FX Outlook. Inflation risk in many guises

Transcription

1 Financial Markets Research 2013 Jane Foley Inflation risk in many guises Senior FX Strategist The Fed, ECB and BoJ maintain very accommodative policies....but inflation risks are far from uniform will usher in the first G10 rate hikes Coinciding with Rabobank s yearly global outlook (the Visie publication due for release on November 13), we have this week pulled together some of our key themes for The carry trade could be high on the agenda for the FX market in The surprise decision by the ECB to cut rates by 25bps at its November meeting followed the assessment by the Bank that the Eurozone may be facing a prolonged period of low CPI inflation. The ECB s refi rate at 0.25% now stands at the same level as the Fed s funds rates. Both central banks have been proactive in providing forward guidance that monetary policy settings will remain accommodative for some time. Reassurances from Fed Chairman Bernanke and more recently from FOMC members such as Pianalto suggest that the funds rate is likely to remain at its current low for another two years. Soft US inflation as measured by both the CPI and the GDP deflator are central to this outlook. Inflation can be measured in different ways, however. For some other G10 central banks the buoyancy of house price inflation has been a source of concern in recent years. Macroprudential measures have been used in many G10 countries to keep house prices and the related rise in household debt under control. However, the admission by the RBNZ in September that there was still risk of house price inflation seeping through into the broader economy confirms that these measures have their limitations. While the Fed, ECB and BoJ are set to maintain extremely accommodative policy setting during 2014, the year will bring the start of the tightening cycle for other G10 central banks. For foreign exchange, this will bring a new phase of the carry trade and potentially also an increase in market volatility. Disinflationary pressures in EMU EUR strengthens as EMU crisis ebbs We estimate that EUR/USD could continue to hold above the 1.30 level for the next 6 months or so. Our 12 mth EUR/USD forecast stands at Page 1 of 8

2 We are currently not expecting the Fed to start tapering the size of the $85 bln monthly asset purchase programme until March This is a commonly held market view. In order to trigger a shift in the consensus, the market will have to be satisfied that the pace of job creation in the US was improving significantly. In addition, the chances of another US political debacle will have to fall. Currently the US debt ceiling is due to expire on 7 February 2014 and, unless an early compromise is reached, there is risk that the US will be forced to the brink of default again at this juncture. Fed officials spent a lot of energy over the summer stressing the fact that tapering is not tightening and even when the pace of monthly asset purchases falls, the Fed will still be following an ultraaccommodative policy for some time. While the Fed s policy is set to stay accommodative for some time, there is speculation that the BoJ and the ECB could ease again. At the post policy meeting press conference in November, ECB President Draghi was keen to point out that the Bank had not reached the lower bound of its policy. For sure, policy options are running low, but it was made clear that the committee is ready to consider all instruments to ensure that the Bank stays true to its mandate to keep CPI inflation close too or a little below the 2% level. Draghi indicated that the level of the EUR exchange rate was not discussed during the November policy meeting. That said, it goes without saying that if a central bank wanted to fight deflationary risk, a weaker currency would be welcome. In the days that followed the publication of the very weak Eurozone October CPI inflation data, the EUR was one of the worst performing G10 currencies as the market chewed over the notion of an ECB rate cut before the end of However, even after the sharp drop in the value of the EUR on the news of November s surprise policy easing, the EUR remained the best performing G10 currency on a 12 mth view. The impact of the currency s gains over the past year or so will have contributed to the downward pressure on inflation. It follows that how the currency performs going forward will be instrumental in governing the ECB s success in managing disinflationary pressures. Easing of EMU & crisis brings an unwanted gain in the EUR In recent years we frequently argued that periods of resilience in EUR/USD were often the result of a weak USD. By contrast in 2013 the EUR has been more deserving of the term resilient. Through the second half of 2012 into early 2013, there was a strong correlation between the value of the EUR vs. the USD and peripheral yields as both reacted to the perception that the worst of the EMU crisis was over. Following Draghi's remarks in summer 2012 that the ECB would do whatever it takes to protect EMU, most commentators would agree that the crisis in the Eurozone ebbed. Clearly this is a welcome development for all Eurozone officials. However, this relief has come at a cost, that being the firmer tone of the EUR. Yellen must balance needs of jobless with the......fed s huge balance sheet The stronger EUR would not be such a disinflationary threat if the USD was independently gaining ground. At the start of this year the market was awash with expectations that the USD would strengthen during the course of this year. Back on January , the Bloomberg survey consensus pointed to a level of EUR/USD1.27 for the end of this year (our forecast was EUR/USD1.35). Somewhere along the line, expectations for USD strength have been Page 2 of 8

3 dissolved by weaker than expected US growth and the realisation that the Fed may not be in a position to start tapering the size of its monthly asset purchases potentially until Through the upward bias on the EUR/USD exchange rate, the continued massively aggressive QE programme by the Fed has imposed an unwelcome policy tightening on the ECB which is attempted to allay. The EUR, however, is not a policy tool of the ECB and cannot be controlled easily. ECB officials chose not even to made direct remarks about the direction of the currency (a policy that derived from a bad too many cooks experience in early 1999). The ECB will continue to try imposing downward pressure on market rates through its liquidity operations and through the use of rhetoric. On the back of this, after the ECB s November rate cut we revised lower our forecasts for some of the EUR crosses moderately on a 1 and 3 mth view. Expectations surrounding Fed policy, however, are likely to continue dominating the EUR/USD cross. Unless expectations for Fed tapering shift in significantly, we estimate that EUR/USD could continue to hold above the 1.30 level for the next 6 months or so. Our 12 mth EUR/USD forecast stands at For USD/JPY to push higher a stronger USD is needed While the Eurozone s October inflation rate surprised on the downside, national CPI inflation in Japan in October rose to its highest levels since late Despite the fact that the country has been fighting deflationary fears for a long time, these data triggered no celebrations. The weaker yen may be good for exporters but it has also increased the prices of imported goods such as much needed fossil fuels. Japan will face further costs push inflation when the consumption tax hike is implemented in April Unless there is more evidence that wages can be increased, the danger is that Japan will fall foul of weak consumption demand as real wages push lower. The extremely accommodative monetary policy settings of the BoJ look set to remain in place for some time. Although the BoJ has not suggested that further policy changes are on the way, there is talk that even more accommodation could follow in order to ease the introduction of the April consumption tax hike. Insofar as USD/JPY has been largely steady since May 2013, around this time the impact of the last round of yen s losses on the inflation index will be lost. This also argues in favour of further BoJ easing in the spring. We have argued repeatedly, however, that in order for USD/JPY to push significantly higher a stronger USD is also necessary. The decisions and successes of the BoJ through 2014 will be therefore also be tied to those of the Fed and the behaviour of the USD. We maintain a 12 mth forecast of USD/JPY at Who will hike first? Focus may be on the Fed, ECB and BoJ but the outlook for other central bank policies is providing several interesting side shows. In September the RBNZ candidly suggested that OCR increases will likely be required next year. Governor Wheeler clarified that the extent and timing of the rise in policy rates will depend largely on the degree to which the momentum in the housing market and construction sector spills over into broader demand and inflation pressures. More recently he also implied that the timing of a policy move could also be delayed by exchange rate strength. That said, the September Monetary Policy Statement projections suggested that tightening will start around April 2014 and that the 90-day interest rate by early 2016 will be around 50 bps above its June projection. Drought and its impact on farming related production had been a significant headwind to New Zealand growth earlier in That said, there is currently plenty of optimism regarding the pace of growth in H2. It is still the case that economic activity is been supported by the Canterbury re-build. In September the RBNZ admitted that it fears that momentum in the housing market may have the potential to create significant inflationary effects. New Zealand, like several other G10 countries has already adopted macro-prudential measures to keep a lid on household debt and house price inflation, but the October QV house price index rose by a stunning 8.9% y/y, the biggest jump since For some time we have perceived the RBNZ to be in pole position as the first G10 central bank likely to hike interest rates this cycle. For a while last year, it appeared that the BoC could be in the running given that it is the first one to adopt a tightening bias. While a worsening in Canadian economic prospects saw this bias watered down during the course of 2013, the BoC could still be preparing for a hike at the end of next year. Page 3 of 8

4 Clearly the disappointing level of growth in the US has weighed on the outlook for the Canadian economy. At its policy meeting in October the Bank of Canada stressed the significant slack in the economy. However, it also mentioned that household debt is already elevated. We expect that the BoC is likely to be hiking rates in Q and that it could be household debt levels which could be the deciding factor. September Canadian existing home sales edged up another 0.8% m/m after a stunning 2.8% m/m rise in August. This translates to a whopping 18.2% y/y September increase, well above the 10 year average in seasonally adjusted terms. Rising bond yields have had some effect in causing would be buyers to act soon in order to lock in better mortgage rates. This implies that demand for housing could slow when higher rates bite. That said it seems that the macro prudential measures aimed at calming the housing market and the level of household debt are failing to have a lasting effect. A year ago the housing market cooled after Fin Min Flaherty tightened the mortgage insurance rules. At this time the level of household debt/% disposable income came off its all time highs. Data released in September, however, shows that in Q that this ratio reached a new record of 163.4% in Q2 up from 162.1% in the previous quarter. Insofar as the BoC is likely to be hiking rates when the Fed funds and the ECB s refi rates remain at its all time low, we expect the CAD to outperform on a 12 mth view. Riksbank Governor Ingves has reiterated that the central bank must keep monitoring levels of Swedish household debt. At the September policy meeting the Riksbank indicated that its rates are likely to start rising at the end of next year. While recent economic data confirm that the economy is generally improving, not all of the latest data have met market expectations. This confirms our expectations that the Riksbank will be hiking rates after the RBNZ and around the same time as the Norges bank. Swedish, Norwegian real estate indices Australian hse prices compared with CPI inflation Norwegian core CPI inflation recently touched the Norges Bank s target for the first time since July However, it has since fallen back though industrial production and PMI data have showed signs of increased activity. The brand new coalition government are poised to increase fiscal spending, though the PM has acknowledged that the budget may have to be pared back if necessary to keep the value of the NOK in check. Like several other G10 countries including New Zealand, Canada and Sweden, Norwegian authorities have also implemented macroprudential measures in order to cap house prices gains. As a percentage of GDP Norwegian households carry a far greater level of debt than the G10 average and this has underpinned fears of a repeat of the 1990s crisis which saw house prices plummeting 40% leaving household with unsustainable levels of debt. A rate hike around the middle of next year currently seems possible. Limited liquidity can increase the volatility in the NOK crosses. However, we would favour selling EUR/NOK on rallies. Australia has been another G10 country which has been forced to implement macro-prudential measure in recent years. However, the end of the mining investment boom left the economy exposed. We expect that the RBA interest rate cutting cycle has now ended. At is November policy decision, the RBA referred to an improvement in Page 4 of 8

5 both indicators of household and business sentiment and talk of the potential for an increase in private demand outside the mining sector. Simultaneously China in this period has confirmed a soft landing. Earlier this year there were fears that China would fail to achieve its growth target for This ability of China to steer away from a hard landing should continue to contribute towards a stable value for AUD/USD through to the end of However, medium-term we envisage that China faces significant structural hurdles that could result in threats to growth. On balance we expect that while hopes that the Fed will delay tapering could support AUD/USD on a 3 mth view that the AUD will be vulnerable into On a 12 mth view we see risk that AUD/USD could revisit this year s low in the 0.88 region. While sterling has made decent progress against both the USD and the EUR since the summer we doubt it is at levels which would bother the BoE. Sterling has failed to win back most of the losses made against the EUR during the financial crisis and cable is close to the average of its long term range. Cable s recent gains are likely to be welcomed by some members of the MPC insofar as it should keep down imported inflation. The minutes of the September policy meeting state that an 8% fall in sterling oil prices in September should produce some downside pressure on the CPI index over the coming year. That said, news that domestic energy bills could increase by 5% later in the year could have an offsetting influence. The expected hike in energy bills appears to have had a disproportionate impact on inflationary expectations insofar as it has been given a lot more headline space than the fall in sterling oil prices. In October a survey suggested that UK inflation expectations have spiked higher on the back of concerns about more energy price increases. Insofar as an unanchoring of inflation expectation could be unsettling for the MPC it is possible that forthcoming BoE publications contain a slightly more hawkish tone which would probably have the effect in bringing forward talk of the first BoE hike. Currently economists survey suggest that the first rate hike from the BoE will be in Q3 2015, our view is that it could come a little earlier in May A combination of continued decent UK economic data and more active inflation expectations would almost certainly result in forecasts for the first BoE move to shift in and therefore forthcoming Inflation Report and MPC minutes still have the potential to offer the market plenty of direction. Given our weak USD view, we would remain buyers of cable on dips into year end. However, with so much good news in the price, sterling will likely need fresh direction from the BoE to push significant higher from current levels. We favour selling EUR/GBP towards 0.82 medium-term. Page 5 of 8

6 Rabobank FX Forecasts US$ Crosses 08-Nov 1m 3m 6m 9m 12m JPY EUR GBP CHF AUD NZD CAD SEK NOK CNY ZAR MXN BRL INR TRY EUR Crosses 08-Nov 1m 3m 6m 9m 12m JPY GBP CHF SEK NOK AUD CAD NZD PLN CZK HUF RUB BRL GBP Crosses 08-Nov 1m 3m 6m 9m 12m EUR JPY CHF AUD NZD CAD Page 6 of 8

7 Financial Markets Research Head Jan Lambregts Macro Elwin de Groot EMU Emile Cardon EMU, Switzerland Bas van Geffen EMU Philip Marey US Michael Every Asia Jane Foley UK Robério Costa Brazil Foreign exchange Jane Foley G Christian Lawrence Emerging Markets Fixed income Richard McGuire Lyn Graham-Taylor Credit markets Eddie Clarke Corporates Stephen Queah Corporates Oliver Burrows Financials Ruben van Leeuwen ABS Sophie Boutar ABS Agri Commodity markets Food & Agribusiness Research and Advisory (FAR) Luke Chandler Global Head Luke.Chandler@Rabobank.com Client coverage Wholesale Corporate Clients Martijn Sorber Global Head Martijn.Sorber@Rabobank.com Hans Deusing Netherlands Hans.Deusing@Rabobank.com David Kane Europe David.Kane@Rabobank.com Brandon Ma Asia Brandon.Ma@Rabobank.com Andrew Millett Australia Andrew.Millett@Rabobank.com Neil Williamson North America Neil.Williamson@Rabobank.com Marco Garcia Mexico Marco.Garcia@Rabobank.com Gaston Iroume South America Gaston.Iroume@Rabobank.com Sergio Nakashima Brazil Sergio.Nakashima@Rabobank.com Financial Institutions Eddie Villiers Global Head Eddie.Villiers@Rabobank.com Arjan Brons Benelux Arjan.Brons@Rabobank.com Bill Cole UK, Eire, Scandinavia, M. East Bill.Cole@Rabobank.com Krishna Nayak Germany, Austria, CEE Krishna.Nayak@Rabobank.com Emmanuel Rodriguez Iberia Emmanuel.Rodriguez@Rabobank.com Philippe Macart France, Italy Philippe.Macart@Rabobank.com Mark Melvin Switzerland Mark.Melvin@Rabobank.com Edwin Bernard Asia Edwin.Bernard@Rabobank.com Sarah Lee USA Sarah.Lee@Rabobank.com Simon Jansen Treasury Sales Europe Simon.Jansen@Rabobank.com Capital Markets Rob Eilering ECM Rob. Eilering@Rabobank.com Mark van Binsbergen DCM Mark.van.Binsbergen@Rabobank.com Herald Top DCM Herald.Top@Rabobank.com Othmar ter Waarbeek DCM Othmar.ter.Waarbeek@Rabobank.com Page 7 of 8

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