Fed Call To Drive Currencies
4 January 2010
Strategy overview: the year starts off with the Federal Reserve very much the focus for currency markets. This marks a departure from last year when investors traded currencies on the back of how equities and other risk assets performed. Our house view remains for the Fed to hike earlier than the consensus. The Fed Funds target rate is likely to be fixed at the top end of its current 0.00-0.25% band at the April FOMC meeting and then hiked by 25bps to 0.50% at the June FOMC. This is likely to keep the USD supported in the first half of 2010. In the table opposite, we upgrade our short term one and three month USD forecasts against the JPY, GBP, CHF,AUD, NZD and CAD to make them more in line with our existing three month view of the EUR falling to 1.40 against the USD.
G3: US payrolls data to set New Year tone. This week there are several key releases in both America and Europe but the focus will be the US payrolls report for December. Following November’s much stronger than expected release, a firm December print showing the labour market beginning to stabilise will increase expectations that the Fed will hike interest rates earlier rather than later this year. We have an open trade recommendation to short EURUSD at 1.4405 with a target of 1.3900 and a stop at 1.4600.
Europe: expect a weaker EUR on the crosses. The SwissNational Bank has allowed EURCHF to fall through 1.50 for the first time since it started intervening in March last year. We have lowered our one and three forecasts to 1.48 for the cross in line with our 2010 target of 1.45. We think EURCHF will stay a sell on rallies this year as Swiss banks deleverage further by selling foreign assets, keeping the CHF supported. Our other 2010 trades include selling EURSEK and EURNOK as the ECB won’t raise interest rates until September this year while Norges Bank has already started tightening and the Riksbank is set to do so in H1’10. We have an open trade recommendation to sell EURSEK from 10.44.with a target of 10.00 and a stop of 10.60. Last, we think EURGBP will also struggle in H1’10 as investors hope the UK general election due this summer leads to a change of government.
Commodity currencies: AUDNZD still a sell on rallies. The AUDNZD cross has fallen sharply at the end of last year from decade highs of 1.28-1.30. But we think it remains a sell on rallies for now. In Q1 the RBA will raise rates to 4.25% but then pause,while the RBNZ is likely to start hiking from March. This will keep AUDNZD under pressure in H1’10.
Short EURUSD from 1.4405, target 1.39 Chart: Policy expectations now hurting EURUSD.We sell EURUSD at 1.4405, targeting 1.3900, with a stopat 1.4600. At the December FOMC meeting, the Fed signalled the end of its liquidity programs and policy expectations are moving forward in the US. In contrast, we expect more ratings downgrades in the Eurozone and fiscal problems may even delay the ECB’s exit strategy. Reserve managers who have been buying euros on dips will have to reassess their positions as EURUSD has fallen through key support at 1.4450-1.45. We also expect an increased focus on US yields bringing about a broader dollar strengthening, as can be seen in USDCHF and USDJPY.
USD: Data and Fed Speak to determine risk view
The major change for the USD in the past month has been the switch from risk sentiment dominating the USD trading direction to the US data improvement driving the USD. The major tipping point came with the better than expected US November payroll release on December 4th. Subsequently USD strengthened and the very negative and stable correlation between the DXY index and the S& 500, seen for most of 2009, broke and moved into positive territory.
Exacerbating the move lower for EURUSD over that time period were worries about sovereign risk in the Eurozone (Greece) and banking sector risk as Austria nationalized a bank. The price action this week is highly anticipated as liquidity should come back post-holidays and as a result, FX movements can no longer be blamed on “thin markets.”The most important release will be December payrolls on Friday, with market participants waiting to see if the November downtick in the UR was a fluke and whether or not past revisions and/or the December payroll headline itself will include a positive read anywhere. The official UBS forecast is -35K for payrolls and 10.2% for the UR. Amove into positive territory for the headline payroll reading,however, would catch the market of-guard and be bullish for the USD as market participants would move up their expectations for a Fed rate hike.Other US releases this week include: the December FOMC minutes, the non-manufacturing ISM, and a plethora of Fed ’speak.We see EURUSD at 1.40 on both the 1 and 3 monthforecasts.
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500, seen for most of 2009, broke and moved into positive territory.