G10 FX Outlook: Policy Divergence Starts to Drive FX

Transcription

1 G10 FX Outlook: Policy Divergence Starts to Drive FX Moscow - June 2014 Steven Saywell Global Head of FX Strategy

2 FX Themes USD: Tapering should support a stronger USD against the other lower-yielding G10 currencies. Long USD positioning has not fully recovered, which provides scope for upside despite for consensus for USD strength. EUR: Further ECB policy easing is increasingly likely and we forecast QE during H EUR will suffer from this while support from inflows is also fading. We forecast 1.30 EURUSD by end Asia: Growth in the region to remain robust, but Fed tapering expectation to impact USD vs Asia. Asian currencies may struggle in JPY: USDJPY to rise as the BoJ remains committed to very loose policy, in contrast to a Fed that is heading towards the exit. Domestic investors to continue to be crowded out of the JGB market and allocating funds abroad. We forecast 110 USDJPY by end GBP: The recovering in UK economy to continue to underpin the GBP. Market positioning is extremely long but it remains cheap vs long-term valuation. We forecast 0.76 EURGBP by end CHF: EURCHF to rally as global growth recovers, but further ECB easing will provide a headwind. As the Swiss begin to recycle large current account surplus we forecast a gentle rise to 1.25 EURCHF by end AUD, NZD, CAD: Pockets of EM resilience + local growth will be enough to shield commodity currencies strong as Chinese growth remains robust.. Our ranking for the bloc is Cad, then AUD & NZD. NOK, SEK: Scandinavian currencies appear oversold currently, in particular the NOK should recover against the SEK in May

3 Germany has fallen from Grace, UK & US now on top Comparison of major countries PMI readings (Manufacturing) UK and US now outpace the rest, eurozone and China lag May

4 US data disappoints, but is not terrible US Data Surprise Index US data has surprised to the downside, but the strength of the data is in line with its long-run average May

5 The USD continues to diverge from US yields DXY (USD Index) vs US 2 yr swap spread - DXY components The USD continues to takes its lead from yields. USD is now lagging the yield pick-up May

6 Largest FX market positions are long GBP & short EUR/CHF BNP Paribas Estimate of FX Market Positioning SHORT LONG GBP 29 NOK 20 NZD 6 AUD 6 USD 1 CHF -5 JPY -7 CAD SEK EUR Jun Jun Methodology BNP Paribas FX Positioning Analysis is a broad gauge of positioning that combines the following factors: Client Exposure Internal sales desks estimate of FX investor exposure IMM The Commitment of Traders (CFTC) is a widely used proxy for US-based hedge-fund/cta activity. Risk reversals Risk reversals indicate the relative price of calls relative to puts, and thus incorporate a option market sentiment function. Beta Decomposition of the BTOP managed currency index. BNPP Trending Indicator. - A technical measure of the strength of a currencies momentum. The overall currency score is then calculated as the equally weighted sum of the components Source : BNP Paribas EUR and CHF shorts are on a par, while GBP remains the largest long positioning May

7 FX participants finally shift to a long USD exposure BNP Paribas Estimate of FX Market Positioning for USD Methodology Client Exposure Internal sales desks estimate of FX investor exposure IMM The Commitment of Traders (CFTC) is a widely used proxy for US-based hedge-fund/cta activity. Risk reversals Risk reversals indicate the relative price of calls relative to puts, and thus incorporate a option market sentiment function. Beta Decomposition of the BTOP managed currency index. BNPP Trending Indicator. - A technical measure of the strength of a currencies momentum. The overall currency score is then calculated as the equally weighted sum of the components FX investors generally establish USD shorts during QE. But the more data contingent nature of QE3 has made markets less comfortable funding in USDs. May

8 Overall FX positioning is low Total G10 positions Positions typically build in Oct. and Nov % BNP Paribas Positioning Analysis Seasonal Factors for G10 FX Positioning * *Seasonal factor is the typical percentage increase or decrease in positioning during the month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source : Ecowin Reuters, BNP Paribas Seasonal analysis shows that October and November are when FX positioning is usually highest May

9 Dislocation between market views and positioning EURUSD Implied Positioning Market consensus is bullish USD, but investors have only started to put on the position May

10 US TIC capital flow data US TIC capital flow data broken down by asset type Inflows into US Treasuries and Agency debt have returned since Summer May

11 US investors starting to repatriate funds US investors purchases of foreign securities, USD billions 3m average There is a reduction in US investor appetite for foreign securities, with 3-month average net flows switching from outflow to repatriation in March. May

12 EUR strength is starting to wane: EURUSD to fall further

13 EURUSD has now diverged from interest rate spreads EURUSD vs. 2-yr euro US swap spread US fiscal stress has pushed EURUSD way beyond fundamentals May

14 EURUSD has been tracking real interest rate spreads EURUSD vs. 2-yr euro US 2-year real rates EUR has tracked real rates so ECB needs to boost inflation expectations to contain currency May

15 ECB needed to act to ensure EUR is viewer as an FX funder Large divergence in inflation expectations EUR 3m Euribor starts to fall Money market rate divergence suggests ECB action will contain EUR gains May

16 Eurozone inflation expectations appear to have based Large divergence in inflation expectations EU inflation expectations have fallen but may be exhibiting signs of rising in the wake of ECB action May

17 EUR yields fall following ECB action Comparison of 2yr Swap Rates EUR has become more JPY-like as an FX funder May

18 Eurozone inflation undershoots sharply Eurozone Inflation CPI (HICP) y/y % change The sharp undershoot in inflation increases prospects for ECB easing. We forecast a refi rate cut in December May

19 Market Positioning is only moderately short EUR EUR Market Positioning Market long high-yielders, short funders (7 May) EUR net positioning BNP Paribas FX Positioning Analysis Sep Jan 10 May Sep Jan 11 May Sep Jan 12 May Sep Jan 13 May 14 Source : BNP Paribas Methodology Client Exposure Internal sales desks estimate of FX investor exposure IMM The Commitment of Traders (CFTC) is a widely used proxy for US-based hedge-fund/cta activity. Risk reversals Risk reversals indicate the relative price of calls relative to puts, and thus incorporate a option market sentiment function. Beta Decomposition of the BTOP managed currency index. BNPP Trending Indicator. - A technical measure of the strength of a currencies momentum.00 The overall currency score is then calculated as the equally weighted sum of the components The market was moderately short EUR when dovish ECB action and rhetoric emerged May

20 EURUSD trades very close to its fair value BNP Paribas FEER for EURUSD BNPP FEER (Fundamental Equilibrium Exchange Rate) is the value of an exchange rate when an economy is operating with an internal balance (i.e. output in line with potential output, full employment and inflation in line with central bank s target) and a sustainable current account balance OECD "Synthetic" EUR prior to BNP Paribas FEER EURUSD Source : BNP Paribas EURUSD FEER is estimated at 1.32, so EURUSD is only slightly overvalued May

21 EURUSD CLEER Forecasting Model BNP Paribas CLEER for EURUSD BNP Paribas CLEER (CycLical Equilibrium Exchange Rate) provide a fair value for a currency based on the relative economic fundamentals Model based projections Jan Jan Jan-2015 CLEER EURUSD Source : BNP Paribas Our own EURUSD CLEER model signals EURUSD downside May

22 Our STEER model signals EURUSD trades below its fair value BNP Paribas STEER fair value model EURUSD *BNPP STEERs are regression based short-term fair-values based on relationships between exchange rates, interest rate markets, equity markets and commodity markets. EURUSD trades towards the lower end of its +/- 1.5 std. dev. corridor May

23 QE will cause a re-pricing of assets in the equity space The S&P 500 vs the Fed Balance Sheet (under QE) F e d. B a l a n c e S h e e t ( U S D, t r n ) thousand billions S & P ( R H S ) Q E 1 Q E 2 O p e r a t i o n T w i s t Q E Source : Reuters EcoWin, BNP Paribas Under ECB QE, equities can rally and the EUR call fall just like the Fed experience May

24 EURUSD s sensitivity* to stocks varies Coefficient, impact of global equities on EURUSD 1. 4 C o e f f i c i e n t, i m p a c t o f g l o b a l e q u i t i e s o n E U R U S D Source : Reuters EcoWin, BNP Paribas *Derived from the correlation of EURUSD to the S&P over previous 12-month period captured by BNP Paribas STEER The EUR is adjusting to life as a funding currency May

25 Demand for eurozone assets peaking Eurozone Portfolio Flows (monthly): EUR billions 3MMA EZ current account, broad basic balance and portfolio flows are showing signs of peaking May

26 Other investment drives outflows to recycle current account Eurozone Portfolio Flows (monthly): EUR billions The offsetting outflow necessary to equilibrate the balance of payments has stemmed from a combination of other investment and FDI. May

27 FX Reserve Diversification

28 Global FX Reserve Accumulation Monthly Valuation-adjusted FX Reserve Accumulation Source : BNP Paribas China s reserve accumulation has continued apace since the start of last year. * Comprised of country level data provided by the largest reserve accumulators. COFER percentage allocations used to calculate the exchange rate valuation impact and estimates for direction of diversification flows May

29 Estimated Diversification Demand for EUR Estimated diversification demand for EUR vs. eurozone portfolio inflows Source : BNP Paribas Estimated demand for EUR from EM reserve managers has shown signs of topping out at the start of last year * Comprised of country level data provided by the largest reserve accumulators. COFER percentage allocations used to calculate the exchange rate valuation impact and estimates for direction of diversification flows May

30 Estimates of China s Reserve Holdings Chinese Official Foreign Asset Holdings Estimated Shares of Allocated Reserves Using bilateral portfolio data, China s estimated holdings of EUR reserves are just under 25% of accounted reserves*. * Approximately USD 2.2 trillion OF China s official foreign assets can be accounted for, out of USD 3.5 trillion, as of Source: US Treasury, Bank of Japan, Japan Ministry of Finance, Financial Supervisory Service of Korea, Australian National Statistics, Canada Statistics, Deutsche Bundesbank, European Central Bank, International Monetary Fund. Source : BNP Paribas, Peterson Institute for International Economics May

31 European Government Bond (EGB) Holdings Asian demand supporting core EUR liquid paper Structural demand from Asian CBs due to rising reserves China: Stable USD reserve demand % World: USD 11.5 Tr % Asia: USD 5.9 Tr % China: USD 3.7 Tr Japan: USD 1.2 Tr % 30% 0 Jan-03 Jul-04 Jan-06 Jul-07 Jan-09 Jul-10 Jan-12 Jul-13 0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 25% World Japan China Main Asia Holdings of Treasuries from China Total Int. Res. China Holdings of US Tr. from China % Asian demand for EUR core liquid assets is being fuelled by rising FX reserves. World international asset reserves rose from USD 2300bn in 2003 to USD 11500bn in December 2013, with Asian reserves (China, Japan, Taiwan, Hong Kong & Korea) accounting fro 53% of the total. Asian foreign-exchange reserves rose from USD 1.2trn in 2003 to USD 5.9trn in December There has been a structural Asian buying flow into the Eurozone (Bunds & OATs mostly). The will to diversify from USD assets into EUR assets also explains the recurring demand fro core EGBs. China: Holdings of US Treasuries have been stable since Q2 2011, while total foreign reserves have kept on rising (relative weight of US Treasuries has fallen by 10% since its August 2010 peak). Source : BNP Paribas May

32 USDJPY to be driven higher by Abenomics.

33 The BOJ undertakes a dramatic increase in policy Japanese monetary base projections (JPY trillions) JPY270 tr (BOJ target) Year end JPY200 tr (BOJ target) Year end JPY 138 tr Year end Source : BoJ, BNP Paribas The policy shift under Governor Kuroda is dramatic May

34 USDJPY is highly correlated to Nikkei 225 USDJPY vs. Nikkei 225 The close link between Japanese equities and the JPY is policy driven by Abenomics May

35 JPY short exposure had fallen to 0 BNP Paribas FX Positioning Analysis (JPY) BNP Paribas JPY positioning indicator signals that investors short JPY exposure has reversed. May

36 Domestic investors are starting to buy foreign assets Japanese investors net purchases of foreign assets Source : Ecowin Reuters, BNP Paribas Japanese investors have turned net long JPY over Q1. Most of this is driven by repatriation. May

37 Aggregate demand-supply balance for JPY 5 F D I + P o r t f o l io in v e s t m e n t + s h o r t - t e r m J P Y lo a n s I n f l o w 4 C u r r e n t a c c o u n t J P Y d e m a n d - s u p p l y b a l a n c e ( S u m o f b o t h s e r ie s ) 3 2 thousand billions R e c y c l i n g o f C / A s u r p l u s v i a c a p it a l o u t f l o w s... h a s n o t b e e n t a k i n g p la c e i n O u t f l o w S o u r c e : R e u t e r s E c o W in Source : Ecowin Reuters, BNP Paribas Evidence has yet to emerge of large-scale JPY outflows but the net inflows are falling May

38 USDJPY long-term fair value is now 74 BNP Paribas FEER for USDJPY BNPP FEER (Fundamental Equilibrium Exchange Rate) is the value of an exchange rate when an economy is operating with an internal balance (i.e. output in line with potential output, full employment and inflation in line with central bank s target) and a sustainable current account balance BNP Paribas FEER USDJPY Source : BNP Paribas Our estimate of long-term fair value (BNP Paribas FEER) continues to fall and now stands at 74 May

39 USDJPY CLEER Forecasting Model BNP Paribas CLEER for USDJPY BNP Paribas CLEER (CycLical Equilibrium Exchange Rate) provide a fair value for a currency based on the relative economic fundamentals Model based projections Jan Jan Jan-2015 CLEER USDJPY Source : BNP Paribas USDJPY CLEER May

40 GBP: Economic recovery to provide ongoing support

41 Recovery in UK Data is Different This Time BNP Paribas Positioning Analysis UK economic dataflow BNPP Data Surprise Index* Jun BNPP Economic Strength Index** Oct 10 Feb Jun Oct 11 Feb Jun Oct 12 Feb Jun Oct 13 Feb 14 * zero indicates that the releases are in line with expectations ** zero indicates the releases are in line with their long-term averages Source : BNP Paribas Economic data is finally strong enough for the output gap to start to narrow May

42 We favour EURGBP downside UK growing much faster than eurozone EURGBP shorts far from extreme level Source : Ecowin Reuters, BNP Paribas We expect the GBP to recover against the EUR, targeting 0.80 EURGBP May

43 EURGBP is significantly above long-term fair value estimates BNP Paribas FEER for EURGBP BNPP FEER (Fundamental Equilibrium Exchange Rate) is the value of an exchange rate when an economy is operating with an internal balance (i.e. output in line with potential output, full employment and inflation in line with central bank s target) and a sustainable current account balance BNP Paribas FEER EURGBP Source : BNP Paribas EURGBP overvalued on longer term valuation estimates (0.76) and has plenty of scope to decline May

44 GBPUSD CLEER Forecasting Model BNP Paribas CLEER for EURGBP BNP Paribas CLEER (CycLical Equilibrium Exchange Rate) provide a fair value for a currency based on the relative economic fundamentals Model based projections Jan Jan Jan-2015 CLEER GBPUSD Source : BNP Paribas EURGBP CLEER May

45 EURGBP tracking real yield differentials EURGBP vs. 5 year yield spreads Real rates maybe a better indicator as central bank policy is now impacting FX through the inflation expectations channel. May

46 EZ-UK rates moving in the GBP s favour EURGBP vs. 2-year Eurozone-UK swap differential Nominal yields still working well on EURGBP May

47 BoE Credibility Gap BoE credibility gap GBP 2y swap rate versus unemployment rate 6 F o r w a r d g u id a n c e s t s t a g e 2 n d s t a g e IL O J o b le s s r a te ( R H S in v e r s e ) G B P 2 Y in te r e s t r a te s w a p Source : Ecowin Reuters, BNP Paribas 8.5 Is the BOE at risk of falling behind the curve? May

48 Easing of eurozone stress now suggests durable Swiss Franc reversal

49 Easing of eurozone stress key for durable Swiss Franc reversal EURCHF vs. Weighted Peripheral Spreads E U R C H F * A v e r a g e o f 2, 5, 1 0 y r s o v e r e i g n s p r e a d s f o r S p a i n, I t a l y, I r e l a n d a n d P o r t u g a l v s G e r m a n y W e i g h t e d P e r i p h e r a l S p r e a d s ( %, R H S ) * Source : Ecowin Reuters, BNP Paribas Easing eurozone stress now signals EURCHF upside May

50 Swiss investment outflows Financial account moves from inflow to outflow I n f l o w s * P o r t f o l i o i n v e s t m e n t, d i r e c t i n v e s t m e n t s a n d l o a n s a n d d e p o s i t s S w i s s I n v e s t m e n t F l o w s * ( B n C H F, Q u a r t e r l y ) billions O u t f l o w s S w i s s I n v e s t m e n t F l o w s ( B n C H F, 4 q u a r t e r a v e r a g e ) Source : Ecowin Reuters, BNP Paribas Total net financial inflows peaked in Q at the same time eurozone stress peaked. Outflows are now taking off. May

51 Easing of Eurozone stress key for durable Swiss Franc reversal EURCHF v. 2-year swap spread S N B F l o o r a t o n E U R C H F I n t r o d u c e d 2 y r E U R - C H F s w a p s p r e a d ( r h s ) E U R C H F ( L H S ) Source : Ecowin Reuters, BNP Paribas CHF appears extremely overvalued vs relative interest rates May

52 EURCHF is undervalued relative to its long term fair value BNP Paribas FEER for EURCHF BNPP FEER (Fundamental Equilibrium Exchange Rate) is the value of an exchange rate when an economy is operating with an internal balance (i.e. output in line with potential output, full employment and inflation in line with central bank s target) and a sustainable current account balance BNP Paribas FEER USDCHF Source : BNP Paribas EURCHF trades significantly below its FEER of 1.40 May

53 EURCHF CLEER Forecasting Model BNP Paribas CLEER for EURCHF BNP Paribas CLEER (CycLical Equilibrium Exchange Rate) provide a fair value for a currency based on the relative economic fundamentals Model based projections Jan Jan Jan-2015 CLEER EURCHF Source : BNP Paribas EURCHF CLEER May

54 Market has turned short CHF from neutral BNP Paribas Positioning Analysis for CHF Market positioning has turned back to short CHF May

55 RUB More weakness ahead

56 Emerging weak from the 08/09 crisis Changes between 2008 and 2014 Russia has seen its macroeconomic fundamentals deteriorate sharply since the 2008/09 financial crisis. These have been further impacted by the geopolitical situation. Changes between 2008 and 2014 The fiscal situation has worsened (also in underlying terms). Potential growth rate has declined. Current account will soon turn into a deficit. Oil prices are not expected to race higher anymore. The main things helping Russia are: Relatively high yield Low debt to GDP Fairly liquid local market. However, the outlook is clearly deteriorating and we do not advise strategic longs. 56

57 Deteriorating fundamentals 57 Worsening C/A Falling potential growth Russia s fundamentals have weakened since the global financial crisis, with the economy steadily more dependent on the oil and gas sectors and on the price of energy commodities. Their share of exports has risen above 60% and real output growth has barely exceeded 2-3% in the last few years. In light of this and of Russia s adverse demographic trends, the country s potential growth rate has fallen below 3%. Investment-to-GDP ratio is falling again and the labour force is ageing and shrinking. Medium term prospects are soft, at best. Russia s low public and external debt means we are less worried about the near-term outlook but the country s deteriorating fundamentals point to growing risks down the line.

58 CBR to cut? 58 GDP prospects are soft, labour market is weak Rate expectations being revised A stabilisation in the situation in Ukraine, coupled with moderating inflation, could see the CBR reverse the 200bp hikes implemented at the start of 2014, later on in the year.

59 CNY Curb your enthusiasm

60 USDCNH is range bound not trending 60 Chart 1: USDCNH spot, fixing and onshore trading band NDF yields are now lower than onshore CNH Curncy CNY Fixing Upper band Lower Band % 8 6 3m onshore DF yield 3m NDF yield Jan-12 Jul-12 Jan-13 Jul-13 Jan-14-2 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 With NDF yields now falling below onshore forwards, sentiment is starting to look a little stretched Investors were too bearish on the RMB when it was weak; now they are too bullish when it's strong. This is actually a range market, not trend of appreciation.

61 Forecasts* USD Bloc Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15 EURUSD USDJPY USDCHF GBPUSD USDCAD AUDUSD NZDUSD USDSEK USDNOK EUR Bloc Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15 EURJPY EURGBP EURCHF EURSEK EURNOK EURDKK E. Eur Bloc Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15 EURPLN EURCZK EURHUF EURRON USDZAR USDRUB USDTRY Asia Bloc Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15 USDSGD USDMYR USDIDR USDTHB USDPHP USDHKD USDRMB USDTWD USDKRW USDINR USDVND Latam Bloc Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15 USDARS USDBRL USDCLP USDMXN USDCOP USDVEF * End of quarter May

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