FX Trends Central bankers push snooze button

Transcription

1 Investment Research 18 March 2014 Central bankers push snooze button Since New Year, the FX market has kept focus on Chinese growth worries, geopolitical risks, ECB (in-)action and a possible Fed tapering pause. While China and recently Ukraine risks have hit risk appetite, the trust in Fed action should these issues eventually hit global growth negatively has limited the potential for USD strength for now. In the Scandi sphere, deflation risks and fears of a Riksbank cut have notably made the Swedish krona suffer more than its Norwegian counterpart recently. On Taylor-rule measures (see chart below), Bank of England (BoE) policy looks increasingly loose as the UK economy has recovered sturdily; the same story largely goes for the Fed. In contrast, ECB policy remains too tight, albeit this hides considerable differences within the eurozone with policy relatively loose for Germany but too tight for Spain. On this measure, Norges Bank also looks like a first mover in the Scandi sphere, albeit recent upward pressure on EUR/DKK may eventually trigger an independent Danish rate hike. Interestingly, the Reserve Bank of New Zealand (RBNZ), which recently initiated a hiking cycle on a fairly aggressive note, already has fairly tight policy on a Taylor-rule metric. Finally, note that the Bank of Japan (BoJ) is in a special situation requiring policy to be looser still, despite Taylor signals suggesting the opposite. Admittedly, such deviations from policy rules should be handled with care in an environment of rates around zero and non-standard policy measures being in place but it is, nevertheless, noteworthy that most major central banks are keen to signal they are in no hurry to ease or to tighten at the moment despite these deviations. Effectively most central banks have thus pushed the snooze button on rates, with notably the ECB constrained by the zero lower bound and an impaired bank-lending channel and the Fed and BoE keen to play down their first-mover status on rates and thus any unwarranted money-market tightening by stressing that eventual rate hikes will be limited and gradual. Deviations of policy rates from Taylor rules Contents Trading FX trends... 3 Trade recommendations... 4 FX top trades EUR/USD... 6 GBP JPY CHF SEK NOK DKK AUD, CAD, NZD RUB CEE LATAM...27 CNY...28 Forecast tables Forecast table EM PPP estimates G Taylor-rule deviations (policy rate - Taylor estimate, %) Policy "too tight" ---> ease Policy "too easy" --> tighten Editor Source: Bloomberg, Danske Bank Markets Chief Analyst Arne Lohmann Rasmussen arr@danskebank.dk Bloomberg: DNSK <GO> Important disclosures and certifications are contained from page 37 of this report.

2 Crucially, we have now become much less convinced the ECB will actually deliver the monetary-policy easing needed to bring the single currency fundamentally lower. While eurozone inflationary pressure continues to be very soft, Mario Draghi and company do not seem to be heading for measures that will be very EUR negative if anything, any ECB action will be focused merely on limiting the potential for rate increases and/or improving the transmission of policy. As a result, we have fundamentally revised both the level and profile of our EUR/USD forecast: while we still believe the Fed/USD part of the story will bring about gradual USD strength in 12M, we do not expect much from the ECB/EUR leg in the way of outright downward pressure on rates or the euro. Yet, we highlight that possible ECB/Fed scenarios combine to span the space for EUR/USD within the next year. In addition, we see the potential for not least the GBP to go stronger still, as the BoE increasingly looks like the first mover on rate hikes (notwithstanding the recent RBNZ increase) as the UK continues to work off the slack in the economy. In contrast, JPY should again come under pressure as BoJ is likely to be forced to bring forward additional easing as fiscal tightening kicks in. Meanwhile, the latest CHF strength should prove temporary and be limited by a firm SNB floor, as deflation risks remain omnipresent. However, much will still depend on China avoiding the hard landing and geopolitical concerns abating; if both these conditions are fulfilled, emerging market currencies could be in for a move higher in the near term. In this publication, we present in-depth views on the major currencies and suggest three recommendations to play these views: go long GBP/JPY spot, sell a 3M EUR/CHF in-the-money put spread and enter a bullish EUR/USD 3M (ratioed) seagull March

3 Trading FX trends Trade recommendation #1: enter 3M bullish EUR/USD ratioed seagull On a 1-3M horizon, we think there is a good chance that the ECB will deliver very little to suppress EUR downside and overall we see potential for further near-term EUR/USD upside. On the other hand, however, a higher EUR/USD would put the ECB s inflation forecasts greatly at risk, especially if a move higher proves sustained, which suggests that the potential for significant euro strength is limited. We recommend positioning for a (limited) move higher in EUR/USD via a 3M bullish (ratioed) seagull. Strategy: buy 3M call, sell 3M 1.42 call and sell put with a double notional at zero cost (indicative prices, spot ref.: ). The strategy is profitable as long as EUR/USD trades above at maturity. The main risk to the trade is the ECB turning dovish again and signalling a deposit rate cut into negative territory. The strategy would generate a loss if EUR/USD trades below at maturity. Trade recommendation #2: buy GBP/JPY spot In FX Top Trades 2014: How to position for the coming year (9 December 2013), we recommended selling a 6M 110 USD/JPY straddle based on the view that the BoJ would have to continue its very aggressive monetary policy in 2014 in order to obtain its inflation goal. We argued that the BoJ was likely to remain on autopilot and that a substantial yen weakening was not likely to materialise in Q1. Since then, economic figures out of Japan have disappointed significantly and we see an increased probability that slow growth and declining Japanese inflation will force the BoJ to step up its easing as early as April. Hence, the case for near-term yen weakening has strengthened and we now prefer being short JPY via a spot position to our straddle position. As an alternative to a long USD/JPY spot position, we recommend selling JPY against GBP as the UK economy continues to look strong in relation to economic growth, employment and the housing market (making room for pent-up demand). Additionally, we expect to see some GBP support from relative rates as fixings may start to rise in anticipation of UK monetary tightening moving closer. Lastly, IMM/CFTC data show that GBP positioning is not stretched contrary to overall USD positioning. Strategy: buy GBP/JPY spot at for a 180 target with a stop-loss at The strategy pays an indicative annualised carry of 0.43%. Trade recommendation #3: sell 3M ITM EUR/CHF put spread The CHF has benefited from the emerging market sell-off in the first months of 2014 despite an unexpected hawkish tone from the ECB recently. Draghi s comments from the latest ECB meeting indicate the barrier for further easing has been raised and consequently Eonia rates have traded higher. European money market rates have previously been an important driver for EUR/CHF and with no SNB rate hike looming, we see potential for some EUR/CHF upside provided the market s risk-off sentiment eventually fades. Thus, we recommend positioning for a move higher in EUR/CHF by selling a 3M in-the-money put spread. Strategy: sell 3M EUR/CHF put and buy 3M put for an up-front premium of 200 CHF pips (indicative, spot. ref.:1.2160). The strategy is profitable if EUR/CHF at maturity trades above and has a risk/reward ratio of 1:2. Hence, maximum potential loss is 100 CHF pips when EUR/CHF trades below at maturity while the maximum potential gain is capped at 200 pips for maturity spot levels above March

4 FX trade recommendations Trade recommendations 2014 Open FX Trades Type Trade Idea Target & P/L* Option Spot Sell 1Y EUR/USD call spread Buy NOK/SEK We recommend selling a 1Y EUR/USD call spread for an indicative premium of USD 590 pips (spot ref ) to position for medium-term downside. Consider scaling into a long NOK/SEK position for a move back to 1.095; place stop at (spot reference: ). * Note that target and stop has been changed on 24 February Opened 08/07/2013 Start 4.59% Target/Stop n/a Now -7.51% P/L -2.92% Opened 20/01/2014 Start Target/Stop /1.06 Now Option Option Enter 1M3M USD/CAD call calendar spread (1:2 ratio at zero cost) Sell 1M NZD/USD call option Utilize the expensive front end of the volatility curve to position for a possible short term move lower in USD/CAD while retaining a longer term long position. Sell 1M call option ahead of the RBNZ meeting. In our view, current pricing of RBNZ seems a little excessive. Additionally, our short-term financial model cannot explain the move higher in NZD/USD and NZD/USD implied volatility also look expensive. Closed FX Trades 2014 P/L 1.39% Opened 06/02/2014 Start Target/Stop - Now P/L 0.47% Opened 12/03/2014 Start Target/Stop - Now P/L -0.95% # Type Trade Opened Level Closed Level P/L 1 Spot Buy AUD/NZD 20/01/ /01/ % 2 Option Sell 3M EUR/PLN 4.19 straddle 06/02/ /02/ % 3 Option Long EUR/CHF via options 20/08/ /02/ % 4 Option Buy 1M EUR/PLN 4.20 call 27/02/ /03/ % FX Trade Performance 2014 # Cum Return Avg Return Avg Days Open Profitable 4 2.7% 0.7% 57 days Loss-Making 2-2.4% -1.2% 4 days All Trades 6 0.3% 0.1% 21 days Source: Danske Bank Markets 4 18 March

5 FX Top Trades 2014 FX Top Trades 2014 (9 December 2013) Type Trade Idea Target & P/L* Option Option Spot Option Option Option Spot Forward USD/CHF call spread USD/JPY straddle Sell EUR/GBP EUR/SEK ratioed seagull EUR/NOK risk reversal EUR/CZK option strategy Long USD vs short AUD and CAD Sell USD/CNH 12M Forward Source: Danske Bank Markets Open FX Top Trades We enter a bullish 6M USD/CHF call spread with a bought call at and a sold call at with a spot ref. of for an indicative price of 125 CHF pips. Sell 6M USD/JPY 110 straddle Sell EUR/GBP spot at for a target with a stop/loss at Enter a seagull (ratioed) for EUR/SEK downside: buy 1*8.90 put; sell 2*8.60 put; sell 1*9.30 call; horizon: 6M (spot ref 8.92). Zero cost (indicative prices) We enter a bearish 6M risk reversal: we buy one EUR/NOK put at 8.30 and sell one EUR/NOK call at The strategy is zero cost with spot ref (indicative prices). Buy EUR/CZK via a 6M 1:2 ratio forward strategy: buy a 6M EUR/CZK call at and sell a 6M EUR/CZK put with a double notional at zero cost, spot ref (indicative prices). Sell AUD/USD (spot ref ) and buy USD/CAD (spot ref ) in equal 100 for a 106 target; stop at 97 Sell 12M USD/CNH for 5.96 and Closed FX Top Trades Opened 06/12/2013 Start 0.90 Target/Stop Now 0.87 P/L -1.06% Opened 06/12/2013 Start Target/Stop Now P/L 1.16% Opened 06/12/2013 Start 0.84 Target/Stop Now 0.84 P/L -0.27% Opened 06/12/2013 Start 8.92 Target/Stop Now 8.82 P/L 1.21% Opened 06/12/2013 Start 8.44 Target/Stop Now 8.30 P/L 0.83% Opened 06/12/2013 Start Target/Stop Now P/L -0.25% Opened 06/12/2013 Start Target/Stop 106/97 Now P/L 1.03% Opened 06/12/2013 Start 6.14 Target/Stop 5.96/6.23 Now 6.18 P/L -0.75% # Type Trade Opened Closed P/L 1 Spot Buy TRY/DKK % 2 Spot Buy RON/PLN % 5 18 March

6 EUR/USD: heading for 1.42 then lower on Fed/ECB on 12M Following the March ECB meeting, we have opted to revise more fundamentally the level and profile of our EUR/USD forecast. We now look for the cross to head a little higher in the near term into the low 1.40s on markets pricing limited ECB action and to stay around that level on a 3M horizon, notwithstanding the possibility of some vague form of easing in April. The potential for downside from there will likely depend on the Fed tapering process as ECB rates are set to stay low for very long. In our baseline scenario we see EUR/USD drift down to the mid 1.30s by year end. As a result, we now project the cross at 1.42 in 3M (previously: 1.34), 1.37 in 6M (1.30), and 1.32 in 12M (1.26). For most of the past year we have held the view that relative monetary policy would induce a gradual move lower in EUR/USD. While the usual prime driver, namely relative interest rates, has in fact supported this call recently, the cross has failed to adhere and edged steadily higher since the autumn. A hawkish ECB and weakness in US data have together with EUR-positive flows deterred a downward move. Current-account and portfolio flows are likely to continue to work against EUR/USD downside as is the long-standing overweight of speculative USD longs, and in the near term we thus see the risk of limited ECB action (if any) bringing the cross above the 1.40 level. However, some of the factors supporting the euro over the past year such as notably flows into peripheral countries in the eurozone should become less EUR supportive going forward. A recoupling of the cross with relative rates may henceforth be expected. Notably, we still see the Fed moving towards higher rates way ahead of the ECB. EUR strength should also be limited as rates are arguably anchored by Draghi s forward guidance and the deflationary pressure it would in itself create in the euro area. FX forecasts EUR/USD 18-Mar M M M M Source: Bloomberg, Danske Bank Markets Relative rates failing to explain EUR/USD lately ECB in disarray to spur near-term EUR lift... Following the March meeting at which Draghi and co decided to stay put on policy despite putting forth a soft inflation outlook until 2016, the bar for further easing from Frankfurt has seemingly been raised substantially. Still, given our economists forecasts for inflation to hit another cycle-low of 0.5% in March, we continue to see a case for further easing in April. However, should this come in the form of a refi cut or end to the sterilisation of the SMP, it is unlikely to be a game changer for the euro as these measures would merely put a lid on how much EUR money-market rates could rise rather than push the level of short-end rates markedly lower. Indeed, given the level of excess liquidity in the eurozone, the deposit rate is effectively what determines EONIA rates and, in turn, should affect the euro. Eurozone headline inflation Source: ECB; Macrobond, Danske Bank Markets If the ECB refrains from easing in April, we believe the window for this in Q2 14 will close. On a 1-3M horizon we think there is a good chance the ECB will deliver very little to suppress EUR downside as the Council currently seems in disarray as inflation drops, activity recovers (albeit slack remains substantial) and non-standard instruments are the only real option. On the whole, this suggests to us that in the near term limited ECB action will not be able to stem the current momentum in the euro. Senior Analyst Christin Tuxen tux@danskebank.dk 6 18 March

7 ...but limited potential for EUR upside further out However, as we still see the ECB inflation forecast as too optimistic with respect to hitting the 2% target in 2016, we nevertheless expect more easing in H2 14. By then, the ECB would likely have had the time to consider in more detail how to set up a quantitative easing (QE) or an Asset Backed Securities (ABS) scheme, both of which could work more directly towards addressing the fragmentation in the eurozone, which continues to worry the ECB in terms of facilitating monetary-policy transmission (see illustration below). ECB view on monetary policy transmission in the eurozone Bank-lending channel Source: ECB However, we stress that none of these programmes directed at fixing the impaired banklending channel in the eurozone would likely be particularly EUR negative as they would be addressing the flows/volumes of credit rather than prices (interest rates) directly. Still, two factors should, in our view, however limit the potential upside to the single currency in the longer term (6-12M horizon). ECB forward guidance seems to be working First, since it was introduced in July 2013, the ECB has reiterated its vague form of forward guidance, stating that key ECB interest rates [are] to remain at present or lower levels for an extended period of time. And, in fact, this has proved another example of Draghi effectively mastering verbal intervention (recall the effectiveness of his announcement of the OMT programme in curtailing the debt crisis in September 2012). Indeed, we note that while 1Y1Y forward rates in the US have edged higher recently, this has not been the case for its euro-area counterpart and notably the two have seemingly decoupled since the autumn. This suggests the ECB has, in fact, managed to keep rate expectations anchored, albeit with a guidance which remains scant compared with the much more explicit time-or state-dependent versions adopted by other central banks in the past. As a result, our rate strategists see the short end anchored throughout most of the year but also stress that it is unlikely to decline much further. Forward guidance at work 7 18 March

8 In relation to this, we note that in the event of the ECB setting up e.g. a QE programme in the autumn and the Fed tapering comes to an end, we also see potential for the crosscurrency basis, which has generally moved in favour of EUR over the past two years, to reverse and thus add to any fundamentally based USD strength. Hence, if we are right in envisaging a recoupling of EUR/USD with relative rates and provided the ECB aims at anchoring rate expectations at low levels and inflation expectations around the 2% level, then relative real interest rates (arguably a more relevant comparison than nominal rates - here shown with a 5Y horizon) should drift further in favour of EUR/USD downside, everything else equal. EUR strength limited by its deflationary effects Second, EUR strength should also be restricted by the very fact that upside directly depresses any inflationary pressure. The importance of the technical assumptions including an unchanged exchange rate and falling oil prices (based on market pricing) for the inflation outlook was a focal point at the ECB press conference in March and Draghi s speech on 13 March: while Draghi has been keen to underline that the ECB does not target a level for the euro, he nevertheless pointed out that one could expect a 10% appreciation in the effective exchange rate to lower inflation by some 40-50bp. With EUR/USD set at a fixed rate of 1.36 in current ECB projections, a move towards 1.42 as we look in 3M could thus potentially, if sustained, in itself cut headline inflation by close to 0.2pp. This suggests that while the ECB may tolerate a temporary move higher in the single currency, it would put its inflation forecasts greatly at risk if a sustained move higher was to be seen. EUR: forget about negative rates? Our baseline scenario now is that the ECB chooses some middle-of-the-road form of further easing (refi cut, stop SMP sterilisation) in the near term to put a lid on how much moneymarket rates can possibly rise, but outright downside to the EONIA curve should not be expected. With a negative deposit rate now seemingly a distant option in the euro area we would, however, not expect any significant EUR downside to materialise from this side. If anything, the ECB is probably more likely to think along the lines of adjusting the volume of credit (stop SMP sterilisation, new LTRO, QE in some form, ABS programme) rather than adjusting the price (rates). Thus, the type of easing we may get, if inflation evolves as we project, is unlikely to be particularly EUR negative. USD: forget about more QE? Despite the deterioration in the US data flow in recent months, the Fed is seemingly complacent about bringing tapering to an end by year end not least after a decent February payrolls report. Indeed, the Fed still appears optimistic on the medium-term outlook for the US and has so far largely dismissed the latest weakness as weatherrelated. Our rate strategists look for the first hike in June 2015 followed by 25bp hikes at each meeting over the following two years. This should induce a steeper US moneymarket curve and support USD albeit the Fed will likely be keen to stress that the tightening pace will be gradual and data-dependent. Real relative interest rates Effective euro exchange rate EUR rates to stay anchored Source: Danske Bank Markets USD rates with upside potential Source: Danske Bank Markets. While a tapering pause could not be ruled out if the data flow deteriorates from here and/or an emerging-markets crisis resurfaces, a new possible scenario at the other end of the spectrum would be that the Fed signals that rate hikes could come earlier than currently projected if the momentum in the US economy is sustained. Needless to say, this would put further downward pressure on EUR/USD March

9 EUR/USD: ECB-Fed matrix spans 1.24 to 1.44 in 12M In ECB and the euro: What to expect from both this year (3 March) published ahead of the March ECB meeting we illustrated our 12M EUR/USD baseline forecast and risks using a matrix of possible ECB and Fed outcomes. We have updated the possible scenarios for the two central banks and adjusted the associated EUR/USD outcomes to reflect that our main scenario now reads 1.32 in a year s time (see illustration below). On the one hand, the prospects for further ECB easing have waned (still, ECB rate hikes are not included as a possible 12M scenario). On the other hand, the likelihood of the Fed pausing tapering has declined somewhat since then and the chance of the Fed adding to QE has probably subsided, for now. Note that EUR/USD 12M risks now span the 1.24 to 1.44 interval with the chosen scenarios. EUR/USD in 12M: ECB Fed outcomes EUR/USD in 12M ECB cuts deposit rate and adds liquidity Fed ends tapering 2014 and signals earlier rate hikes Fed ends tapering 2014 and signals no imminent hikes Fed pauses tapering Baseline scenario ECB cuts refi rate or adds liquidity No ECB easing Source: Danske Bank Markets 9 18 March

10 GBP: support from strong economy The UK recovery has continued at a strong pace, pushing the unemployment rate significantly lower towards the old 7.0% threshold line. Coupled with very low inflation in the eurozone and the ECB being low for longer, this bodes well for sterling against euro on six- and 12-month horizons. However, UK growth expectations are elevated and the Bank of England (BoE) is eager to convince the market that rate hikes are not imminent given the spare capacity in the UK economy. Overall, we expect EUR/GBP to trade close to the current level of 0.83 on a three-month horizon. On a 12-month horizon, relative monetary policy and a stronger US dollar is expected to push the cross down to Still strong economic outlook The Q4 GDP breakdown confirmed that the UK economy grew by 0.7% q/q driven by investment and net trade. The recent PMI surveys also point to a continued recovery, with output and employment expanding at a decent pace. The latest PMI manufacturing came i at 56.9 the seventh consecutive month with the indicator above 56. The NIESR GDP estimate indicates that growth continued at, or slightly above 0.7% q/q in Q1. Hence, compared to the eurozone the UK economy is clearly still outperforming. However, note that UK growth expectations are also high, which is reflected in the UK surprise index, which started to edge lower in March. FX forecasts EUR/GBP 18-Mar M M M M GBP/USD 18-Mar M M M M Has the UK surprise index peaked? The UK housing market is also still on a strong footing with house prices continuing to increase at a rapid rate, up approximately 10% y/y. While data on lending to individuals points to a continued improvement in secure credit flows, these are still well below precrisis levels. Hence, there is still room for some pent-up demand in the UK housing market. Although we expect the recovery to be sustained, imbalances in the public budget, weak growth in real disposable income posing a substantial headwind for consumer spending and relatively modest prospects for export growth suggest that growth will be a bit more modest going forward. CPI inflation is currently at 1.9% and we expect it to remain close to this level near term. The latest RICS house price indicator might also show that the housing market has peaked, though it still clearly points towards higher prices. Source: Macrobond, Bloomberg UK housing market still strong (% y/y) Labour market strong but not strong enough to trigger rate hikes this year For monetary policy, the unemployment rate is of course pivotal not least after monetary policy was made conditional on the unemployment rate in In the February Inflation Report, the BoE laid down the next phase of guidance, setting out the factors that will guide its decisions and how the bank rate is likely to evolve once the 7% unemployment threshold is reached. The unemployment rate came in at 7.2% in January. Source: Macrobond, Bloomberg BoE: will not tighten just because 7.0% unemployment threshold is breached The BoE argues that there is a lot of spare capacity and with inflation projected to be below target two-three years ahead, the MPC signalled that the economy still needs a low-rate policy and that once the bank rate does begin to rise, it is expected to be gradual and limited versus pre-crisis levels. Source: Macrobond, Bloomberg, Bank of England March

11 We expect the first rate hike in the spring of 2015 in expectation of macro data continuing to be consistent with an above-average pace of expansion gradually removing economic slack in the economy. This should keep fixings flat for now but they could start moving higher late this year in anticipation of monetary tightening moving closer. The UK money market curve should also start to steepen relative to the euro curve on six- and 12-month horizons. Hence, despite the market being well prepared for a rate hike next year, we believe that relative monetary policy will be a clear supportive factor for sterling on 6M and 12M horizons. Not least, we argue that the ECB is going to surprise on the dovish side in Note that EUR/GBP still has a high correlation with relative rates (here the 2Y swap rate spread is used) and it seems that GBP has some catching-up potential. Relative rates to push EUR/GBP lower in 2014 The question is how much more GBP strength there is in store. Even though we have seen a significant GBP appreciation since August 2013 both against the euro and US dollar, it is noteworthy that the so-called IMM/CFTC data shows that speculative positioning in, for example, GBP/USD does not look stretched. According to the data, non-commercial net long positioning only accounts for 8.7% of socalled open interest. The relative low speculative positioning for a stronger GBP, despite the pronounced appreciation trend, underlines that this is not just a trend triggered by speculative flows, but a more fundamental re-pricing of sterling after the strong headwind seen in the beginning of GBP to trade in tandem with USD In 2011 and 2012, we saw a decoupling between the US dollar and sterling and very low correlations between the two currencies. The positive correlations were re-established during 2013 and we think it will become higher going forward as both currencies will be traded as early movers in respect of monetary policy. Hence, our view that EUR/USD will rise to 1.42 in three months time is also likely to push EUR/GBP higher short term not least as the BoE is likely to try to convince the market that a rate hike is not imminent despite the recent fall in the unemployment rate. More importantly on the 12-month horizon, the correlation between EUR/USD and EUR/GBP is also expected to hold, which given our 1.32 EUR/USD forecast is one important reason together with relative monetary policy, why we expect EUR/GBP to drift back below 0.80 on this horizon. Chief Analyst Arne Lohmann Rasmussen arr@danskebank.dk Still room for speculative long GBP positions Source: CFTC, Danske Bank Markets The correlation between GBP and USD might be changing Correlation between EUR/GBP and USD/GBP, 26 week rolling Source: Bloomberg, Danske Bank Markets March

12 JPY: higher inflation requires weaker yen We expect the Bank of Japan (BoJ) to remain the most aggressive central bank when it comes to monetary easing, as the combination of slower growth and declining inflation will eventually force the central bank to step up its already extreme QE programme even further. This will contribute to a weaker yen over time. GDP growth disappointed significantly in H2 13, raising concerns that the Japanese economy might not overcome the negative effects from the announced VAT hike. If the economy is as weak as GDP figures suggest, we see a high probability of further BoJ easing already in April which could potentially ignite the next uptrend in USD/JPY. We target USD/JPY in 114 in 12 months time while EUR/JPY is expected to rise to 151 over the same period. Recovery fades and recession risks rise Japan has entered the next stage of Abenomics, which will be much more difficult. Most importantly, Abenomics will lose the fiscal stimulus pillar as substantial fiscal tightening is on the agenda for both 2014 and 2015 where fiscal policy is still expected to be tightened by close to 1% of GDP in However, following GDP growth rates above 4% (quarterly, annualised) in H1 13, economic growth disappointed significantly in H2 13 where the final revisions of GDP growth estimates showed that the Japanese economy only expanded at an annual rate of 0.9% and 0.7% in Q3 and Q4 respectively. While the outlook for Q1 looks fairly strong as households are expected to frontload purchases of durable consumer goods prior to the hike in the consumption tax from 5% to 8% in April, there is a risk that the running start stemming from monetary and fiscal stimulus needed to quickly overcome the negative effects from the fiscal tightening is too slow. In addition, most business and consumer indicators seem to have peaked in Q1 pointing towards an economic slowdown later this year. This has to some extend been expected due to the announced fiscal tightening, but it still underlines that headwinds looms ahead and currently, and the risk that Japan actually might face a new recession in H2 14 has risen significantly if the economy is as weak the recent GDP figures implies. FX forecasts EUR/JPY 18-Mar M M M M USD/JPY 18-Mar M M M M Source: Reuters EcoWin, Danske Bank Markets Very weak GDP growth in H2 13 Higher inflation requires a weaker yen BoJ action warranted Inflation likely to drop below 1% again On the surface, it looks as though the BoJ is defeating deflation and should be able to reach its 2% inflation target at some stage in However, the increase in inflation has so far mainly been driven by a weaker yen working mainly through higher prices on energy and other imported goods, and we believe that it will be much more difficult to push inflation higher from here. Our inflation forecast implies that CPI excluding fresh food and adjusted for the consumption tax hike (the measure the BoJ targets) will soon peak and start to decline again to below 1% y/y by mid In our inflation forecast we assume that core inflation will gradually increase towards 1.3% y/y and that USD/JPY will gradually increase to 114 over the next 12 months. In our view, this highlights how extremely dependent the BoJ is on a weaker yen in order to achieve its 2% inflation target in Without continued depreciation of JPY it will be impossible to reach its 2% inflation target in Senior Analyst Morten Helt mohel@danskebank.dk Assistant Analyst Kristoffer Kjær Lomholt klom@danskebank.dk March

13 Current account deficit just another argument for a weaker yen Japan s current account balance dropped further to a new record low of JPY-1,589bn in January. It was the fourth consecutive month with a current account deficit and while some of the decline can be related to a pick-up in domestic demand ahead of the sales tax hike in April, the drop also represents a fundamental shift in the Japanese economy. We see a high probability that Japan could face a current account deficit for 2014 as a whole and potentially turn into a deficit nation in coming years. As a consequence, Japan will need funding from abroad to finance its budget deficits which represents a long-term upside risk to Japanese bond yields. However, it would be just another argument for a weaker yen. Japan likely to face a current account deficit in 2014 BoJ s monetary policy will lead to further yen weakness We still expect the BoJ to remain the most aggressive central bank when it comes to monetary easing, as the combination of slower growth and declining inflation will eventually force the central bank to step up its already extreme QE programme even further. At the same time, we expect the Fed to continue its current tapering path, bringing QE to an end this year which will eventually lead to a steeper US money market curve. Hence, relative monetary policy still support the case for further USD/JPY upside going forward and we target USD/JPY at 105 in 3M, 110 in 6M and 114 in 12M. We have for several months argued that USD/JPY was likely to range-trade in Q1 as BoJ was set to remain on autopilot for some time keeping monetary policy on hold. However, if the Japanese economy is as vulnerable as suggested by the Q4 GDP data, there could be strong arguments for the BoJ to move forward additional easing of monetary policy. This could come as soon as in connection with the April meeting when the BoJ will also release its new macroeconomic outlook report. Thus, while our base scenario remains that the BoJ will announce additional easing measures in the late part of Q2 when it has had some time to evaluate the effects from the VAT hike, we highlight that weak economic growth has indeed increased the probability of BoJ easing earlier. Hence, provided that the current risk off in the market will not be prolonged, the next spike in USD/JPY could be just around the corner. Short JPY positioning not extremely stretched March

14 According to the so-called IMM/CFTC data, speculative short JPY positions have been reduced markedly in the wake of the emerging markets sell-off. While positioning remains relatively stretched, the recent termination of short JPY positions has reduced the space for further USD/JPY downside. Moreover, we note that a stretched positioning is no barrier for further yen weakness and thus from a positioning point of view, we favour positioning for further yen weakness via a long USD/JPY spot position March

15 CHF: reversal in safe-haven flows to drive CHF-weakening The Swiss franc has benefited from the emerging market sell-off in the first months of 2014 despite the PIIGS rate spread to Germany tightening at the same time. Together with the very low inflation figures out of Switzerland this has increased the pressure on the SNB although a surprisingly hawkish ECB has relieved some of the short-term pressure in relation to the 1.20 EUR/CHF floor. On a 6-12M horizon, however, we still expect EUR/CHF and USD/CHF to move higher primarily driven by a continuation in the reversal of safe-haven flows. The emerging market sell-off has benefitted the CHF We entered this year with a moderately bearish view on the CHF vis-à-vis the USD and the EUR. In our FX Top Trades 2014: How to position for the coming year, 9 December 2013, we argued that a bullish USD/CHF call spread was a short EUR/USD position in disguise and how the USD/CHF position was preferable as it served as some insulation against the risk of continued euro peripheral sentiment improvement. FX forecasts EUR/CHF 18-Mar M M M M USD/CHF 18-Mar M M M M In 2014 economic data out of the eurozone have generally surprised to the upside and the PIIGS rate spread to Germany has indeed tightened since we sent out the trade recommendation. On the other hand, the CHF has benefitted from the emerging market turmoil experienced in the first three months of The emerging market sell-off was originally initiated by a growing concern about Chinese growth but has recently been catalysed by the Ukrainian-Russian conflict. The resulting inflows to Switzerland one of investors preferred safe havens have strengthened the CHF. Deflation and rapid credit growth increasing the pressure on the SNB The SNB under pressure Low inflation figures continue to pose a deflation risk for the Swiss Central Bank and CPI figures for February indeed showed a decline in prices on a y/y basis of 0.1%. The pressure on the SNB is building up, although a surprisingly hawkish ECB relieved some of the imminent short-term pressure on the 1.20 EUR/CHF floor. The president of the SNB, Thomas Jordan, recently said that we fundamentally exclude no measures that help us to guarantee adequate monetary conditions, highlighting the readiness of the central bank. Among possible tools available to the SNB, we find raising the current 1.20 EUR/CHF floor or alternatively introducing penalty rates on CHFdeposits the most likely. Both would weaken the CHF. However, our main scenario remains that the SNB will maintain its current 1.20 EUR/CHF target until further action is taken by the ECB. Another concern of the SNB is a booming residential real estate market, which already back in January led to its submission of a proposal to the Federal Council to increase the countercyclical capital buffer from 1% to 2% of risk-weighted positions secured by residential property in Switzerland. Senior Analyst Morten Helt mohel@danskebank.dk Assistant Analyst Kristoffer Kjær Lomholt klom@danskebank.dk March

16 ...CHF to weaken going forward Our FX short-term financial models indicate that neither EUR/CHF nor USD/CHF trade with significant misalignments relative to the models fair value estimates although USD/CHF spot has recently moved somewhat below our model estimate. Nonetheless, our PPP-models suggest that the CHF is currently overvalued against both the EUR and the USD. In the next six to 12 months we expect EUR/CHF to gradually edge higher towards 1.26 mainly driven by a reversal of safe-haven flows. In the short run, however, we do not expect USD/CHF to move higher. Draghi was surprisingly hawkish at the March ECB meeting and as long as there are no indications of an imminent ECB easing we think it will cap the shortterm upward potential in USD/CHF. On the other hand, Eonia rates have increased recently and as long as the ECB does not take further actions, we do not expect rates to fall back. Eonia rates have previously been an important driver for the cross and with no SNB rate hike looming, higher European money market rates could support the case for some nearterm EUR/CHF upside when the market s risk-off sentiment eventually fades. Eonia 3M rates to support EUR/CHF The absolute correlation to risksentiment has increased FX short-term financial model estimates for EUR/CHF FX short-term financial model estimates for USD/CHF Source: Bloomberg, Danske Bank Markets Source: Bloomberg, Danske Bank Markets Risks The biggest risk to our projections is the possibility of global risk appetite tumbling, which could spark a flight to safe-haven currencies including the CHF. In the short term the most likely catalyst is an escalation in the ongoing Ukrainian/Russian conflict. Not only could an escalation tamper with global risk appetite, safe-haven flows to Switzerland could be amplified by Russian banks withdrawing funds from the United States and placing them in Swiss Banks. Fundamentally the large current account surplus will benefit the CHF going forward. Measured as a percentage of GDP the current account surplus is currently at 11%, which dampens the extent to which we can expect to see medium- and long-term moves higher in EUR/CHF and USD/CHF. CHF is currently overvalued according to our EUR/CHF PPP-model... and USD/CHF PPP model Source: Bloomberg, Danske Bank Markets Source: Bloomberg, Danske Bank Markets March

17 SEK: pause The krona has performed well versus the major currencies so far this year despite a rate cut in December, falling money market rates and worryingly low inflation that seem to prolong the period of low rates further and further. Support has been received by betterthan-expected real (hard) data and valuation. We stick to our 3M target of Due to a less bearish euro view, we have chosen to raise our 6M and 12M target to 8.80 (8.70) and 8.60 (8.50), respectively. If EUR/SEK edges lower in the coming weeks, we will consider early profit-taking in our short EUR/SEK Seagull, initiated in FX Top Trades 2014: How to position for the coming year (9 December 2013). From cheap to neutral We entered this year with a modestly bullish view on the SEK, which was expressed by a bearish EUR/SEK seagull (see FX Top Trades 2014: How to position for the coming year, 9 December 2013). We argued that EUR/SEK should head lower because (1) the pair was significantly (more than two standard deviations) overbought relative to our interest rate implied fair value model and (2) we saw a window opening in Q1 where Swedish macro data had the potential to surprise on the upside. The trade is decently in the money. Indeed, we have seen EUR/SEK adjusting lower since mid-december despite the fact that the Riksbank cut the repo rate to 0.75% and that OIS rates through the end of 2015 are down by 25-35bp. The euro OIS curve is lower as well but less, which implies that EUR/SEK has managed to come down without support from momentum in relative rates. The result is that EUR/SEK has approached and is now trading close to the interest rate implied fair value. Case closed for now. We have received predominantly better-than-expected Swedish macro data since the last week of 2013 (see chart on next page). Repeatedly, these surprises have had a positive impact on the krona. The most recent surprise was the Q4 GDP reading, which slashed economists forecasts including ours and the Riksbank s. Admittedly, the main driver was inventories (1.4pp of the 3.1% y/y) but private consumption and fixed investments were also on the strong side of expectations. As a consequence, we have raised the 2014 GDP forecast from 2.5% to around 3.0%. Swedish growth and growth-related data will significantly outperform euroland this year, which is a factor that in our view will weigh on EUR/SEK over time. However, the potential for positive surprises has decreased and looks more neutral. Case closed for now. FX forecasts 18-Mar M M M M USD/SEK 18-Mar M M M M Re-pricing of the Riksbank has coincided with a stronger SEK 2,00% 1,50% 1,00% 0,50% EUR/SEK Pricing SEK-OIS 1m swap 0,00% dec13 jun14 dec14 jun15 dec15 jun16 dec16 jun17 Current 13-dec-13 Policy Rate Next policy move live Source: Danske Bank Markets EUR/SEK and relative rates The Riksbank has shifted to inflation Over the past couple of months, the Riksbank has shifted focus on the back of tryingly low inflation, which has undershot its short-term forecasts over and over again. Enough is enough it seems to think, so from now on monetary policy will first and foremost be driven by the inflation outlook and inflation outcomes. Household debt and real macro data will still matter but be of secondary importance. CPIF inflation currently runs about 0.1pp below the Riksbank forecast. This is not enough to trigger an April cut. While we think the Riksbank will abstain from lowering the repo rate below 0.75%, we do not see a hike before next summer. Furthermore, based on our below-the-riksbank inflation forecast the risk balance for 2014 should continue to be tilted in favour of a cut rather than a hike. Current pricing for the next 6-18 months seems fair. Source: Danske Bank Markets Senior Analyst Stefan Mellin mell@danskebank.se March

18 Notably, one of the Riksbank board members, Per Jansson, at the last monetary policy meeting went as far as committing himself not to vote for a rate hike before CPIF inflation exceeds 1.5%, which he and the Riksbank expect will happen in Q1 15. We think later. Should the ECB ease its policy stance, pressure on the Riksbank to follow suit should mount, and vice versa. We have had a constructive view on NOK/SEK based on the view that relative monetary policy was skewed. After the recent re-pricing of the two central banks, the relative rates argument has become less attractive. USD/SEK may go somewhat lower if the recent trend in EUR/USD can be sustained. But it is hard to ignore the fact that levels are low already. GBP/SEK has been range-bound for several months now. The market is currently pricing in a scenario where the Bank of England has delivered its first rate hike early next year, clearly ahead of the Riksbank. Relative pricing has become somewhat stretched; thus, the upside in GBP/SEK is limited from a monetary policy point of view. SEK stronger with better data Source: Danske Bank Markets and is not entirely happy with the exchange rate How concerned is the Riksbank with the exchange rate? Crucially, the Riksbank actually anticipates, and imbedded in its forecast, a 1% effective SEK appreciation (KIX index) until December 2014 and a cumulated 2% appreciation until late The KIX index has averaged at YTD, which is exactly in line with the Riksbank Q1 forecast. But even though the exchange rate developments have tracked its forecasts extremely well, a few board members have expressed concern about too strong a currency lately. This suggests that it is something they will monitor closely going forward. We argue however that it should not be a problem for the Riksbank (its inflation forecast) if the krona were to appreciate an additional 2% or so, but we get the impression that the central bank has become more sensitive and ready to mitigate excessive moves in the wrong direction. Riksbank anticipates stronger SEK Source: Danske Bank Markets Dividend time April is the main dividend payment period for Swedish companies. This may have some very short-term impact on the krona on individual days. But while a significant share will be paid to foreign owners, a large part of it is arguably being reinvested, and we have not found any historical evidence of SEK depreciation during the weeks when dividend disbursements peak. Fundamental backdrop intact The fundamental backdrop remains supportive for the SEK. Relatively low inflation has improved Sweden s competitiveness further and the current account and savings surpluses suggest there is still long-term value in the krona. Indeed, foreign appetite for Swedish fixed income assets seemed to stabilise/rebound at the end of last year March

19 NOK: sentiment has improved It seems that there has been a shift in sentiment this year towards the NOK after the strong depreciation in We expect EUR/NOK to decline towards 8.00 over the next 12 months. Relative rates, investor flows, inflation on target and less risk attached to the NOK will be supportive factors in However, the soft rhetoric from Norges Bank in 2013 and the lack of demand for safehaven currencies underline that a new strong appreciation trend as witnessed in 2012 is unlikely. The housing markets, global risk appetite and a turn in the oil investment cycle continue to be the main risks to our positive NOK view. Moderate growth and inflation close to target Economic growth in Norway continues at a moderate pace of around 2%. After a continued weakening picture throughout 2013, there are currently signs that the Norwegian economy is bottoming out in terms of growth. Industrial production is up 2.7% y/y and manufacturing PMIs have been consistently above 50 since the summer of The unemployment rate has stabilised just below 3%, after some time with increased unemployment. The latest regional network report from Norges Bank also showed some improvement but it certainly did not indicate booming growth. FX forecasts EUR/NOK 18-Mar M M M M USD/NOK 18-Mar M M M M The past two core inflation figures came out at 2.4%. As such, Norway is one of few countries with inflation close to target (2.5%) and given the focus on deflation at most other central banks the inflation picture is a positive factor for the NOK in the next couple of quarters. We have seen a spike in import prices in the trade statistics and together with the lagged effect from the NOK depreciation in 2013 there is still some upside potential for Norwegian core inflation. However, eventually the effect from the currency depreciation will disappear and core inflation is expected to stabilise around 2.0%. NOK depreciation has pushed imported inflation higher Import prices to push CPI higher Source: Danske Bank Markets, Macrobond Source: Danske Bank Markets, Macrobond Economic risk factors: housing market and oil investments In respect of the Norwegian economy and the Norwegian krone we would still point to the housing market and oil investments as the two main risk factors. Norwegian house prices have been under some pressure since mid-2013 but according to the EFF house prices are just down 2-3% from the peak in the autumn and in both January and February prices actually rose 0.3% s.a. Note, though, that the average time to sell a house has gone up, whereas the number of transactions is still holding up fairly well. All in all we hold the view that the Norwegian house prices will be stable throughout 2014 supported by income growth, still low rates and stable bank lending standards. We certainly do not foresee a collapse in house prices. If we are correct, a big risk factor should be removed from the NOK and support investor sentiment. Chief Analyst Arne Lohmann Rasmussen arr@danskebank.dk March