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Jose Wynne+1 212 412 [email protected]
Marvin Barth+44 (0)20 313 [email protected]
Aroop Chatterjee+1 212 412 [email protected]
Mitul Kotecha 65.6308.3093 [email protected]
Foreign Exchange ResearchMarch 2015
PLEASE SEE ANALYST CERTIFICATION(S) AND IMPORTANT DISCLOSURES
BEGINNING ON LAST PAGE.
Global FX QuarterlyBrief break in the USD uptrend
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Barclays | Global FX Quarterly
CONTENTS
Top Trades
....................................................................................................
3 Our top thematic trades are short EURUSD spot, long USDCAD spot,
and long USDCNH spot. Our top relative value trades are long INRTWD
and short SGDPHP.
Overview
.......................................................................................................
4 Brief break in the USD uptrend Slower US growth and softer
inflation have given the Fed reasons to delay and flatten its rate
hiking path. These developments have caught the USD a bit ahead of
itself, but given the recent correction, we expect it to stabilize
around current levels. We think the USD is likely to take a break
before resuming its uptrend at a slower pace. We forecast 5% USD
REER appreciation by year-end.
Theme 1: EUR
............................................................................................10
Taking depth soundings Two-way risks have increased but the two key
drivers of the multi-year downtrend in the EUR remain in force. In
our view, a stabilization or turn in the EUR will require a
sustained and convincing pickup in real investment or an
acceleration in core inflation. Neither looks likely to be on offer
anytime soon.
Theme 2: JPY
..............................................................................................15
Range-bound The yen will likely remain range-bound against the USD
in the year ahead amid countervailing factors. Expected USD
strength into the Feds first hike may continue to exert upward
pressure on USDJPY, although we have delayed our expectation of a
Fed rate hike to September, which could reduce some of the upward
momentum in the USD in the near term.
Theme 3: GBP
............................................................................................17
Unprecedented political uncertainty Growing political risk premium
ahead of the particularly uncertain 7 May general election should
put downward pressure on GBP. Beyond the election, economic
outperformance relative to the euro area should see continued GBP
appreciation versus the EUR. However, very low UK inflation and
risks of an extended period of unchanged BoE policy are likely to
temper the degree of sterling outperformance and contribute to
significant GBPUSD depreciation.
Theme 4: SEK and CHF
...........................................................................20
Club sub-zero Unwanted currency strength, in anticipation of or as
a result of ECB QE, has forced smaller G-10 central banks like the
SNB and the Riksbank to ease policy recently, cutting rates below
zero and announcing QE. We expect both central banks to keep an
easing bias, at least in the short term.
Theme 5: CAD and NOK
.........................................................................23
Yet to price the oil slippage Lower oil prices have weakened
fundamentals and widened output gaps in oil-producing Canada and
Norway. We believe the effect of lower oil will be pervasive in
2015, and we remain negative on both CAD and NOK.
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Theme 6: CNY
............................................................................................25
More flexibility, less complexity We expect China to take steps to
accommodate greater CNY flexibility this year, through a
combination of more volatile but modestly higher USDCNY fixings and
a widening of the trading band.
Theme 7: AUD and NZD
.........................................................................28
More room to fall Although both AUD and NZD have depreciated in
recent months, we think there is scope for further depreciation
versus USD given contrasting monetary policy stances and a firm
USD. However, we do see some scope for AUDNZD to move higher, with
the currency pair bottoming out around current levels.
Theme 8: EM Asia
.....................................................................................32
Exploiting divergence within the pack Asian currencies have
outperformed during Q1 2015 but it has not been an easy ride. Given
the headwinds from expected Fed rate hikes and a strong USD, we
expect Asian currencies to depreciate against the greenback to
varying degrees.
Theme 9: BRL
.............................................................................................36
BCB behind the curve BRL offers value, but we suggest staying on
the sidelines waiting for the central bank to get ahead of the
curve. High risk premia on domestic assets, along with a weaker
BRL, would ordinarily make being long the currency an inviting
proposition. We are not constructive, however.
Theme 10: TRY
..........................................................................................38
Less negative, but still on the sidelines TRY may find some
stability in Q2 15 as the USD rally takes a breather. Although TRY
provides attractive carry, we think idiosyncratic risks make it an
unattractive long. We maintain our fundamentally negative view on
TRY into H2 15 (Q4 15: 2.75 and Q1 16: 2.85).
Theme 11: RUB
..........................................................................................40
Weaker spot but inside USD forwards The RUB looks set for modest
depreciation in 2015 on lower oil prices, persistent geopolitical
risks around Ukraine and broad USD strength. Additionally, with the
CBR having turned more growth-oriented amid high inflation,
monetary policy support for the currency is likely to wane.
FX Views for the Year Ahead
.................................................................43
Open Trades
...............................................................................................48
FX Closed Trades
......................................................................................49
FX Forecast Tables
...................................................................................52
26 March 2015 2
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Barclays | Global FX Quarterly
FX STRATEGY
Top trades
Thematic trades
1. Short EURUSD spot We now forecast that EURUSD will be below
parity by year-end. Although the broad USD rally may slow in Q2, a
strengthening US outlook and stable euro area interest rates
(backed by a highly elastic supply of euros from the ECB) imply
that short EURUSD remains the best way of expressing the long USD
view.
2. Long USDCAD spot We believe the market is underpricing rate
cuts by the Bank of Canada. Lower oil prices have finally begun
feeding through into activity data and we expect the BoC to cut
rates by 50bp over the next 3-6 months.
3. Long USDCNH spot We expect Chinas weaker growth trajectory to
be consistent with further depreciation in the CNY. To avoid
significant REER appreciation to an already strong currency, in the
face of a strong USD, we expect the authorities to condone a move
higher in USDCNY.
Relative value trades
1. Long INRTWD INR remains one our favoured currencies because
of improved fundamentals and reform prospects and, unlike in the
past, it appears far less susceptible to capital outflows. We find
TWD to be an attractive funding currency as policymakers provide
room for further weakness.
2. Short SGDPHP In our view, PHPs fall versus the USD will be
more modest given its solid current account surplus, low external
borrowings and relatively low foreign ownership of local assets.
SGD is another attractive regional funding currency given the
appetite of the MAS for currency weakness.
Aroop Chatterjee
+1 212 412 5622 [email protected]
26 March 2015 3
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Barclays | Global FX Quarterly
OVERVIEW
Brief break in the USD uptrend Slower US growth and softer
inflation have given the Fed reasons to delay and
flatten its rate hiking path. These developments have caught the
USD a bit ahead of itself, but given the recent correction, we
expect it to stabilize around current levels. We think the USD is
likely to take a break before resuming its uptrend at a slower
pace. We are forecasting 5% USD REER appreciation by year-end.
Features of the liquidity facilities introduced by the ECB
suggest selling EURUSD is the best way to express a long USD view,
when the trend resumes. The Eonia curves insensitivity to positive
European growth surprises suggests there is a highly elastic supply
of euros in place, at the ECB refi rate. This implies that EURUSD
volatility will come mostly from the US side. We also think that
even positive growth surprises in EA could be negative for the EUR,
against common wisdom, if inflation expectations rise and send real
rates lower.
A USD breather is likely to benefit EM carry in the near term.
Unfortunately, some of these currencies fundamentals have
deteriorated and therefore we remain selective in spite of the
positive global backdrop for this class. The INR remains our
preferred carry long, funded out of TWD. While we expect the TRY
and RUB to trade inside the forwards the risks are too substantial.
BRL offers value but we are waiting for the Central Bank of Brazil
to get ahead of the curve.
Sterling is likely to remain under downward pressure and see
volatility ahead of the May 7 general election, but it is well
priced by options in our view. Post-election volatility, however,
likely is underpriced.
Stay long USDCAD and cautious on NOK as central banks need to
ease beyond what is priced in. Lower oil prices are only starting
to permeate through their economies.
We continue to believe the BoJ will avoid pursuing further yen
weakness given the unintended contractionary consequences, and
instead encourage wage policies to boost demand and inflation in
the medium term. Topside volatility in yen crosses also seems too
elevated, in our view.
We remain long USDCNH in spot as we believe a lower EUR, and
weak domestic demand and softer inflation in China may lead
authorities to mitigate the steep REER appreciation implied by an
otherwise stable USDCNY. We also think Chinas fears of floating are
overblown.
An enticing global backdrop for FX A remarkably desynchronized
global recovery, volatile oil markets, unconventional and
heterogeneous monetary stimulus, and vulnerable emerging markets
continue to offer a fascinating landscape for FX markets in 2015.
As if this backdrop were not attractive enough for FX investors, we
think tail risks are also interesting, mildly fading on global
disinflation concerns, providing a better backdrop for risky
assets, and regionally mutating away from Greek exit into a more
serious Chinese slowdown than we and markets may be
anticipating.
The Fed has paused the USD rally after expressing its concerns
about the greenbacks rapid strengthening, acknowledging a slower
underlying growth trend, and by revising its NAIRU estimate lower.
In other words, the FOMC has shifted the unemployment threshold
necessary for a rates liftoff, which, together with a slower pace
of job creation, should delay the beginning and flatten the path of
the eventual US hiking cycle. This softer outlook for
Jose Wynne +1 212 412 5923 [email protected] Aroop
Chatterjee +1 212 412 5622 [email protected]
The macro backdrop poses an enticing environment for FX
markets
The Fed change of stance and the softer US outlook left the USD
trading ahead of itself
26 March 2015 4
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the US economy has left the recent USD strength trading ahead of
itself and likely prone to consolidation around current levels
during the early part of Q2. However, we look for the uptrend to
resume once lower oil prices are clearly proving beneficial to
global consumer spending, and hence expect the USD to catch up to
our latest set of forecasts by year end, starting as soon as it
becomes evident that the Fed is indeed ready to hike in September
(previously expected for June).
How high can the USD go? Against this backdrop, market
participants want to know whether the bulk of the USD rally now
stands behind us. We acknowledge that the risk-reward in long USD
positions has deteriorated, but we believe there is still
substantial room for further upside in the USD as its valuation is
far from stretched and cyclically the US economy is still poised to
outperform.
Figure 1 shows three alternative measures of USD valuation: REER
relative to its average, unit labour cost relative to US trading
partners, and our measure of currency misalignment relative to the
USD long run fair value (see the description of our BEER model
here). While our BEER model suggests that the USD is 9.6%
overvalued, equivalent to a 0.9 standard deviation move relative to
fair, we anticipate that the misalignment could move into the
1.5-2.0 standard deviation range relative to fair value as the US
business cycle continues to improve ahead of a sluggish world.
Indeed the USD REER seems to be strongly correlated with the US
output gap relative to its trading partners (Figure 2). Under all
other valuation metrics, the USD seems to have even more room for
appreciation, which should ease valuation concerns from the USD
path in the near term, in our view.
While we think the USD has room to rally on valuation grounds,
we expect a milder appreciation trend relative to what has already
taken place since July 2014. Beyond our expectation of a slower US
hiking path for the reasons mentioned above, we have reasons to
believe that two features of this global recovery may slow the USD
uptrend once it resumes, and hence we are only forecasting 5% of
REER appreciation by year-end, after the 10% move observed since
July 2014.
The first feature is that, this time around, the USD rally may
have a more disinflationary impact on the US economy than in the
past, which will impede a fast normalization of US rates. Figure 3
shows US import prices by origin since the 1990s. While the data
are incomplete, it seems that US import prices were much less
volatile during the 1990s and, hence, more muted to USD swings. In
other words, inflation in the US was more shielded to USD
fluctuations during the 1990s and was much more Asian focused. US
import prices have been much more flexible since
We look for near-term consolidation of the USD, but still see it
strengthening 5% in REER terms by year-end
FIGURE 1 USD, far from expensive yet
FIGURE 2 US relative output gap, closely linked to USD REER
Source: Bloomberg, Barclays Research Source: Barclays
Research
Three features of this recovery suggest the USD appreciation
will be more limited this time
First, the USD appreciation may be more disinflationary for the
US
-30
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Mar-80 Mar-86 Mar-92 Mar-98 Mar-04 Mar-10
% misval.
vs. BEER vs. REER ave vs. ULC
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USD rel. OG (LHS) USD REER (RHS)
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the early 2000s for most countries, with the exception of those
in Asia. Given our view that USD appreciation is likely to come
primarily from outside Asia, mainly from a weaker EUR and EMEA FX,
we suspect that we may see a more significant pass-through from a
stronger USD into US inflation this time around. Thus, while the
USD has room for appreciation on valuation considerations, we think
the scope for steep appreciation may be more limited this time.
The second feature of this recovery that will slow the USD
appreciation is that the world is likely to continue to enjoy a
major source of cheap liquidity for years, as per the ECBs easing
measures. We believe this feature will go a long way in keeping a
big part of emerging markets well funded and, therefore, less
vulnerable to Fed tightening relative to past USD rallies. For this
reason, potential USD appreciation may be more subdued, contained
by a more limited EM REER depreciation.
ECB liquidity features and why these matter Beyond the
desynchronized recovery that we expect to keep the USD trend alive,
FX markets will need to learn to trade the idiosyncratic features
of the ECB liquidity facilities as the Fed prepares to withdraw USD
funding globally. Just a few questions hold the key to excess
returns in FX markets in the upcoming months: how fungible is the
Fed versus ECB liquidity as sources of global funding? What are the
differences, and why do they matter for FX markets?
We think that the liquidity facilities put in place by the ECB
differ from those of the Feds in three important aspects with
direct relevance for FX markets. First, the impact on global
interest rates of US quantitative easing, for an equivalent size,
is likely much more significant than that of the ECB. When the Fed
eases, many central banks follow either via cutting overnight rates
or by defending their own currencies, particularly in EM, which
adds downward pressure on longer-end rates. In other words, the Fed
drives the pulse of global rates much more than the ECB, maybe
because global capital markets are much more integrated into the US
and reliant on USD funding (the amount of USD funding taken by EM
sovereigns and corporates is substantially greater than that in
EUR). On the same logic, Fed easing should have a more muted impact
on interest rate differentials and therefore the USD. In contrast,
the recent QE easing by the BoJ had a substantial impact on onshore
JPY rates, but only a more muted impact on global rates, hence, the
impact on interest rate differentials and the JPY was large. We
should expect the ECB QE programme to have greater impact on the
EUR than similar Fed moves on the USD, although admittedly a much
more muted impact than that of the BoJ on the JPY.
Second, EM FX will not melt versus the USD, as ECB funding will
still be available for EM
FIGURE 3 US import prices by origin
Source: Haver Analytics
How fungible the ECB liquidity is relative to that of the Fed is
something to learn about in the coming months
80
100
120
140
160
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200
Jun-92 Dec-94 Jun-97 Dec-99 Jun-02 Dec-04 Jun-07 Dec-09 Jun-12
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EC LatamPacific Rim Asian NICsIndustrialized Other
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TLTRO: All you can eat Second, the ECBs TLTRO has profound
implications for FX markets because the programme essentially
commits to an infinitely elastic supply of EUR. In contrast, when
central banks set an overnight target rate, they essentially commit
to fund the market at that rate only until the next monetary policy
meeting. In developed markets, a positive growth or inflation
surprise would then tend to appreciate the value of the currency as
participants anticipate a tighter future monetary policy stance.
This behaviour also manifests itself through selloffs in domestic
rates, proving that the supply of liquidity is not infinitely
elastic at the current overnight rate (as supply shrinks in
response to a demand shock).
But given that TLTROs essentially fund the system at the
refinancing rate for several years, locking in future funding
costs, fluctuations in EUR demand exert virtually no pressure on
the Eonia curve, and therefore on the EUR. Figures 4 and 5 show the
year-to-date ranges for USD OIS and Eonia, respectively. The
highest 5y Eonia rate this year has been only 9bp higher than the
lowest, while the equivalent range in 5y OIS rates has been
54bp.
In other words, this feature of the ECBs liquidity provision
essentially makes the supply of euro infinitely elastic at the refi
rate. Because of this, positive growth or inflation surprises in
the euro area (EA), or stronger inflows into equities, or any other
source of demand for EUR are unlikely to lead to a stronger EUR (as
supply would respond). In fact, we think positive growth surprises
could actually be EUR negative if they increase inflation
expectations, as nominal rates would remain unchanged while onshore
real rates would likely go lower.
We think these features suggest that selling EUR will continue
to be the best way to express a long USD view. In this respect, we
think it should be noted that positive US growth surprises tend to
coincide with higher US rates. Given that a positive US growth has
positive global growth spillovers, we would also expect to see a
coincidental selloff in other countries rates, albeit by a much
lesser extent. But for as long as the perception of this infinite
EUR supply remains in place, this is unlikely to be the same for EA
rates. Hence, a positive US growth surprise is likely to have a
more severe impact on interest rate differentials against the EUR
than, say, the CAD or MXN or any other cross.
In other words, these features of the ECBs funding facilities
make EURUSD mostly insensitive to data surprises in EA, but overly
sensitive to growth or inflation surprises in the US. This is the
main reason why EURUSD remains our preferred long for the USD when
the
The supply of EUR is highly elastic at the refi rate; positive
EUR demand shocks (portfolio inflows, EA growth surprises), should
not drive the EUR higher
FIGURE 4 USD OIS curve range YTD
FIGURE 5 Eonia curve range became insensitive to positive EA
growth surprises
Source: Bloomberg, Barclays Research Source: Bloomberg, Barclays
Research
5y Eonia rates do not react to growth surprises anymore
Selling EUR is the best way to express a long USD view
EA growth surprises do not pose risks to our short EURUSD
view
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Barclays | Global FX Quarterly
latter resumes its uptrend. Indeed, the recent retracement in
EURUSD has not been driven by the EA positive growth surprises, but
has more stemmed from disappointing growth and inflation data in
the US, backed by a still patient Fed. Indeed, we think more
positive EA growth surprises could significantly damage the value
of the EUR as they could send EA real rates even lower, as has been
seen lately (Figure 6).
EM fear of floating The third feature of this recovery that may
limit the USD rally relates to Chinas fear of floating, a concern
about FX volatility versus the USD, not versus the EUR. Thus, from
this perspective, the flow of EUR funding should not be completely
fungible relative to USD funding. The fear of floating argument is
that central banks prefer to curb the volatility of their
currencies for three widely cited reasons: asset/liability
mismatches, which due to funding positions in EM is related to the
value of the USD in local currency terms; contractionary
depreciation caused by a confidence shock on investment induced by
sudden moves in the value of the USD; and credibility concerns that
tend to erode public confidence, via rising inflation expectations,
when USD moves push a central bank to hike rates.
This issue is particularly sensitive in China at the moment, a
reason why our USDCNY forecasts are more stable than the macro
backdrop would suggest. Chinas fear of floating is limiting the
much-needed monetary policy easing, as authorities find it hard
enough to cut rates and/or reserve requirements without adding
pressures on the currency, which is already trading at the top of
the band. The lack of USDCNY flexibility implies that the world
faces one large USD block composed of the US and China. Given
Chinas size, if its growth slows significantly, the pegging to the
USD would be a drag on the value of the USD itself, much as the EA
periphery limited the value of the EUR, despite Germanys stronger
outlook. In other words, this time around, the US may grow without
accelerating Chinas growth, and the fact the CNY is practically
pegged should impose headwinds on the USD.
Top FX views and positions With this framework in mind, we
explain why we still hold high conviction in staying short EURUSD
in Theme 1, even as we acknowledge more two-way risks. In Theme 2
we provide an update on the yen and support our arguments for a
stable yen versus even the USD. We believe this provides room for
investors to consider short EURJPY positions as a serious
FIGURE 6 ECB is finally impacting EA breakevens, maintaining
downward pressure on EURUSD
FIGURE 7 Largest stocks of external borrowings are in Latin
America and EEMEA
Source: Barclays Research Note: These are non-fin
foreign-currency borrowings from banks and through
international debt issuance as a percentage of GDP. We adjusted
Chinas external borrowing to include 80% of bank borrowing from
abroad following this methodology. Source: BIS, Haver Analytics,
Barclays Research
The USD rally may be more limited by the CNY peg, or fear of
floating, to the USD
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Apr-11 Apr-12 Apr-13 Apr-14
UST 5y real rates Bunds 5y real rates
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PLN
RON
INR
KRW
THB
EM CO
PIL
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RUB
CZK BR
LM
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YR CLP
% GDP
Current
26 March 2015 8
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Barclays | Global FX Quarterly
contender to the short EURUSD or EURGBP. The wide range of
outcomes in the upcoming UK elections make us think that
post-election option implied volatility may be too low for the
risks, as we argue in Theme 3. We discuss our bias to be short CHF
and SEK, on deflation concerns, in Theme 4. In Theme 5 we also
explain that we retain a negative view on NOK and CAD, due to still
underpriced oil concerns.
China seems to be struggling with its own rebalancing act, as
activity is slowing more than markets expected, but monetary policy
seems still too tight for the circumstances. In Theme 6, we explain
why we believe fears of letting the currency weaken and adjust to a
stronger USD environment may be constraining policy, and why we
still see interesting optionality in staying long USDCNH in spot,
even though our 12-month forecasts remain inside the forwards. This
troubled outlook is likely to exert further weakening pressures on
both AUD and NZD, as we discuss in Theme 7. The rest of EM Asia FX
will likely see divergence from the bottom up, as the strong USD
environment should not pose too much trouble for those with better
idiosyncratic stories, as presented in Theme 8. Indeed, we suggest
being long INRTWD and short SGDPHP, funding the good stories within
Asia with regional funding currencies to avoid USD or EUR funding
volatility for now.
The brief break in the USD uptrend should also present a
supportive backdrop to high carry EM currencies other than INR. For
these reasons we have turned less negative RUB, TRY, and BRL at
current levels, as we argue in Themes 9, 10, and 11. These
currencies fundamentals have deteriorated from the bottom up,
however, making us retain our cautious stance. Among the three, BRL
offers the most attractive opportunity given the large premia build
in local currency bonds, nominal and inflation linked. We would
look for a stronger message from the central bank with regard to
its commitment to keep inflation expectations well anchored,
however, before engaging in outright longs.
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Barclays | Global FX Quarterly
THEME
EUR: Taking depth soundings How much lower can the EUR fall? By
our soundings, a lot. Two-way risks have increased but the two key
drivers of the multi-year downtrend in the EUR remain in force. In
particular, as long as the ECB is committed to highly elastic
provision of liquidity, the EURUSD will struggle to find its
footing and risks come primarily from the US economy. In our view,
a stabilization or turn in the EUR will require a sustained and
convincing pickup in real investment or acceleration in core
inflation that all into question the ECBs commitments. Neither
appears on offer anytime soon.
After plunging 23% in 10 months, the question of how much
further EURUSD can drop has moved to the fore. The question is
redoubled by market expectations of sizeable foreign purchases of
euro area equities and by the shift in market expectations to a
slower pace of Federal Reserve policy tightening. Two-way risks
almost certainly have risen and we do not expect the torrid pace of
EUR depreciation to be sustained. But the two drivers of EUR
weakness that we identified last summer low economic returns to
capital and the European Central Banks (ECB) Odyssian commitment to
lower rates for longer appear strong, suggesting to us that the EUR
still has much further to fall in its multi-year downtrend. We now
expect EURUSD to fall to parity by Q3 15 and to 0.95 by end Q1
16.
Two primary drivers of EUR weakness: Many have attributed
EURUSDs decline to expectations of Fed policy tightening, but
internal drivers of EUR weakness have been just as important, as
confirmed by its significant underperformance within a trend of USD
appreciation. EURUSD downside is merely the clearest manifestation
of euro area weakness because the cyclical divergence is most
extreme versus the US. The main internal drivers of broad-based EUR
weakness, in our view, remain the two that we identified last
summer: 1) persistently low expected returns to capital in the euro
area due to its relatively larger output gap and its structural
impediments to growth; and 2) an Odyssian commitment by the ECB to
a long period of low (or negative) interest rates (see EUR: Have
faith The ECB delivers, rewards believers, 27 March 2014; EUR:
Extending the downside, 10 September 2014). Both forces continue to
augur for a much lower EUR, despite an encouraging pick-up in euro
area economic indicators and a likely slowing in the pace of Fed
tightening.
Low returns to capital The euro area output gap is at its widest
recorded level relative to its trading partners and is unlikely to
narrow soon (Figure 1). The large utilization gap means there is
little return to capital expenditure beyond modernization and
needed equipment upgrades. Deviations from trend investment in the
euro area and its predecessor economies have been tightly
correlated with the relative output gap since at least the early
1990s as capacity constraints have driven rapid investment growth
and economic slack has led to weak investment.
Exchange rates play a primary role in reallocating capital and
production across economies, shifting capital from economies with
excess slack to those with capacity constraints, and production in
the opposite direction. The EUR REER (synthetic before 1999) has a
long and persistent correlation with both detrended investment
growth and the relative output gap of the euro area and its
predecessor economies going back to 1980 (Figure 1). The portfolio
rebalancing following the launch of the euro in 1999 is the only
notable deviation. Historically, the EUR and its predecessors have
bottomed only when the investment cycle has turned.
Marvin Barth
+44 20 3134 3355 [email protected]
Two-way risks for the EUR are increasing, but its downtrend
still is in place
The two key drivers of EUR weakness we identified last summer
low returns to capital and the ECBs Odyssian commitment to easy
policy persist
The euro areas output gap relative to its trading partners
remains at a historical wide, depressing returns to capital
The EUR continues to reallocate capital to economies with
greater investment demand
26 March 2015 10
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Barclays | Global FX Quarterly
FIGURE 1 EUR vs relative output gap and real investment
FIGURE 2 Euro area excess capacity and real investment
Note: *Log deviation from Hodrick-Prescott trend scaled by 10
for ease of visualization. Note: Euro area relative output gap is
the difference of its output gap from the trade-weighted average of
its trading partners respective output gaps. Source: Haver
Analytics, OECD, EcoStat, Barclays Research
Note: Gross fixed capital formation is the log difference of
actual GFCF from its Hodrick-Prescott trend. Source: Haver
Analytics, European Commission, Barclays Research
Yet despite the pickup in euro area activity, there is little
indication that the euro area is facing capacity constraints or
needs a sustained acceleration in investment. The European
Commissions industrial survey shows still-high capacity (Figure 2)
and that demand and financing remain the primary constraints on
production, not equipment (Figure 3). With so large an output gap
relative to its trading partners, this situation is unlikely to
change soon. Until it does, the EUR likely will remain under
broad-based pressure to depreciate as capital shifts to more
constrained economies. The US economic recovery began in mid-2009,
but the USD continued its nine-year downtrend for another two
years, until, coincidentally, the US output gap relative to its
trading partners bottomed in 2011.
And a credible commitment to lower for longer Similarly, the
ECBs Odyssian commitment to low interest rates for the foreseeable
future has been strengthened and, as we expected, appears to be
driving an extension of EUR hedging activity among longer-term FX
market participants and increased use as a funding vehicle by
shorter-term participants. As we noted in June, TLTROs are a strong
Odyssian commitment to low future rates as the ECB, like Odysseus
strapped himself to the mast of his ship, ties itself to 0.25%
rates on 400bn in contractual loan commitments for four years.
Since then, the ECB has strengthened the obligation by lowering the
interest rate to 0.05% and augmented it with an open-ended Odyssian
commitment to buy European government bonds until inflation and
inflation expectations return to mandate-consistent levels. As a
result, euro interbank rates now are negative through five years,
and the curve beyond is much flatter.
As we expected, the strong commitment to low rates for the
foreseeable future has led to an ongoing extension of hedging
maturities. Not only have EURUSD basis swap rates fallen sharply
EUR lenders must discount offshore interest rates they have fallen
more at longer tenors (5 and 10 years) than at shorter tenors,
suggesting strong pressure from EUR lenders extending their
maturities (Figure 4). Negative deposit rates further out the EONIA
swaps curve have encourage banks to lend offshore further out the
curve, but a large surge has come from foreign issuers of
EUR-denominated notes swapping EUR proceeds into USD.
EUR IG issuance by non-euro area entities, especially
non-financial issuers, has surged to its highest level since the
2005-07 credit boom (see Figure 5 and Supply Monthly: Here today,
gone tomorrow, 5 February 2015). One difference with the prior boom
is a significant lengthening of maturities (see Supply Monthly:
Index ex-tender, 4 March 2015). But the key
-3
-2
-1
0
1
2
3
60
65
70
75
80
85
90
95
1980 1984 1988 1992 1996 2000 2004 2008 2012
%ptsIndex
EUR real effective exchange rateEuro area output gap relative to
trading partners (RHS)Gross fixed capital formation* (RHS)
-0.10
-0.05
0.00
0.05
0.10
0.15
0
5
10
15
20
25
30
35
40
45
50 Log trend deviation
% balance: Sufficient-Insufficient
Capacity Gross Fixed Capital Formation (RHS)
With little sign of a sustained investment boom in the euro
area, the EUR will likely remain under downward pressure
Similarly, the ECBs Odyssian commitment to low rates for the
foreseeable future has been strengthened and made more
attractive
This has led to a further decline in the EURUSD basis, extending
further out the curve
Foreign issuers are borrowing more in the euro area at longer
maturities
26 March 2015 11
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Barclays | Global FX Quarterly
difference has been that the current surge is occurring
alongside a dearth of euro area investment activity. The funds
raised by foreign corporates are not being used for domestic
investment, but for repayment of USD debt or capex in more
capital-constrained economies.
Most of this debt appears to be swapped into USD, putting
pressure on EURUSD basis; but not all of it. Some issuance is being
used by non-euro area corporates to hedge their euro area
receivables. More significantly, the downward pressure on offshore
EUR rates relative to USD makes more attractive extended hedging of
EUR receivables and long-lived assets through more traditional
instruments like forwards and options. As we noted in September,
the incentive to extend hedges is increased by a tipping point in
expectations for EUR depreciation that is reinforced by its
sustained resource underutilization.
The ECBs commitment is not unbreakable, however. Just as the Fed
has developed mechanisms to overcome the Odyssian commitment of its
large balance sheet interest on excess reserves and reverse repos
the ECB can offset both its contractual TLTRO commitment and its
balance sheet expansion. However, it has credibly committed to
raising inflation and likely will not untie itself from that mast
before that obligation is fulfilled. The ECB forecasts a return to
2% by the end of 2016, but that appears overly optimistic given
recent inflation dynamics, the euro area output gap and persistent
downward pressure on inflation globally. Accordingly, we see little
prospect of higher euro-area interest rates for the foreseeable
future and continued incentive for FX market participants to extend
their hedges.
Can the EUR float on equities? Although returns to physical
capital remain low, many observers have pointed to the portfolio
returns likely on European equities given EUR depreciation and
upward pressure on asset prices from the ECBs QE program. Euro area
equities seem attractive (see the Asset Allocation chapter in the
Global Outlook), but we do not expect foreign portfolio inflows
into them to support the EUR. As Figure 6 shows, there is no clear
relationship between net portfolio inflows into the euro area and
the EUR. Indeed, the correlation is often negative. This is even
more likely in the current circumstance with unusually attractive
conditions for hedging portfolio purchases of euro area assets due
to the highly elastic provision of liquidity by the ECB. As a
result, we do not expect demand for euro area equities to offset
the two key drivers of EUR weakness noted above.
FIGURE 3 Factors limiting production in euro area industry
FIGURE 4 EURUSD basis swap rates by tenor
Source: Haver Analytics, European Commission Source:
Bloomberg
Sometimes swapped to USD and sometimes not as companies extend
the maturities of their hedges
Without inflation pressure which is not apparent euro area rates
will likely remain attractive for extended hedging
We see little prospect for portfolio inflows into euro area
equities to offset the broader drivers of EUR weakness
0
2
4
6
8
10
12
14
16
18
0
10
20
30
40
50
60
70
1990 1993 1995 1998 2001 2004 2007 2010 2012
% balance% balance
Demand Equipment (RHS) Financial (RHS)
-45
-40
-35
-30
-25
-20
-15
-10
-5
0
5
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15
bps
1yr 5yr 10yr
26 March 2015 12
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Barclays | Global FX Quarterly
Nevertheless, two-way risks have increased Although we expect
significant further downside for the EUR, we also see rising
two-way risks. Euro area economic activity has accelerated just as
the Fed has taken some of the wind out of the USDs sails by pushing
back the schedule of policy tightening. As long as the ECB
continues to commit to unlimited liquidity over the medium term,
however, we see this risks as tied to the USD side. We see little
prospect for this to change this year.
Longer term, convincingly sustainable growth in the euro could
present a more significant risk. The factors that we are watching
closely are money and credit growth, both of which already may be
reflecting better-than-expected success of ECB policies. Money
growth has accelerated sharply and even lending growth has become
significantly less negative (Figure 7), although this appears to be
mostly financial lending that may reflect the hedging activity
noted above (Figure 8). Perhaps most hopeful, the third TLTRO
auction had an uptake more than twice as large as expected (see
Larger-than-expected TLTRO3, 19 March 2015). As we highlighted in
Three Questions: Quantum Evolution, 27 January 2015, the best
prospects for a sustained pickup in euro area activity and
inflation likely come from its credit easing
FIGURE 5 Euro area investment grade bond issuance by
nonresidents
FIGURE 6 European net equity inflows and the EUR
Note: GFCF is log gross fixed capital formation deviation from
its Hodrick-Prescott trend. Source: Haver Analytics, EuroStat,
Dealogic, Barclays Research
Source: Haver Analytics, ECB, Barclays Research.
FIGURE 7 Euro area money and credit growth, y/y
FIGURE 8 Euro area MFI lending growth, by type, y/y
Source: Haver Analytics, ECB Source: Haver Analytics, ECB
In the near term, ECB commitments imply that risks to EURUSD
come primarily from the US
But in the medium term, the success of ECB policies may present
a more serious risk of EUR upsidei
-0.10
-0.05
0.00
0.05
0.10
0.15
0
10
20
30
40
50
60
70
2005 2006 2007 2008 2009 2011 2012 2013 2014
Log trend deviation
bns
Financial Nonfinancial GFCF (RHS)
-500
-400
-300
-200
-100
0
100
200
300
60
65
70
75
80
85
90
2000 2001 2003 2005 2007 2008 2010 2012 2014
bnsIndex
EUR REER Net equity inflows, 12mms (RHS)
-5
0
5
10
15
20
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
%pa
M1 M3 Credit to private sector
-15
-10
-5
0
5
10
15
20
25
30
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
%pa
Lending to nonfinancial corporatesLending to householdsLending
to nonmonetary financial intermediaries
26 March 2015 13
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Barclays | Global FX Quarterly
measures like the TLTRO. A sustained pickup in both activity and
inflation are precisely the ingredients we identify above as
necessary for a stabilization or reversal of the EUR, but we are
doubtful the signs will be convincing enough to change the EURs
trend in the near term.
Yet another risk comes from valuation. The EUR is currently 9%
below its fundamental long-term equilibrium value on a
trade-weighted basis, on our calculations. Given the euro areas
large output gap and historic cyclical divergence from its global
trading partners (particularly the US) we believe even greater
undervaluation is justified and likely before the EUR turns. But
the case is less compelling now following the euros swift fall over
the past 10 months. As a result, the pace of longer-term hedging
may begin to slow and with it the pace of EUR depreciation. Already
we are seeing larger retracements in the pattern of EUR
depreciation as position-squaring by shorter-term FX market
participants meets with less USD supply from longer-term
participants.
We still think EUR trend depreciation has much further to go and
is not significantly threatened in the near term. But the pace
likely will slow in the year ahead and retracements on the path
lower likely will increase. Accordingly, although we retain high
conviction in a lower EURUSD, trading it has become more
difficult.
as does the swift descent of the EUR to cheaper valuations
Thus, our high conviction in a lower EURUSD is balanced by a
greater appreciation of its risks
26 March 2015 14
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Barclays | Global FX Quarterly
THEME
JPY: Contained on both sides Range-bound The yen will likely
remain range-bound against the USD in the year ahead due to
countervailing factors, as we argued in our last FX Mid-Quarterly
Update. On the one hand expected USD strength into the Feds first
hike may continue to exert upward pressure on USDJPY, although we
have delayed expectations of a Fed rate hike to September, which
could reduce some of the upward momentum in the USD over the near
term.
In addition, portfolio rebalancing outflows from Japan are
likely to support USDJPY. Indeed, Japanese investors have
accelerated their cross-border investment, led by pension funds
after the GPIF announced its new benchmark portfolio in October
2014 (Figure 1). Going into the new fiscal year in April, we
believe that external investment will likely continue at its recent
solid pace, led by both portfolio investment and cross-border
M&As.
However, it will not be a one-sided story for USDJPY by any
means. Already extended valuations of the yen (yen stands 32% or
2.1 standard deviations below its long-term fair value, according
to our BEER model), Japans improving current account due to lower
energy prices, and recent political rhetoric against sharp yen
depreciation should limit the upside in the currency pair.
Admittedly, the currency pair remains prone to a temporary sharp
correction lower in reaction to deterioration in risk sentiment, as
seen earlier this year due to rising uncertainties over Greek
political developments. Moreover, a bout of surprise monetary
policy easing by various central banks around the world has already
resulted in lower cross-yen rates, resulting in an appreciation of
trade-weighted JPY since the beginning of the year, despite the
move higher in USDJPY (Figure 2).
More QQE to have a limited effect on JPY Inflation dynamics
deteriorated further in the recent months. Core CPI (excluding
fresh food decelerated to mere +0.2% y/y in February 2015 from its
peak at +1.4% in June 2014. We revised our core inflation forecast
further down and now expect that core CPI will turn negative around
summer 2015 (Figure 3). If the actual negative reading on core
inflation results in nonlinear downward adjustment on inflation
expectations, it may exert greater pressure on the BoJ. Core
inflation is unlikely to reach the BoJ price stability target of 2%
even at the beginning of 2017, despite closing output gap by
mid-2016, in our view.
FIGURE 1 Portfolio rebalancing flows accelerated since
mid-2014
FIGURE 2 Yen appreciated on trade-weighted basis in early
2015
Note: Sum of external portfolio investment, foreign-currency
investment funds and deposits, and external FDI. Source: Bank of
Japan, JITA, Barclays Research
Source: Bank of Japan, Barclays Research
Shinichiro Kadota +81 3 4530 5038 [email protected]
Yuki Sakasai
+1 212 412 5652 [email protected] Jose Wynne +1 212 412
5923 [email protected]
Core inflation dynamics deteriorated further
-2
-1
0
1
2
3
4
04 05 06 07 08 09 10 11 12 13 14
Non-bank deposit inst Life insurancePension funds Nonfinancial
corpHouseholds
JPY trn/4Qma
100
105
110
115
120
12584
86
88
90
92
94
96
9814/9 14/10 14/11 14/12 15/1 15/2 15/3
JPY NEER (LHS) USDJPY (RHS)
26 March 2015 15
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Barclays | Global FX Quarterly
BoJ also recognized such a trend by making the third consecutive
downgrading of its assessment on inflation. The March BoJ statement
said that the core CPI ex-VAT effects is in the range of 0.0-0.5%
after around 0.5% in February and in the range of 0.5-1.0% in
January statements. BoJ also revised its outlook for core inflation
to expected to be about 0 percent for the time being, down from is
likely to slow for the time being. Against this backdrop, we
continue to expect that the BoJ will step up its annual pace of ETF
purchases to JPY5trn from the current JPY3trn at the July meeting,
but its effect on the JPY should be more limited than the past
expansions of QQE due to limited adjustment in terms of quantity
and the muted relative effect given wave of easing globally, in our
view.
Subdued inflation dynamics will keep the JPY weak Major
manufacturers response to the 2015 annual spring wage negotiations
(i.e., shunto) has been generally positive. Large auto and
electronics companies whose earnings have improved on the back of
yen weakness responded with a larger increase in base pay than last
year. On the other hand, wage increases by non-manufacturing
companies were relatively modest. This may be due to some adverse
effect of the weak yen and limited wage pressure given increasing
participation of women and the elderly in the non-manufacturing
sectors. However, all-in-all, we expect this years shunto will
result in a wage increase of +2.35%, further above 15-year high
increase of +2.19% agreed last year.
This years shunto developments are encouraging, especially for
manufacturers, and tight labor markets should continue to put
upward pressure on wages (Figure 4). Yet, we note that shunto
decisions affect only a small portion of the Japanese workforce and
it remains to be seen if non-manufacturers and SMEs follow suit. In
Japan, labor mobility is low and labor force adjustments tend to
occur through participation over time rather than short-term
movement. Hence, we think third arrow structural reform of
Abenomics to boost labor mobility and steepen Philips curve will
hold the key for longer term outlook for inflation.
Having said that, subdued core inflation dynamics suggest that
the BoJ will maintain its aggressive easing policy for an extended
period, keeping the yen weak in the year ahead despite its overshot
valuations. We expect the USDJPY to trade in the current range at
about 120 throughout 2015. The outlook for the BoJ and the yen
beyond 2016 depends largely on core inflation dynamics. If there
are signs of a pick up inflation dynamics it may finally allow the
JPY to correct for its sharp undervaluation, but this seems a long
way off at present.
Some positive developments on wage front
FIGURE 3 Inflation outlook deteriorated further
FIGURE 4 Tight labor markets to support wage growth
Source: MIC, Barclays Research Source: BoJ, MHLW, Barclays
Research
Yen to stay weak in the year ahead
-3
-2
-1
0
1
2
3
08 09 10 11 12 13 14 15 16 17
Core CPI ex-VATBarclays current forecastPrevious forecast (30
Jan 15)
y/y%
2%
-20
-15
-10
-5
0
5
10
15
20
25
30-6
-4
-2
0
2
4
96 98 00 02 04 06 08 10 12 14
Scheduled earning (LHS)
Employment DI (RHS)
y/y% DI
26 March 2015 16
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Barclays | Global FX Quarterly
THEME
GBP: Unprecedented political uncertainty Growing political risk
premium ahead of the particularly uncertain 7 May general election
should place downward pressure on GBP, in our view. Near-term GBP
implied volatility is appropriately elevated but we think
post-election volatility is underpriced. Beyond the election,
economic outperformance relative to the euro area should see
continued GBP appreciation versus the EUR. However, very low UK
inflation and risks of an extended period of unchanged Bank of
England policy are likely to temper the degree of sterling
outperformance and contribute to significant GBPUSD
depreciation.
Uncertainty is the only known Growing political risk premium
ahead of the 7 May general election should support high levels of
currency volatility and place downward pressure on GBP, in our
view. This years UK general election is probably the least
predictable in a generation and, combined with a lack of a defined
process for forming a government following a likely hung
parliament, means GBP volatility may remain elevated well after the
election a scenario that continues to be underpriced by FX markets,
in our view (UK Elections Series: Pride and precedent: GBP
volatility, 18 March 2015). As such, the confidence intervals
around our GBP forecasts are much larger than usual. We forecast
further GBPUSD depreciation to 1.42 in Q2 2015 and modest EURGBP
appreciation towards 0.74 over the next one to two months as
political risk premium increases. Further ahead, our expectations
for economic outperformance relative to other European economies
lead us to expect GBP to be the strongest of European currencies
over the year ahead. However, very low inflation and risks of an
extended period of unchanged Bank of England policy is likely to
temper the degree of outperformance and should support significant
GBPUSD depreciation. As such, we now forecast EURGBP and GBPUSD to
reach 0.70 and 1.36 in Q1 2016, respectively.
Hamish Pepper
+ 44 (0)20 7773 0853 [email protected]
Election uncertainty to support currency volatility and weigh on
GBP A likely hung parliament leaves a broad spectrum of policy
outcomes
FIGURE 1 1-month relative GBP volatility
FIGURE 2 3-month relative GBP volatility ahead of key political
events
Notes: Measures represent the average 1-month (forward or spot)
volatility for GBPUSD and EURGBP divided by the average volatility
for the same 1-month window in EURUSD, USDJPY, AUDUSD, and USDCAD.~
View historical spot levels and implied or realized volatility in
Oasis on Barclays Live. Click here to view basket volatilities for
EURGBP and GBPUSD vs EURUSD, USDJPY, AUDUSD, and USDCAD. Source:
Bloomberg, Barclays Research.
Notes: Measure represents the average 3-month implied volatility
for GBPUSD and EURGBP divided by the average volatility for the
same 3-month volatility in EURUSD, USDJPY, AUDUSD, and USDCAD 32
trading days prior to 7 June 2001 election, 5 May 2005 election, 6
May 2010 election, 18 September 2014 Scottish Referendum and 7 May
2015 election. Average captures the average of this measure between
January 2000 and 16 March 2015. View historical spot levels and
implied or realized volatility in Oasis on Barclays Live. Click
here to view basket volatilities for EURGBP and GBPUSD vs EURUSD,
USDJPY, AUDUSD, and USDCAD. Source: Bloomberg, Barclays
Research
0.6
0.7
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15
Relative vol
Election window Post election window Spot
0.0
0.2
0.4
0.6
0.8
1.0
1.2
2015 elec. 2010 elec. Scottish ref.
Average 2001 elec. 2005 elec.
Relative vol
26 March 2015 17
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Barclays | Global FX Quarterly
Ahead of the May general election, the rise of alternative
parties has eroded support for the traditionally dominant Labour
and Conservative parties, making plausible an unusually wide set of
outcomes. Most election projections continue to indicate a hung
parliament is highly likely. Taking an average of the latest UK
election forecasts from Elections Etc, Election Forecast, May 2015,
and the Guardian, the Conservatives and Labour are currently
projected to achieve about 280 seats each. Based on projections for
other parties, neither is likely to be able to form a coalition
government with less than two partners, much less secure an
outright majority where 326 seats are needed. Accordingly, the
resultant range of policy implications is broad, including
political deadlock, EU referendum and variations around the fiscal
consolidation path which is important for the pace of Bank of
England (BoE) policy normalisation (for further discussion see UK
2015 general election: Unprecedented political fragmentation fuels
uncertainties, 23 February 2015).
GBP implied volatility around the election continues to be
consistent with a highly unclear outcome but post-election
uncertainty remains underpriced by FX markets, in our view.
Updating the analysis we presented earlier this year, Figure 1
plots three measures of 1-month GBP volatility, scaled by broader
G10 volatility. The dark line represents a rolling time series of
the forward volatility straddling the election on 7 May; the blue
line is the rolling forward volatility immediately after but not
including the election, and the grey line is spot 1-month
volatility. One-month forward volatility including the election
continues to trade close to the levels around last years Scottish
referendum. However, post-election volatility, while higher than
earlier this year, remains relatively contained.
We continue to think FX represents the cleanest expression of UK
election risk in asset markets. We think high GBP implied
volatility and growing political risk premium should place further
downward pressure on GBP as we approach Election Day. A comparison
of current GBP implied volatility with relevant historical
political events yields some interesting results. The UK election
is about 30 trading days away. Figure 2 plots 3-month GBP relative
implied volatility the same number of days prior to other key
political events. The current measure is appropriately above
average (GBP implied volatility tends to trade at a discount to
other G10 implied volatility) and at higher levels than the
Scottish referendum; but surprisingly, it is also at comparable
levels to the more-certain 2010 election. Indeed, 30 trading days
out from the 6 May 2010 general election, polls suggested an
average Conservative lead over Labour of 5-10 percentage points.
Furthermore, in the lead-up to both the 2010 election and the
Scottish Referendum, GBP implied volatility was relatively slow to
respond, not trading at a premium over other G10 implied volatility
until the month before each event.
Post-election uncertainty remains underpriced by FX markets
Historical precedent suggests growing political risk premium
should place further downward pressure on GBP
FIGURE 3 UK CPI inflation should pick up sharply at the end of
this year
FIGURE 4 Significant fiscal consolidation is a key downside risk
to GBP
Source: Haver Analytics, Barclays Research Source: Office for
Budget Responsibility, Haver Analytics, Barclays Research
-0.50.00.51.01.52.02.53.03.54.04.55.05.5
07 08 09 10 11 12 13 14 15 16 17 18
BoE Feb IR BoE Nov IR CPI (%y/y) Barclays-4
-3
-2
-1
0
1
2
3
4
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18
OBR Forecast
Change in cyclically-adjusted primary balance (end FY, % of
GDP)
26 March 2015 18
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Barclays | Global FX Quarterly
Relative UK economic performance remains the basis for our GBP
forecasts With the election outcome highly uncertain and the most
probable outcomes involving weak coalitions that are unlikely to
meet ambitious fiscal consolidation plans, our forecasts remain
driven by our expectations for the relative path of the UK economy.
Our forecast of economic outperformance relative to other European
economies leads us to expect GBP to be the strongest of European
currencies over the year ahead but depreciate significantly against
the broad-based strength of the USD.
The strong pace of UK economic growth remains consistent with an
ongoing tightening in the labour market and an eventual pickup in
inflation. We think a combination of lower oil prices and continued
wage growth should support a recovery in investment and consumption
growth after Q4 weakness. Indeed, BoE Governor Carney has
consistently emphasised that a supply-driven fall in oil prices is
unambiguously positive for the UK economy, increasing household
disposable incomes and supporting wider business margins. This was
reflected in the BoEs February Inflation Report which, despite
sizeable downward near-term revisions, incorporated higher 2017
inflation forecasts (Figure 3). In the context of a stabilisation
in euro area activity, the UKs largest trading partner, we expect
robust activity and a likely re-emergence of inflation towards the
end of this year to support continued GBP outperformance versus the
EUR.
We continue to expect the BoE to leave its policy settings
unchanged until Q4 this year but there are emerging risks that
policy could remain unchanged for longer. Recent currency strength,
combined with lower energy prices, will likely add further downward
pressure to UK inflation, which we expect to bottom at -0.1% y/y
this month. GBP appreciation of almost 20% on a trade-weighted
basis since Q1 2013 has weighed heavily on already-low import
prices over the past year and this is likely to persist. Indeed,
the BoEs March MPC meeting minutes indicated growing concern within
the MPC that recent EURGBP depreciation had the potential to
prolong the period for which CPI inflation would remain below the
target and exacerbate the risk that lower expectations of inflation
might become more persistent.
The risks associated with the 7 May election suggest that
confidence intervals around our GBP forecasts are larger than
usual. Indeed, with both the Conservative and Labour parties
promising substantial fiscal consolidation, a majority victory,
while unlikely, may represent a particularly negative scenario for
GBP. Details of Labours policies are yet to be revealed but the
recent Budget confirmed the Conservative governments intention to
return the headline current budget deficit of 5.6% of GDP to
surplus by FY2018/19. Based on forecast changes in the cyclically
adjusted primary balance, this represents aggressive fiscal
tightening of 1.2% of GDP per year on average for the next five
years. If this occurs, it will be the most significant period of
fiscal consolidation in close to 20 years and likely holds
important implications for the pace of BoE rate hikes (Figure
4).
Superior UK economic growth should support medium-term EURGBP
depreciation
Robust economic activity should support GBP
But downside GBP risks include low inflation
and fiscal consolidation
26 March 2015 19
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Barclays | Global FX Quarterly
THEME
SEK and CHF: Club sub-zero Unwanted currency strength, in
anticipation, or as a result of ECB QE, has forced smaller G-10
central banks like the SNB and the Riksbank to ease policy
recently, cutting rates below zero and announcing QE. We expect
both central banks to keep an easing bias, at least in the short
term. We expect negative interest rates and SNB FX interventions to
maintain EURCHF stability. We forecast EURCHF to appreciate to 1.08
in Q2 before depreciating to 1.05 by Q1 2016. On the other hand, we
expect moderate EURSEK appreciation in H1 2015 and expect the cross
to reach 9.50 by Q2 2015. From there on, we think the SEK may reach
a turning point as fundamentals strengthen and inflation stabilizes
further. We expect EURSEK to depreciate to 8.90 by Q1 2016.
CHF: SNB welcomes CHF weakness In the short term, we expect the
SNB to preserve its easing bias, with negative interest rates
providing a meaningful disincentive to hold large CHF deposits.
Negative rates and the downside risks to inflation and growth from
an overvalued CHF imply significant CHF depreciation in effective
exchange rate terms, in our view. Further out, we think that the
SNB may allow some EURCHF depreciation under our baseline of a
multi-year EUR downtrend. We now expect EURCHF to appreciate to
1.08 in Q2 before depreciating to 1.05 by Q1 2016.
Since the SNB abandoned the EURCHF floor, the CHF has retraced
about 50% of the roughly 20% REER appreciation, driven primarily by
broad-based EUR weakness. Nonetheless, the CHF remains more than
20%overvalued according to our BEER model and remains at the heart
of the SNBs decision process. Indeed, the SNB has repeatedly stated
that the CHF remains an important policy target and that it may
continue to intervene in FX markets if necessary. We model the SNBs
reaction function using a simple forward-looking Taylor rule that
includes inflation, output and exchange rate deviations from
target. We use the SNBs forecasts and an inflation target of 1% in
our calculations. We use OECD estimates for the Swiss output gap
and our BEER misevaluation for the exchange rate deviation.
Nikolaos Sgouropoulos
+44 (0)20 3555 1578 [email protected]
Negative rates still a meaningful disincentive to hold large CHF
deposits
The CHF remains an important policy tool for the SNB besides
negative rates, which are expected to persist
FIGURE 1 Forward-looking Taylor rule implies negative rates for
the rest of the year
FIGURE 2 KOF indicator suggests downside risks to economic
activity in coming quarters
Source: SNB, Haver Analytics, Barclays Research Source: Haver
Analytics, Barclays Research
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14
%
Policy rate Taylor rule estimate
-4
-3
-2
-1
0
1
2
3
4
5
70
80
90
100
110
120
Mar-00 Mar-03 Mar-06 Mar-09 Mar-12 Mar-15
% y/yIndex
KOF GDP
26 March 2015 20
-
Barclays | Global FX Quarterly
Our model fits history adequately and forecasts negative rates
throughout 2015 (Figure 1). Moreover, further CHF depreciation
would help improve a rather grim economic outlook. Consumer prices
dropped further into negative territory in February, whereas the
effect of the latest CHF appreciation has yet to be fully reflected
in the inflation data. The recent sharp drop in the KOF leading
indicator for growth poses downside risks to GDP in the forthcoming
quarters (Figure 2).
The exchange rate remains the most important intermediate policy
target for the SNB. The market has been speculating that the
current EURCHF target range is 1.05-1.10. We would caution making
such conclusions, however. The expansion in the ECBs asset purchase
program implies that the SNB may not be solely focused on the
EURCHF exchange rate despite the euro areas importance as its
largest trading partner. If the EUR weakens further owing partly to
ECB QE (also against USD), we would expect the SNB to accommodate
some further appreciation against the EUR, before intervening in FX
markets again.
SEK Recommend buying, but not just yet A highly pro-active
Riksbank with a strong easing bias is likely to keep SEK under
pressure in the short term. The recent shift towards targeting a
weaker SEK suggests that the risks for further easing, in the form
of further negative rates and/or expansions in the existing QE
program, remain high for now. Nonetheless, once inflation
stabilises, we think strong fundamentals will help support the SEK
against other European currencies like the EUR and the NOK.
Furthermore, SEK undervaluation of about 16% suggests room for a
medium-term correction higher, in our view. We expect EURSEK to
appreciate to 9.50 in Q2 but see a likely turning point towards the
second half of the year as positive fundamentals support the
SEK.
Loose monetary policy will likely keep the SEK under pressure in
H1 2015. Citing a strong SEK, particularly against the EUR, the
Riksbank decided to make its monetary policy even more expansionary
in March to support the recent upturn in inflation. Indeed, the
Riksbank re-iterated that it was too early to call a bottom in
inflation, despite its recent stabilization, highlighting that a
stronger currency continues to pose downside risks to the inflation
outlook. On this basis, we remain sceptical about sustained SEK
appreciation in the near term and see limited scope for a
significant shift in the Riksbanks reaction function, which will
likely remain sensitive to economic and political developments in
the euro area. We think risks of further repo rate cuts and/or
greater expansion on the Riskbanks QE program remain high, but we
continue to assign a low probability to FX interventions.
CHF depreciation to help alleviate downward pressures to
inflation
The SNB is likely to allow some CHF appreciation vis--vis the
EUR as the single currency depreciates further
Recent focus on SEK strength likely keeping the Riksbank on an
easing bias
Too early to call for stabilization in inflation, keeping us
skeptical about sustained SEK appreciation in the near term
FIGURE 3 Swedens relative output gap to turn positive in
2015
FIGURE 4 as savings decline and consumption is boosted
Source: OECD, Haver Analytics, Barclays Research Source:
Riksbank, Haver Analytics, Barclays Research
-6
-4
-2
0
2
4
1991 1995 1999 2003 2007 2011 2015
% GDP
EUR SEK NOK DKK
4
6
8
10
12
14
16
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
2000 2003 2006 2009 2012 2015
% income% y/y
Consumption Real disposable incomeSaving ratio (RHS)
26 March 2015 21
-
Barclays | Global FX Quarterly
We believe that accommodative monetary policy, a weaker SEK,
lower oil prices, and the incipient euro area recovery will provide
a supportive environment for growth and inflation. In the context
of significant SEK undervaluation of about 16% according to our
BEER model and our expectations for further EUR depreciation, we
expect the Riksbank to tolerate some SEK strength once further
signs of stabilizing inflation are realized.
We expect the SEKs depreciation trend to turn around during
Q3-Q4 of this year, by which time both our and the Riksbanks
estimates suggest further stabilization in inflation and improving
economic growth. Using OECD estimates and our BEER weights, we
calculate a measure of Swedens output gap relative to its trading
partners (Figure 3). According to our estimates, Swedens relative
output gap is expected to turn positive by the end of 2015, in line
with the Riksbanks estimates of increasing consumption growth
driven by a reduction in the rate of savings (Figure 4).
We expect a turning point in the SEK towards the end of year as
the currency trades in line with positive economic fundamentals
26 March 2015 22
-
Barclays | Global FX Quarterly
THEME
CAD and NOK: Yet to price the oil slippage Lower oil prices have
weakened fundamentals and widened output gaps in oil- producing
Canada and Norway. We believe the effect of lower oil will be
pervasive in 2015, and we remain negative on both CAD and NOK. The
prospect of rate cuts in Canada, which we believe the market is
underpricing, suggests that the CAD is a more reliable short.
Further downside in NOK likely will have to wait until the Norges
Bank is more comfortable with domestic financial stability
issues.
Underpriced BoC rate cuts increase CAD downside We continue to
think that the market is significantly underpricing the risks of
additional stimulus from the Bank of Canada. After falling by 10%
on a NEER basis between mid-2014 and January 2015, the CAD NEER has
been in a tight range and USDCAD has largely been responding to
broad USD movements. USDCADs sharp rise in recent months has
mirrored moves in the relative rate expectations for the US versus
Canada (Figure 1). We expect the divergence in Fed/BoC monetary
policy to intensify in the months ahead.
We think the BoC has yet to respond to the economic effects of
the nearly 60% decline in oil prices (Western Canada Select) since
September 2014. Lower oil prices will reduce investment and weigh
on consumption as aggregate income and wealth fall on the negative
terms-of-trade shock. Our hypothesis that oil prices may remain
volatile is an additional negative for investment in a Canada where
production tends to be capital intensive (see Oil Special Report:
The Volatility Hypothesis, 12 March 2015). Furthermore, we think
that the recent decline in CAD and the BoCs January rate cut will
not be enough to offset these negative growth dynamics.
Without additional monetary easing, BoC projections suggest
growth could undershoot its baseline by 1.4pp over the next two
years. However, its official growth forecasts are only 0.2pp lower
over the same period. We see this as indicating its intention to
cut rates to offset the disappointment. We estimate that at least
50bp of cuts will be needed over the next 3-6 months, significantly
more than priced (Figure 2). As such, the movement in relative
output gaps between the US and Canada is likely to become more
supportive for USDCAD. Our Q4 15 and Q1 16 forecasts are 1.32 and
1.36, respectively,
Aroop Chatterjee
+1 212 412 5622 [email protected] Nikolaos
Sgouropoulos +44 (0)20 3555 1578
[email protected]
FIGURE 1 Fed-BoC policy divergence has been crucial for
USDCAD
FIGURE 2 Barclays forecasts for the Fed and BoC expect this to
intensify, pushing USDCAD higher
Source: Bloomberg, Barclays Research Source: Bloomberg, Barclays
Research
-2.00
-1.50
-1.00
-0.50
0.00
0.50
1.00
0.90
0.95
1.00
1.05
1.10
1.15
1.20
1.25
1.30
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
USDCAD Curncy US-CA 1y1yf nominal (RHS)
0.0%
0.1%
0.2%
0.3%
0.4%
0.5%
0.6%
0.7%
0.8%
0.9%
1.0%
Q1 15 Q2 15 Q3 15 Q4 15 Q1 16
Policy rates
USD FF futures CAD OISFed: Barclays forecast BoC: Barclays
forecast
26 March 2015 23
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Barclays | Global FX Quarterly
We think the recent retracement in rate cut expectations in
Canada and rate hike expectations in the US is an opportunity to
buy USDCAD. We remain long USDCAD spot (FX Focus: CAD: Downside
ahead, 25 February 2015).
NOK is a lower conviction short now Our expectation of rising
oil imbalances in the near term, coupled with likely
lower-for-longer oil prices, imply more NOK downside, in our view.
Despite the lack of proactive central bank policy in March, we
maintain our view that further easing will eventually materialise.
Although we still like long USDNOK spot positions and see upside
risk for EURNOK, the NOK has become a lower-conviction short in the
near term as financial stability concerns delay easing.
We expect the NOK to remain an underperformer in 2015 given our
expectations of material demand-supply oil imbalances in the short
term, lower-for-longer oil prices further out and elevated oil
price volatility weighs on energy investment. In this environment,
we think the Norges Bank will likely keep a strong easing bias and
cut by at least 50bp in 2015.
Norwegian output growth is expected to slow and was revised
lower by both Norway Statistics in its Outlook Survey and the
Norges Bank at its 19 March meeting. At the same time, the sharp
decline in oil prices implies that activity in the petroleum
industry is declining more rapidly than previously envisioned
(Figure 3). Employment growth is expected to slacken; as a result,
the Norges Bank has revised the path of the policy rate
significantly lower and signalled rate cuts as soon as lower oil
prices start to materially affect the data, which we expect as
early as Q2 2015 (Figure 4). Any further easing will likely be
against a backdrop of elevated concerns about financial stability
linked to the Norwegian housing market, with the central banks
reaction function likely, in our view, to start weighting expected
capacity underutilization more heavily than concerns about an
overheating housing market.
The main risk scenario for the economy and the NOK, however, is
a prolonged period of low oil prices, materially exposing the
economys structural reliance on the oil sector. Under this
scenario, we see scope for looser monetary policy initially, though
incremental rate cuts would likely exhibit diminishing efficacy.
During the global financial crisis, when oil prices last plunged,
the Norges Bank cut rates by 4.5pp in nine months. But the level of
rates was markedly higher then and the economic outlook materially
gloomier, allowing for more aggressive monetary policy adjustments.
With the Norges Bank now significantly nearer its lower bound, room
for large manoeuvres may be limited, though we still think monetary
policy easing will be the first line of defence. Under the scenario
of lower-for-longer oil prices, we see more reason for a weaker NOK
to provide some protection for local-currency exports.
FIGURE 3 Lower oil prices weighing on confidence and
investment
FIGURE 4 signaling potential rate cuts
Source: Norges Bank, Barclays Research Source: Norges Bank,
Haver Analytics, Barclays Research
-20.00
-15.00
-10.00
-5.00
0.00
5.00
10.00
-4
-2
0
2
4
6
8
10
Apr-09 Oct-10 Apr-12 Oct-13 Apr-15
IndexExpected growth (%)
Oil Aggregated Consumer confidence (RHS)
-1.00
-0.80
-0.60
-0.40
-0.20
0.00
0.20
0.40
Sep-
15
Dec
-15
Mar
-16
Jun-
16
Sep-
16
Dec
-16
Mar
-17
Jun-
17
Sep-
17
Dec
-17
Demand CostsInterest rates abroad Exchange rateChange in
rate
26 March 2015 24
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Barclays | Global FX Quarterly
THEME
CNY: More flexibility, less complexity We expect China to take
steps to accommodate greater CNY flexibility this year, through a
combination of more volatile but modestly higher USDCNY fixings and
a widening of the trading band. We think this reflects Chinas
recognition of the increasing costs associated with limiting the
exchange rates ability to respond to changes in external and
domestic economic conditions. We maintain our year-end 2015
forecast of USDCNY at 6.40.
The cost of restricting greater USDCNY flexibility is rising We
believe China has the capacity to maintain exchange rate stability.
Even if selling pressures on the CNY were to intensify, Chinas
large FX reserve holdings (of around USD3.8trn) should allow the
authorities to engage in FX intervention for a prolonged period to
limit the CNYs decline. However, as we discussed in CNY: Deflation,
downturn and the deepening monetary dilemma, 12 February 2015,
recent developments increasingly point to a reduced need for China
to maintain a strong currency, especially on a trade-weighted
basis:
First, inflation in China is less of a concern, in our view,
while deflation risks have risen. Pre-emptive moves to allow for
greater flexibility in the USDCNY to help dampen the CNY REERs
appreciation would be desirable, in our view, as studies have shown
that the exchange rate has a significant impact on inflation in
China.
Second, CNY overvaluation is getting more extreme, with USDCNY
remaining relatively stable while trade partner currencies fall
sharply versus the USD. Our BEER model estimates that the CNY is
around 20% overvalued, making it one of the most expensive currency
globally.
Third, FX intervention to limit CNY depreciation pressure would
dampen the effectiveness of liquidity-easing efforts. Economic
activity at the start of this year was weaker than expected (our
China Economists have downgraded their 2015 GDP forecast to 6.8%
from 7.0%) and monetary easing efforts are not helping to lower
market interest rates. However, FX intervention to limit CNY
weakness (ie, selling USD)
Mitul Kotecha
+65 6308 3093 [email protected] Dennis Tan +65 6308
3065 [email protected] Recent developments increasingly point
to the reduced need for China to maintain a strong currency
FIGURE 1 CNY REER has appreciated sharply, up more than 17%
since July 2014
FIGURE 2 USDCNY has pulled away from the top of the band
Source: Barclays Research, Bloomberg Source: Barclays Research,
Bloomberg
35
40
45
50
55
60
65
70
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
CNY REER
CNY REER (rolling 10-yr average)
Index
+17.3%
5.95
6.00
6.05
6.10
6.15
6.20
6.25
6.30
6.35
6.40
Jan-14 Jul-14 Jan-15
USDCNH Upper band
USDCNY fix Lower band
26 March 2015 25
-
Barclays | Global FX Quarterly
is having the effect of tightening domestic CNY liquidity. The
PBoC does have room to cut the reserve requirement ratio (RRR) rate
to offset the liquidity impact of FX intervention, as the current
RRR level of 19.5% is high by historical standards the ratio was as
low as 6% in 2002. However, a further drain of liquidity may not be
appropriate if a step-up in monetary easing is needed to counter a
sharper growth slowdown and to bring down elevated funding
costs.
Fourth, the global recovery remains uneven and desynchronized,
with the US being the sole engine of growth. While Chinas exports
are so far performing better than other EM Asian economies, the
recent sharp CNY REER appreciation might have a dampening effect on
Chinese exports to countries apart from the US.
The government does not seem overly concerned about capital
outflows Chinas capital outflows are accelerating. The monthly
trade surplus has risen to a record high this year, but we view the
surge in FX deposits as a sign that Chinese corporates are keeping
their export proceeds in USD, possibly in anticipation of greater
CNY adjustments ahead (see CNY: Unprecedented surge in FX deposits,
6 March 2015). Commentators have often cited hot money outflows as
a factor preventing China from allowing greater currency weakness.
However, recent comments by the PBoC governor Zhou Xiaochuan and
PBoC adviser Yi Gang at the National Peoples Congress (NPC) seem to
suggest that the government is not overly concerned about the
increase in capital outflows and CNY volatility.
China has typically refrained from making policy adjustments
when selling pressures on the CNY are heaviest. However, the recent
softening in the USD post-FOMC and the pullback in USDCNY from
levels near the top band may present an opportunity for Chinese
policy makers to make changes should USDCNY long liquidation extend
further. USDCNY has moved sharply away from the top of the band
(Figure 2), while the spread between USDCNH and USDCNY has narrowed
(Figure 3), suggesting less bearishness in the offshore market
relative to onshore. USDCNY fixings have also been moved lower as
the authorities appear to be dampening expectations that they would
like to engineer a weaker currency. This, in our view, could
provide a suitable backdrop for a band widening as the risk that
USDCNY moves to the top of the wider band has receded.
Capital outflows are accelerating but official comments suggest
that the PBoC is not overly concerned
FIGURE 3 USDCNH USDCNY spread narrows, suggesting bearishness in
the offshore yuan market is easing
FIGURE 4 Hot money' outflows are persisting, but official
comments suggest the government is not overly concerned
.Source: Haver Analytics, Barclays Research Note: *Net FX
purchases of financial institutions less the sum of the sum of the
trade balance, net FDI flows and portfolio flows. Source:
Bloomberg, Barclays Research
Recent pullback in USDCNY from close to the top of the band
could present an opportunity to make policy changes
-400
-300
-200
-100
0
100
200
300
400
Jan-13 Jul-13 Jan-14 Jul-14 Jan-15
Spread between USDCNH - USDCNY spot spread (5-day avg)
No of pips
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
-100
-80
-60
-40
-20
0
20
40
60
80
100
Estimated 'hot money' inflows*
3M chg in CNY vs. USD (RHS)
USD bn
26 March 2015 26
-
Barclays | Global FX Quarterly
We believe a move to adjust currency settings should not be seen
as a sign of capitulation on the part of China under the pressures
of slowing economic growth and growing capital outflows. Instead,
against the backdrop of an intensifying currency frictions
externally and growing growth headwinds domestically, we think
China may be recognising the increasing costs associated with
limiting the ability of the exchange rate to respond to changes in
external and domestic economic conditions. Refinements to the
existing framework to allow for greater flexibility and to allow a
greater role of market forces in determining the value of the CNY
is a step in the right direction, in our view. We maintain our
year-end 2015 forecast for USDCNY of 6.40. We also tighten the
stop-loss on our long USDCNH recommendation initiated on 24
September 2014 (see CNY: No longer a one-way trade in Global FX
Quarterly: ECB says EURs, 24 September 2014) to our entry level of
6.1414 from 6.0450 previously.
China appears to recognise the increasing costs associated with
limiting the exchange rates ability to respond to changes in
external and domestic economic conditions
26 March 2015 27
-
Barclays | Global FX Quarterly
THEME
AUD and NZD: More room to fall Although both AUD and NZD have
depreciated in recent months, we think there is scope for further
depreciation versus USD given contrasting monetary policy stances
and a firm USD. However, we do see some scope for AUDNZD to move
higher, with the currency pair bottoming out around current
levels.
Closer to fair value? AUD has declined steadily since September
2014, dropping around 20% versus the USD. It has also fallen
sharply against the NZD, dropping around 8% since the end of
October 2014. A number of factors have weighed on the AUD,
including the RBAs active encouragement of a weaker FX trajectory,
narrowing yield differentials and declining commodity prices, all
against the background of a strong USD. Moreover, the decline in
AUD continues to track the deterioration in Australias terms of
trade, with little sign yet that the worsening in the terms of
trade is close to ending.
Nonetheless, the drop in AUD has helped to reduce some of the
currencys overvaluation. Indeed, the AUD REER deviation with its
long-term (20 year) average has now declined to around 2.6%, while
the RBAs own fair value model estimates also put the currency at
around 2% expensive earlier in Q1 (our own version of the same
model shows that the AUD is 4% expensive in Q1 to date). However,
our BEER model estimate suggests that the AUD is around 14%
overvalued, implying scope for further depreciation on this
measure.
Given the sharp depreciation in the AUD in recent months, the
RBA no longer argues that the exchange rate is significantly
overvalued relative to fundamentals; instead, it has reframed its
criticism of the high exchange rate, with Assistant Governor Kent
arguing that the exchange rate remains relatively high given the
state of our overall economy. This suggests to us that the RBA
would be comfortable if the AUD were to overshoot fair value. We
think this implies that a potential move to around 0.70 cents would
not fuel any discomfort from the RBA. Indeed, our revised forecast
now looks for a drop to cl