The State of Global Foreign Exchange Markets

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1 The State of Global Foreign Exchange Markets Nick Bennenbroek

2 The State Of Global FX Markets Nick Bennenbroek Head of Currency Strategy June 2015 Please see the disclosure appendix of this publication for certification and disclosure information. All estimates/forecasts are as of 6/12/15 unless otherwise stated.

3 After a Strong Start to 2015, the Greenback s Performance has Been More Mixed Recently 120 Fed's Broad U.S. Dollar Index Source: Ecowin and 4

4 A Slow Start for the U.S. Economy in % U.S. Economic Growth % qtr/qtr annualized 6% 3% -3% GDP -6% Final domestic demand -9% Source: Ecowin and 5

5 The Fed has Signaled a More Gradual Pace of Rate Hikes than Previously Anticipated Appropriate Pace of Fed Tightening Median FOMC policymaker forecast 3% End-2015 End % 1% Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Source: Ecowin and Given economic softness in early 2015, rate hike expectations were pushed back as Fed comments suggested a June rate increase was unlikely. 6

6 Growth is Recovering and the Labor Market is Improving 6% U.S. Consumer Income and Spending % year/year, three-month average 3% -3% Real Disposable Income Real consumer spending Source: Ecowin and Job and income gains, and lower energy prices, should support the consumer sector. 7

7 Fed Interest Rate Increases Still Likely Later in 2015 Two-Year Government Bond Yields Major Countries, trade-weighted, left scale United States, right scale 1.85% 1.35% % % % Source: Ecowin and The U.S. policy outlook contrasts with the still generally easy global monetary policy stance. 8

8 Monetary Policy Divergence Suggests Trend U.S. Dollar Strength D Dollar Index vs. Two-Year Yield Spread Year Yield Spread, U.S. less foreign, left scale Fed's Dollar Index vs Major Currencies, right scale Source: Ecowin and Greater currency volatility is possible as the greenback reacts to economic swings and monetary policy signals. 9

9 Eurozone Deflationary Risks Persist 6% Eurozone Growth and Inflation % year/year 3% 3% 2% -3% -6% GDP, left scale Core CPI, right scale 1% Source: Ecowin and Inflation is very low, while the Eurozone economy is growing only modestly; disinflationary forces will likely remain. 10

10 European Central Bank Active, Monetary Policy Dovish 20 ECB Weekly Asset Purchases Euro Billions Note: Combined purchases of public sector bonds, covered bonds, and asset backed securities Source: Bloomberg LP and The ECB has cut rates (including a negative deposit rate), added liquidity and begun a 1.1 trillion asset purchase program of public and private securities. 11

11 Eurozone Economic Underperformance Also Argues for a Weaker Euro 6.0 Relative Growth vs. Euro Performance 24% % % PMI/ISM gap, 3- mth ave, left scale Change in euro, % y/y, right scale -24% -36% Source: Ecowin and Existing euro short positions could restrain the speed of the euro s decline. 12

12 Subdued Growth and Inflation Point Consistent with Ongoing Bank of Japan Easing 8% Japanese Growth & Inflation % year/year 4% 4% 2% -4% -2% -8% GDP, left scale -4% -12% * Excluding consumption tax Core CPI, right scale* -6% Source: Ecowin and A lack of new Bank of Japan policy signals could limit the yen s near-term weakness. 13

13 Lower Energy Prices Pose Economic Risk for Canada Resource Sector: Employment and Output 2 % year/year Employment: Forestry, fishing, mining, oil and gas Output: Mining, oil and gas extraction Source: Ecowin and 14

14 The Canadian Dollar Has Already Substantially Adjusted to Weaker Oil Prices Canadian Dollar and Commodity Prices Bank of Canada Commodity Prices, left USD/CAD exchange rate, inverted, right Source: Ecowin and 15

15 But Fed Tightening Could See the Canadian Dollar Drop Further 130 Canadian Dollar and Bond Yields Year Yield Spread: Canada less U.S., basis points, left USD/CAD exchange rate, inverted, right Source: Ecowin and 16

16 China s Slowdown Has Continued 15% Chinese GDP Growth % year/year 12% 9% 6% Source: Ecowin and Policy easing could help to stabilize the medium-term growth outlook. 17

17 FX Inflows Have Slowed, while There Are Also Signs of Some FX Outflows Central/Commercial Bank FX Purchases 800 CNY billions Source: Ecowin and 18

18 Growth and Inflation Fundamentals Still Consistent with Gradual Renminbi Gains 1 Chinese CPI vs. Renminbi % year/year CPI, left scale 12% 8% 6% 4% 2% Renminbi gain, right scale 9% 6% 3% -2% -3% Source: Ecowin and 19

19 Relative Resilience for the Indian Rupee 6% India's External Balances % of GDP 4% 2% -2% Net Direct & Portfolio Investment Inflows Current Account Deficit -4% Source: Ecowin and Growth and external balance fundamentals are favorable, although Fed tightening and Indian monetary easing should still see some decline in the rupee. 20

20 Firming Economy Should Help the Mexican Peso to Eventually Recover 12% Mexican Economic Activity % year/year, three-month average 6% -6% -12% GDP Retail sales Industrial output Source: Ecowin and Economic growth is improving gradually overall, and, despite low inflation, recent peso weakness means the next move in interest rates is likely to be up. 21

21 FX Positioning Should Limit Peso Downside, Support Peso Upside 180 MXN & IMM Positioning USD/MXN, inverted Net contracts, '000s Source: Bloomberg LP and The Mexican central bank has also introduced currency support measures to help limit peso declines. 22

22 Wrapping It Up After a strong start to 2015, soft data and an expected delay to Federal Reserve rate hikes have contributed to a more tentative U.S. dollar performance. Monetary policy divergence still suggests trend strength in the greenback. The European Central Bank s balance sheet expansion likely will continue for some time, while the yen s near-term weakness may be limited. The Canadian dollar has arguably adjusted to lower oil prices, but could fall further on Fed tightening. China s growth slowdown has continued, although we continue to view growth and inflation fundamentals as consistent with modest renminbi gains. An overall strengthening in Mexico s economy should help the peso to eventually recover, while the central bank has also introduced currency supportive measures in recent months. 23

23 Wells Fargo FX Forecasts Source: 3M 6M 12M 18M EUR/USD USD/JPY GBP/USD AUD/USD USD/CAD USD/CNY USD/MXN

24 Disclosure Page Wells Fargo Securities Economics Group publications are produced by, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited.. ("WFS") is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. ("WFBNA") is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. WFS and WFBNA are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. does not compensate its research analysts based on specific investment banking transactions. s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm, which includes, but is not limited to investment banking revenue. The information and opinions herein are for general information use only. does not guarantee their accuracy or completeness, nor does assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Conduct Authority. The content of this report has been approved by WFSIL a regulated person under the Act. For the purposes of the U.K. Financial Conduct Authority s rules, this report constitutes impartial investment research. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE

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