A report by UAE bank, Emirates NBD, analyses the recent and forward movement for a basket of global currencies.
USD strengthens as risk appetite fades
The USD saw further strength last week benefiting from a rise in risk aversion as equities weakened and risk was taken off the table. Despite some optimistic statements by US policymakers it does not appear as if investors are willing to believe that a deal to avoid the ‘fiscal cliff’ before the end of the year is certain. Other factors that contributed to risk aversion were delays to the approval of the next tranche of aid for Greece, as well as renewed tensions in the Middle East. Markets expect the Eurozone issue to be partly resolved this week with finance ministers expected to approve the disbursement of EUR32bn of aid to Greece at a meeting on Tuesday. However, some national parliaments will then also have to approve the transfer, meaning that Greece will probably not receive the aid until the end of the month.
Even then it still remains likely that Greece will also need a further restructuring of its existing debt, most of which is now held by national governments as well as by the ECB. And all the time there are delays the Eurozone appears to be falling deeper into recession. Preliminary data released last week showed that despite residual modest strength in Germany and France, the whole of the Eurozone contracted by 0.1 per cent in Q3, with weakness not only seen in the periphery but in core countries such as the Netherlands which contracted by a whopping 1.1 per cent. In the coming week, the Eurozone composite PMI for November and the German IFO index are expected to show that these recessionary conditions likely continued into Q4.
Japanese elections depress the JPY
As well as the expected vulnerability of EUR/USD another principal beneficiary of expected USD strength should be USD/JPY. Last week saw the Japanese parliament dissolved and a general election called for December 16th. This has already seen USD/JPY rally from the mid-79.0’s to 81.40, as markets assume a change of government is at hand. Indeed the opposition LDP, under its head and former PM Shinzo Abe, has already put forward a more stimulatory economic agenda, incorporating both looser fiscal and monetary policies. In reality, however, with debt/GDP already 235 per cent in Japan, there is a constraint on how much more expansionary fiscal policy can be, leaving monetary policy as the area where more will need to be done. And with the Bank of Japan also due to see a change of leadership in early 2013, it is plausible to expect the BoJ to be more receptive to such pressure for further stimulus to weaken the JPY. Abe has already called for the inflation target to be raised from 1 per cent to 2-3 per cent, which coming from a current deflationary backdrop implies that the BoJ will have to be much more aggressive in undertaking QE, potentially including the purchase of foreign assets. As far as this week’s BOJ board meeting is concerned it is probably too early to expect another policy change, given that it has already eased monetary policy twice over the last two months.
GBP has not been immune to USD strength either, as despite some evidence of stronger UK growth (Q3 GDP of 1 per cent) and inflation (October 2.7 per cent) which contributed to the BoE suspending its QE programme in November, the pound appears to be not believing that these situations will last for long. Indeed both in USD terms and EUR terms the pound has lost ground since early November, with the suspicion remaining that both the recovery and the pause in QE will not last. Indeed, Governor King has more or less said as much, suggesting that the economy could contract again in Q4. And with retail sales sinking by 0.8 per cent in October, there is already early evidence that this will indeed be the case.
The minutes of the November Monetary Policy meeting will be released in the week ahead, with a unanimous decision to halt QE expected. Any deviation from this outcome, however, could cause GBP to slip further. Furthermore, with UK fiscal policy coming into focus ahead of the December Autumn Statement, October’s public finance figures to be released this week will also be important in relation to whether Chancellor Osborne will meet his deficit targets. Finally, attention will also turn on the BoE itself, with the decision over a new Governor to replace Mervyn King expected to be made in December. Given this backdrop of uncertainty over monetary policy, fiscal policy and leadership at the BoE it would not be surprising to see GBP continue to struggle in coming weeks.
Commodity currencies in abeyance
Finally the situation in China will remain interesting to FX markets following the announcements over the leadership handover made last week. Recent signs of stabilisation in Chinese growth have been encouraging, making the flash HSBC PMI indicator of particular interest later this week. A recovery back above 50 in November from 49.5 in October would be particularly reassuring. However, to the extent that it may also discourage the need for further stimulus measures from the new Chinese government, it may have a mixed impact on markets. It would seem that the Chinese authorities are already leaning towards a cautious approach next year, which may entail lowering the 2013 growth target from 7.5 per cent this year. This would be consistent with a shift towards encouraging a better quality of growth rather than just quantity for its own sake. Such a prospect would also have implications for growth elsewhere, helping to keep appetite for commodity currencies (which rely on demand from China) like the AUD, NZD and the CAD in abeyance.