Currencies | Apr 22 2013
– USD To grow stronger
– Yen to slip then flatten soon
– Euro to firm a little lower
– AUD weakness, soon
By Andrew Nelson
It’s been a volatile few months for FX traders thanks to the Japanese. It started with the election of Shinzo Abe late last year and then months of steady talk from Japan about its intention to undertake some massive stimulus to bring the country’s economy back to life. Then the Bank of Japan (BoJ) made it official a few weeks back and the ride got even rougher. What’s worse, market volatility hasn’t just been limited to yen crosses, with Japan’s moves making waves that are being felt across the FX world.
Analysts at Canada’s CIBC World Markets point out that the expectations for flows from Japan have probably been the main driver of the fluctuating, but firmer levels we’ve been seeing in the AUD, euro and the Canadian dollar, or loonie. In this article we’ll take closer looks at the implications for the Aussie and US dollars as well as the euro.
One the thing the Canadian bank does expect is something that will sound like music to Australian ears: a stronger US dollar for longer. The evidence of this recent economic deceleration aside, there has still been growing talk the Fed may soon be looking at slowing down the pace of the current QE program. This has seen the greenback give back some earlier gains. Yet at this point, notes CIBC, markets have already started to build in the expectations for a lull in growth over the next few quarters. With the bar now set pretty low, the bank thinks it unlikely we’ll see any real negative impacts on the USD.
In fact, the bank believes growing numbers are turning too pessimistic on the topic of US growth. But CIBC notes one bad payroll reading does not mean much in a data series that was always volatile, long before the recession began.
Thus while we may see a more subdued growth recovery than hoped for in the US, it will probably still outpace most other developed countries. Add to that a weaker than hoped for acceleration in China, and continued recession and political risk in Europe and US outperformance and risk-off sentiment should keep the USD reasonably well supported.
What’s more, if the US does pick up in the final quarter of the year, with sequestration and budget talks in the rear view mirror, CIBC sees a chance the Fed’s stimulus push could be wound up before year-end. Combined with what will likely be a still deflating yen and increasing expected inflows into US assets and you’ve got a much stronger than expected USD in 2104.
For the euro, more weakness, with structural and economic headwinds and increasing expected outflows into US assets making for continued weakness. Japan’s monumental policy easing will also add to the pressure.
CIBC explains the current Japanese interest in the EUR/JPY is providing some support for the EUR/USD, but the bank believes the prospect of deteriorating fundamentals in the eurozone and deepening political divisions between France and Germany will likely come back to weigh on the euro more heavily than the support currently being provided. The bank further predicts current European softness will soon lead to misses on public sector debt targets. This could easily spell more bailouts of peripheral countries. While a weaker euro is certainly not the best medicine for the economic woes of the region, it is necessary step in the return to growth.
All that being said, CIBC does not expect the euro weakness to be as drastic as many fear. In the near term, CIBC expects to see further easing from the ECB. Maybe even as early as next month’s policy meeting. The bank expects the euro ease back to US$1.23, but not much lower, although there will also be a longer wait for a meaningful recovery.
That brings us to the home front and what will hopefully be some good news for Australian investors. Recent signs of weakness in the labour market have grabbed the attention of many. While admittedly a volatile read, CIBC is nonetheless growing increasingly concerned about the ability of the non-mining sector to make up for the earlier than expected peak in the investment boom.
While there were some early signs from China that might have put these concerns to rest, CIBC notes the latest batch of weaker than expected Chinese data has already seen prices of key commodities such as iron ore pull back. As noted earlier, the Canadian Bank is cautious on the prospect of growth in China this year, especially as the Beijing appears increasingly reliant on investment to support short term growth.
Despite few cuts coming through of late, the RBA has maintained its easing bias for a reason, notes the bank, saying it would not be surprised if the market once again starts to price in further cuts given softening fundamentals. Then you’ve got the political uncertainty to weigh up, CIBC admitting the September 14 election is a major factor behind its bearish view on the AUD.
Why? Because a government in trouble, such as Australian Labour, is likely to be clamouring for cuts in a search for some support in the polls.
Finally, the bank sees much of the recent support for the Aussie as coming from AUD/JPY inflows, as Japanese investors hunt for higher yields. Yet with the aforementioned belief that further aggressive yen depreciation from here is unlikely, fund flows from Japan into the Aussie dollar will soon start to come off. This has CIBC predicting a drop in the AUD below parity against the USD as soon as this quarter. The bank says the NZD is a better relative value play in the region, given its lower reliance on metals prices.
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