Currencies | Oct 31 2011
– This week is a critical one for currency markets in ANZ's view
– Risk currency rally following European package could continue
– G20 meeting could drive further weakness in US dollar
– Rate cut expectations will be the key for the Australian dollar
By Chris Shaw
With Europe announcing a new policy package dealing with its sovereign debt crisis last week, ANZ Banking Group suggests this week will be a critical one for currency markets.
For Europe, ANZ's global head of forex strategy Richard Yetsenga notes there have been few if any constructive assessments of the policy package announced last week. Despite this, risk currencies continue to rally.
While there is likely an element of short covering in this price action, positioning isn't enough on its own to explain the price moves in Yetsenga's view. This implies something more fundamental is currently in play.
According to Yetsenga, possible explanations of what this could be are that Europe is not actually in a financial mess, Asia is recovering from its 1H economic slowdown, or the US dollar is structurally weak and this is supporting all risk assets.
As Europe does appear to be a mess, Yetsenga suggests the first option can be ignored. The other two options are probably having some impact as the US dollar has been unable to sustain a rally in the face of bad global news and recent Asian economic data have improved slightly in recent weeks.
Yetsenga suggests if some of the smaller country Purchasing Managers Index (PMI) readings in Asia can stabilise, particularly those of Singapore and South Korea, the current move in Asian currencies could well be extended.
The policy announcement last week in Europe has seen the G20 meeting slip into the background in terms of the market's focus, but Yetsenga suggests the meeting remains important. While only a handful of the players at the meeting matter with respect to Europe, there is potential for some mutual back-scratching at the meeting as various players have some key wishes.
As examples, Yetsenga notes Europe wants foreigners to buy its bonds, China wants to be given market economy status by Europe and Japan needs to garner international support for its currency intervention efforts.
Assuming some mutual agreements were reached, Yetsenga suggests the US dollar may weaken substantially, with USD/JPY the exception. ANZ has been downplaying the potential for successful intervention by the Japanese, but formal European support for the Japanese currency stance would likely see the bank re-visit this view.
Turning to Australia, Yetsenga expects the Reserve Bank of Australia (RBA) will announce a 25-basis point rate cut tomorrow. More important for the currency is not the move but the market's assessment of likely future moves, as Yetsenga notes the short end of the Australian market still has more than 100-basis points of rate cuts priced in over the next 12 months.
If the ANZ view is correct in expecting any RBA easing cycle is likely to be shallow, then any dip in the currency is likely to be immaterial. This is especially the case given Yetsenga's view the fundamentals for the Australian dollar still appear quite robust.
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