FX Week Overlapping themes keep EUR underpinned There are a number of overlapping issues at the start of the week that are creating considerable uncertainty in the currency markets. The main macro concerns relate to the strength of the recovery, with the latest jobs data failing to provide a convincing answer about when an interest rate rise will actually be warranted. Then there is the Eurozone where the Greece crisis continues to fumble on towards some form of endgame, but with little optimism about what that end will be. Thirdly there is the sharp rise in bond yields in the last fortnight, led by the collapse in Eurozone bonds but also impacting on Treasuries. With conflicting arguments about the cause, the EUR has also been lifted to weekly highs, but there remains significant uncertainty about whether either will be sustained, especially against such a muddy macro backdrop. Weekly 1 May 215 data maintains tightening uncertainty Our starting point is that although the economic data that in the case has shown signs of improvement, this has not been enough to justify any near-term change in monetary policy, or the significant swings in bond yields seen over the last two weeks. Although April non-farm payrolls increased by a respectable 223k, with the unemployment rate also falling to a seven-year low of 5.4%, a downward revision to an already weak March report (85K instead of 124k) took the shine of the rebound. With average hourly earnings also rising by just.1%, the data reinforce our view taken after the March payrolls report that the June FOMC meeting will be too soon to expect lift-off from the Fed. Rather it is more likely that the Fed s revised unemployment rate target of 5.-5.2% will be reached in H215, setting the stage for a September hike instead. Against this background, along with an array of other data that points to a delayed Fed rate rise rather than an imminent one, it is surprising how bond yields have risen sharply in the last two weeks, even allowing for the drive for that increase coming from the Eurozone rather than the. Puzzling over bonds and the EUR Even the arguments for higher Eurozone bond yields do not look convincingly to do with fundamentals either, having risen around 5bps from their April low (see chart). Granted some economic indicators in the Eurozone have improved of late, but inflation is still barely rising and the situation in Greece can hardly be viewed as encouraging. EUR supported by rally in yields Tim Fox Chief Economist +971 4 23 78 timothyf@emiratesnbd.com Aditya Pugalia Analyst +971 4 23 782 Adityap@emiratesnbd.com www.emiratesnbdresearch.com.9.8.7.6.5.4.3.2.1 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 1.3 1.2 1.1 1 Germany 1 year bond yields EUR/D exchange rate (RHS) Source: Bloomberg, Emirates NBD Research
Oil prices, of course have risen, which might in some quarters be providing optimism that deflation risks are overdone and that bond yields had fallen too far. But it remains too soon to assume that oil price trends have reversed for good, or that the ECB s QE program will last any less than the eighteen months originally envisaged. Even if there is an element of underlying optimism represented by the rally in yields, our suspicion is that in the Eurozone s case in particular this will prove short lived, with a technical correction looking the most straightforward explanation for the reversal. From the market s perspective, it makes sense that if Eurozone bond yields were a drag on Treasury yields previously, their rebound reduces the case for buying Treasuries as well. Eventually should Eurozone yields fall back again, we suspect that bond yields may be more resistant, however, as the economic recovery there should have better traction. This should see the EUR lose ground again, while the D and yields hold up relatively better. Eurozone finance ministers to meet again over Greece The coming week may even be an early test of the EUR s durability above 1.1, with the Greek crisis facing another key deadline at the start of the week, when a Eurogroup meeting will take place Monday to decide if Greece warrants the remaining EUR7.2bn tranche of its second bailout. Our feeling is that this will not be approved, leaving the Greek government to draw on its own dwindling funds to stay afloat and make the EUR76 million payment to the IMF that is due on Tuesday. However, time is clearly running out and without regional support it is very hard to see how Greece will meet its EUR1.5bn of debt payments to the IMF that are due in June. Otherwise the focus will also be on the first estimate of Eurozone GDP, which is expected to have risen slightly from Q114 s.3% growth pace. Meanwhile economic data in the coming week includes retail sales, industrial production and consumer confidence, none of which are expected to provide significant impetus to rate tightening thoughts. UK election outcome supports GBP but for how long? Sterling rallied in the wake of the Conservative party s victory in the general election held last Thursday. Because the opinion polls had not anticipated the result there was room for GBP to advance 2 3 cents against the D, for Gilts to rally and for UK equities to perform well too. With the Conservatives winning a complete majority concerns about drawn out political wrangling disappeared and fears that the 5.% budget deficit might not be reined in were also reduced. However, the Conservative Party win brings with it different issues for UK markets to consider, most notably the prospect of an in-out referendum on the UK s membership of the EU, something which PM Cameron was quick to emphasize will go ahead, most likely still in 217. Ahead of this there will be two years of negotiations between the UK government and the EU over reforms that the British government would like to achieve, a process that is likely to unsettle UK markets and GBP periodically. In addition the success of the Scottish National Party also suggests it may not be long before independence for Scotland is again on the political agenda. For the time being the Bank of England will probably be relieved that there will be continuity in terms of the government s policy of balancing the budget in the next parliament, allowing it to focus wholly on the economy when it comes to deciding when to raise interest rates. Needless to say the MPC s belated policy announcement on Monday is not expected to see any change in either rates or in its QE program. However, the upcoming Inflation Report on Wednesday may raise the inflation forecasts a little in view of the recent recovery in oil prices, but in most other respects it will likely leave the outlook unchanged as the election result keeps the previous thrust of economic policy intact. So we still believe that rate rises will still be an issue for 216 rather than this one, leaving GBP unlikely to be able to push much higher than the peaks seen in the last Page 2
few days Asian focus on data D/JPY continues to tread water without much direction or conviction. The market probably expects that it will push higher eventually, when interest rates start to rise, but right now it appears to be tiring of failed attempts to break convincingly above 121, with the minutes of the Bank of Japan April meeting failing to provide clues as to the timing of any new monetary policy stimulus. Otherwise there is a fair amount of Asian economic data due out in the coming week, mostly from China, where production and investment data for April will be closely watched. Chana s inflation data this morning was mixed, showing a small increase in y/y inflation to 1.5%, up from 1.4% in March, but with pipeline producer prices still heavy at -4.6% y/y.. The AUD firmed surprisingly last week, even though the RBA cut interest rates to 2.%. However, its dropping of its dovish bias persuaded markets that it will be the last rate reduction, allowing for profit-taking on short AUD positions to help it reach over.8 at one point. However, by the end of the week the AUD was off its highs, with weaker than expected employment data highlighting that recovery will not be straightforward. Indeed the limited scope for further interest rate cuts probably means there will be greater focus going forward on keeping a competitive exchange rate. INR underperforms Finally the INR has lost -2.7% over the last month with the pace of decline gaining momentum over the course of last week dropping -.8%. The fact that the D was actually weaker during the same period suggests that local factors were at play. The sell-off in equities triggered by concerns over the minimum alternate tax (MAT) notices to FIIs has resulted in outflows of D 1.63bn over the last seven trading sessions. Additionally, higher oil prices fuelled demand for Ds by oil companies and weak trade data also contributed to a weaker INR. With the government forming a committee over the weekend to look into issues surrounding MAT, and with an interest rate hike in the looking a more distant prospect, the INR should remain range bound for a while albeit within a wider range. We will be revisiting our INR forecasts when we publish our Monthly Insights later this week. Page 3
FX Forecasts FX Forecasts - Major Forwards Spot 8.5 1M 3M 6M 12M 3M 6M 12M EUR/D 1.1199 1.3 1. 95. 1.1213 1.1231 1.1281 D/JPY 119.76 122. 125. 127. 13. 119.6268 119.4425 118.829 D/CHF.933.98 1. 1.3.927.9232.9148 GBP/D 1.5455 1.4 1.45 1.5 1.55 1.5445 1.5436 1.5429 AUD/D.7932.76.75.73.7.7893.7855.779 D/CAD 1.271 1.28 1.3 1.35 1.286 1.212 1.212 EUR/GBP.7251.75.71.67.61.7265.7281.7317 EUR/JPY 134.18 128 129 127 123.5 134.182 134.182 134.1793 EUR/CHF 1.427 1.3 1.3 1.3 1. 1.43 1.377 1.328 NZD/D.7489.74.72.7.7.7424.7364.7258 FX Forecasts - Emerging Forwards Spot 8.5 1M 3M 6M 12M 3M 6M 12M D/SAR* 3.752 3.75 3.75 3.75 3.75 3.752 3.754 3.754 D/AED* 3.673 3.67 3.67 3.67 3.67 3.6728 3.6728 3.6729 D/KWD.317.29.29.29.3.384.3157.3312 D/OMR*.3848.38.38.38.38.398.3968.418 D/BHD*.3771.376.376.376.376.38.382.3874 D/QAR* 3.645 3.64 3.64 3.64 3.64 3.6434 3.6465 3.6495 D/EGP 7.6335 7.7 7.8 8. 8.3 7.935 8.135 8.5752 D/INR 63.9375 62. 61. 6. 58. 63.9499 63.9613 63.982 D/CNY 6.293 6.25 6.3 6.35 6.4 - - - Source: Bloomberg, Emirates NBD Research *Denotes D peg Page 4
Major Currency Pairs and Interest Rates Interest Rate Differentials - EUR. 1.4 1.35 -.2 1.3 -.4 1.2 -.6 -.8 1.1-1. 1. Interest Rate Differentials - GBP.6 1.75.4 1.7 1.65.2 1.6. 1.55 -.2 1.5 -.4 1.45 German 2yr yield - 2yr yield GBP 2yr yield - 2yr yield Interest Rate Differentials JPY Interest Rate Differentials - CHF.9 13..8 125..7.6 12..5 115..4 11..3.2 15..1 1. 1.8 1.1 1.5 1.3 1. 1..8.95.5.3.9..85 2yr yield - JPY 2yr yield 2yr yield - CHF 2yr yield Interest Rate Differentials - CAD Interest Rate Differentials - AUD.4 1.3 3. 1.. -.4 -.8 1.2 1.1 2.5 2. 1.5.95.9.85.8.75-1.2 1..7 2yr yield - CAD 2yr yield AUD 2yr yield - 2 yr yield Source: Bloomberg, Emirates NBD Research Page 5
(contracts s) (contracts s) (contracts s) (contracts s) (contracts s) (contracts s) Major Currency Positions CFTC Speculative Positions - EUR 15 1.5 1 1.45 5 1.4 1.35 1.3-5 -1 1.2-15 1.1-2 -25 1. CFTC Speculative Positions - GBP 1 1.75 75 1.7 5 25 1.65 1.6-25 1.55-5 -75 1.5-1 1.45 CFTC Speculative Positions - JPY CFTC Speculative Positions - CHF 8 8 5.75 3 9 25.85-2 1-7 -12-17 11 12-25 -5.95 CFTC Speculative Positions - CAD CFTC Speculative Positions - AUD 15 1 1.1 5 1.2-5 -1-15 1.3 15 125 1 75 5 25-25 -5-75 1..95.9.85.8.75.7 Source: Bloomberg, Emirates NBD Research Page 6
Economic Calendar Date Country Event 11-May UK BoE Rate Decision 12-May France Bank of France Business Sentiment UK India India Russia Trade Balance 13-May Japan Trade Balance France GDP China Retail Sales China Germany GDP Germany France Italy GDP UK ILO Unemployment Rate Eurozone Eurozone GDP Italy UK Bank of England Inflation Report MBA Mortgage Applications Retail Sales Advance 14-May UK RICS House Price Balance India Wholesale Price Index Brazil Retail Sales PPI Initial Jobless Claims Russia Saudi Arabia 15-May Empire Manufacturing U of Michigan Sentiment Source: Bloomberg Page 7
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