The State of Global Foreign Exchange Markets Nick Bennenbroek
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.
After a Strong Start to 2015, the Greenback s Performance has Been More Mixed Recently 120 Fed's Broad U.S. Dollar Index 110 100 90 Source: Ecowin and 4
A Slow Start for the U.S. Economy in 2015 9% U.S. Economic Growth % qtr/qtr annualized 6% 3% -3% GDP -6% Final domestic demand -9% Source: Ecowin and 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-2016 2% 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
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
Fed Interest Rate Increases Still Likely Later in 2015 Two-Year Government Bond Yields 2.0 1.5 Major Countries, trade-weighted, left scale United States, right scale 1.85% 1.35% 1.0 0.85% 0.5 0.35% 0.0-0.15% Source: Ecowin and The U.S. policy outlook contrasts with the still generally easy global monetary policy stance. 8
Monetary Policy Divergence Suggests Trend U.S. Dollar Strength D Dollar Index vs. Two-Year Yield Spread 1.0 0.3 2-Year Yield Spread, U.S. less foreign, left scale Fed's Dollar Index vs Major Currencies, right scale 97 87-0.4 77-1.1 67 Source: Ecowin and Greater currency volatility is possible as the greenback reacts to economic swings and monetary policy signals. 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
European Central Bank Active, Monetary Policy Dovish 20 ECB Weekly Asset Purchases Euro Billions 15 10 5 0-5 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
Eurozone Economic Underperformance Also Argues for a Weaker Euro 6.0 Relative Growth vs. Euro Performance 24% 3.0 12% 0.0-3.0-12% -6.0-9.0 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
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
Lower Energy Prices Pose Economic Risk for Canada Resource Sector: Employment and Output 2 % year/year 1-1 -2 Employment: Forestry, fishing, mining, oil and gas Output: Mining, oil and gas extraction Source: Ecowin and 14
The Canadian Dollar Has Already Substantially Adjusted to Weaker Oil Prices Canadian Dollar and Commodity Prices 1000 860 Bank of Canada Commodity Prices, left USD/CAD exchange rate, inverted, right 0.70 0.83 720 0.96 580 1.09 440 1.22 300 1.35 Source: Ecowin and 15
But Fed Tightening Could See the Canadian Dollar Drop Further 130 Canadian Dollar and Bond Yields 0.90 96 1.00 62 1.10 28 1.20-6 -40 2-Year Yield Spread: Canada less U.S., basis points, left USD/CAD exchange rate, inverted, right 1.30 1.40 Source: Ecowin and 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
FX Inflows Have Slowed, while There Are Also Signs of Some FX Outflows Central/Commercial Bank FX Purchases 800 CNY billions 600 400 200 0-200 Source: Ecowin and 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
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
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
FX Positioning Should Limit Peso Downside, Support Peso Upside 180 MXN & IMM Positioning USD/MXN, inverted 11.80 90 12.80 13.80 0 14.80-90 Net contracts, '000s 15.80 Source: Bloomberg LP and The Mexican central bank has also introduced currency support measures to help limit peso declines. 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
Wells Fargo FX Forecasts Source: 3M 6M 12M 18M EUR/USD 1.1100 1.0800 1.0400 1.0000 USD/JPY 122.00 123.00 125.00 127.00 GBP/USD 1.5400 1.5300 1.5100 1.5200 AUD/USD 0.7600 0.7500 0.7300 0.7200 USD/CAD 1.2400 1.2500 1.2700 1.2900 USD/CNY 6.2000 6.1900 6.1700 6.1500 USD/MXN 15.5000 15.6000 15.6000 15.4000 24
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