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#MARKET STRATEGY — 26.09.2023

Focus Currencies September 2023

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Summary

1.The US dollar index (DXY) increased by 1.4% in August while the Euro index (EXY) decreased by -0.95%.

2.Flows in the FX market has been characterized by a move towards higher global yields, especially in the US and a risk-off sentiment favoring the USD. The latter has been fueled by economic uncertainty in China.

3.Currencies related to China suffered a gradual decline in August as a result of increasing uncertainty around China. The Chinese currency also suffered due to a reduction in policy rates which has increased the interest rate differential in favor of the USD. We increase our 3-month target from 6.9 to 7.2 (value of one USD) and our 12-month target from 6.5 to 6.8.

4.Similarly, the Japanese Yen depreciated against the dollar. The Bank of Japan allowed the 10-year yields to rise up to 1% from 0.5% previously but the rate difference relative to the US is likely to keep the Yen weak until the outlook for Fed rate cuts becomes clearer. We increase our USD/JPY 3-month target from 138 to 140 (value of one USD) and our 12-month target from 128 to 134.

5.We see less upside for the Australian and New-Zealand dollar. We decrease our 3-month target for the AUD/USD from 0.7 to 0.68 (value of one AUD) and our 12-month target from 0.73 to 0.7. Similarly, we decrease our 3-month target for the NZD/USD from 0.65 to 0.60 (value of one NZD) and our 12-month target from 0.65 to 0.63.

USD VIEW >>  TARGET 12M VS EUR: 1.08

More upside for the Euro

The EURUSD appreciated over recent weeks and breached the 1.10 mark (value of one euro). The main tailwinds were the 2-year yield differential and the relative economic momentum, both pushing in favor of the Euro. The banking sector in the US is experiencing some turbulences as some regional banks are still showing signs of weakness. This has not altered the Fed’s decision to hike the target rate by 25bps on May 3rd, as markets anticipated. This was however followed by a statement suggesting a likely “pause” in hikes. Meanwhile the core CPI inflation- closely followed by the central bank- saw a slight increase in April at 5,5%.

The European Central Bank’s 25bp rate hike on May 4th is expected to be followed by another hike in June. The relative economic momentum (business surveys) moved in favor of the Euro, and the EU terms of trade improved as energy prices (especially gas prices) stabilized at levels last seen in 2021.

Eurozone core CPI printed 5.6% in April, a slight decrease from its peak in March. Meanwhile, the EU economic surprise index decreased from 50 to 10 suggesting that economic figures are still beating market expectations.

We may be ending an eight-year cycle below the purchasing power parity (PPP) currently estimated at 1.37 (value of one euro). These factors suggest that the Euro has more room to appreciate. In the short-term we cannot exclude a temporary rebound of the dollar.

Therefore, we increase our 3-month target from 1.06 to 1.08 and our 12-month target from 1.08 to 1.15.

 

GBP  VIEW >>  TARGET 12M VS EUR: 0.88

No clear trend

The EURGBP (value of one euro) has remained flat since the beginning of the year at around 0.88. This is largely due to a combination of economic and political factors mainly in the UK.

Inflation printed higher than expected in March and April at 10.4% and 10.1% respectively. The Bank of England’s 25bps hike in March suggested this would suffice to tamper inflation. On May 11th the BoE increased its bank rate another 25bp to 4,5, as expected..

The composite PMI printed higher than expected at 54.9 suggesting an expansion in economic activity.

The recent sharp fluctuations in the yield differential between the eurozone and the UK seems to persist. Both the Euro and Sterling are benefiting from the rapidly falling gas prices and signs of robust economic growth. The GBP is resisting against the broad strengthening of the Euro.

We maintain our 3- and 12-month targets at 0.88 (value of one euro), which suggests a lateral move of the currency from current level.

 

CHF VIEW >> TARGET 12M VS EUR: 0.98

CHF to remain strong

The EURCHF (value of one euro) has been trading close to parity with an attempt to breach the parity mark end of April. It was trading at 0.98 as of May 3rd. The Swiss franc is resisting against the strengthening of the Euro.

In April, the CPI YY printed 2.6%, lower than expected. This is the steepest decline in almost three years, mainly due to lower energy costs. This move may still not be enough to stop the central bank from raising interest rates again in June. As of May 4th, markets were pricing a 99% probability of a 25-bps hike end of June.

Overall, the SNB should hike rates slightly less than the ECB over the course of the coming year, as inflation in Switzerland remains much lower than in the euro area.

Despite the KOF leading economic indicator printing lower than expected at 96.4 in April and the manufacturing PMI 47, also lower than expected, Swiss economic fundamentals remain overall strong, and GDP is expected to expand quarter on quarter.

We maintain our 3- and 12-month targets at 0.98 (value of one euro), which suggests no major move of the Swiss franc relative to current levels (May 10th).

 

JPY VIEW >>  TARGET 12M VS USD: 128

More strength for the Yen

The Yen (JPY) weakened again against the dollar in over recent weeks bringing the value of the Yen to around 135 as of May 10th.

The Fed’s terminal rate expectations were tempered following the collapse of Silicon Valley Bank. The new governor of Japan’s central bank (BoJ) K. Ueda is expected to maintain its YCC (yield curve control) while adopting a slightly more hawkish view by widening its yield curve control range by 0.5% to 0% ± 1.00% during the first semester. This should support the JPY over the coming months. On April 28th, the BoJ’s meeting did not lead to major decisions.

The trade balance has been improving since the beginning of the year. It was driven by higher-than-expected exports and lower than expected imports. Most of these figures are greatly driven by China’s reopening.

Looking forward, the expected oil price rebound should decrease the current account surplus and could limit the upside for the currency. Lower Japanese demand for US fixed income assets this year is also likely to support the JPY's strength.

We maintain our 3-month target to 130 (value of one USD) and the 12-month target to 128. 

 

SEK VIEW >>   TARGET 12M VS EUR: 11

Moderate upside

The Swedish currency (SEK) lost ground against the Euro over April. We saw a rebound early May.

On May 3rd, the Riksbank raised its policy rate by 50bps to 3.5%. The 2-year interest rate differential has however been pushing in favor of the Euro since 2022.

Meanwhile, Sweden’s main concern is the housing market, as rates have decreased demand for houses due to mortgage rates. Hence hiking rates could worsen the situation, especially when considering that about 60% of mortgages are on floating rates. This lingering headwind for the SEK suggests that the pair has limited downfall.

Year-on-year retail sales have reached an all time low at -11.6% due to the relatively high CPI inflation at 10.6% for the month of April (compared to last year), rising credit costs and a poor overall sentiment.

The main factors mentioned above seem largely priced at this stage. All in all, we see no clear trend from current levels for the coming months.

 

We keep our 3- and 12-month targets at 11 (value of one euro). 

 

NOK VIEW >>TARGET 12M VS EUR: 10.30

Less upside for the NOK (target change)

The NOK is the worst performing currency in the G10 currency universe so far in 2023. We however saw a rebound of the Norwegian currency since early May.

The weakness over April can be attributed to the recent market turmoil and reduced liquidity/volatility conditions in the FX market. The Norges bank is adopting a cautious approach to rate hikes and this is a drag for the currency.

The CPI inflation for March printed 6.5%, higher than expected. On May 4th  the Norges bank acted by hiking interest rates by 25bps to 3.25%. According to Governor Ida Wolden Bache rates could continue to rise. Hence, another hike is likely in June.

The yield differential has favored the Euro until late April but has reversed since early May. The expected rise in oil prices and technical factors continue to point to a stronger NOK.  

 

We increase our 3-month target from 10.6 to 11.3 and our 12-month target from 10.3 to 10.8 suggesting a strengthening of the NOK.

 

AUD VIEW >>  TARGET 12M VS USD: 0.73

Upside from current levels

The Australian dollar (AUD) experienced higher volatility over recent weeks, loosing some ground against the US dollar.

On May 2nd, the central bank surprised the market by increasing its cash rate by a further 25bp to 3.85% followed by a statement indicating that inflation was still relatively high, and that the unemployment rate was at its lowest in over 50 years.

This rate hike is a way to prevent upside risks in services inflation. The latter remained high as reflected in the higher-than-expected CPI inflation at 7% for the month of April (compared to April last year). As of May 5th, markets were pricing a 94% chance of no hikes at the next meeting on June 6th .

Meanwhile, the reopening of China and rising demand for key industrial commodities, especially those needed for batteries and electronics, should improve Australia’s terms of trade, ultimately favoring the AUD.

We maintain our 3- and 12-month target at 0.70 (value of one AUD) and 0.73, respectively suggesting an appreciation of the Australian dollar.

 

NZD VIEW >> TARGET 12M VS  USD: 0.65

Looking for a rebound

NZD gained against the USD early May after a disappointing performance over April. The central bank raised its cash rate another 50bps now at 5.25%. A pause in future hikes would provide some relief to household, but inflation needs to fall more before it can end it rate hike cycle. Inflation fell back to 6.7% year on year in the first quarter 2023.

Domestically the focus is on the labor market which remains under some pressure as reflected in the unemployment rate printing lower than expected at 3.4%. A higher unemployment rate should reduce wage inflation and be a sign of relief for the central bank.

The recent reopening in China is yet to be reflected in New Zealand’s  trade balance which printed negative 16.40B (NZD) for the month of March.

The price of milk has increased 8% in April reaching an average selling price of 3’506.00 USD per ton which could support the NZD as milk represents about 20% of New Zealand’s exports.

We maintain our 3- and 12-month targets at 0.65 (value of one NZD). This suggests a moderate appreciation of the NZD from current levels.

 

CAD VIEW >>TARGET 12M VS USD: 1.30

Moderate upside

The Canadian dollar (CAD) hovered around 1,34 (value of one USD) over recent weeks. With the US eyeing a decrease in rates and the Bank of Canada maintaining a hawkish tone we see potential for the CAD to appreciate.

On April 12th, the Bank of Canada maintained its rate at 4.5% as it waits to see the full effect of its restrictive policy to pass through into the economy. Inflation seems under control with core CPI inflation for the month of March printing 4.3% lower than expected. The trade balance for March was higher than expected with a surplus of 0.97Bn (CAD). The unemployment rate however printed lower than expected at 5% for the month of April.

The CAD was influenced by oil price movements over recent weeks. Oil prices are expected to move gradually higher and this could give the CAD additional upside. The high level of household debt to GDP ratio (103% for Q4 2022) could however be a drag.

We maintain our 3-month target to 1.32 and our 12-month target to 1.30 (value of one dollar), suggesting a moderate appreciation potential from current levels.

 

CNY VIEW >> TARGET 12M VS  USD: 6.50

Strength ahead

The CNY (value of one dollar) was quite stable over recent weeks. It was hovering around 6.90 most of the time.

The Medium-Term Lending Facility remains unchanged at 3.65%. The central bank announced no change in its policy rate for the eighth consecutive month, partly due to a strong economic recovery following the withdrawal of most anti-covid measures in December.

China’s economy expanded 4.5% year-on-year and exports for the month of March rose sharply to 14.8%. Imports on the other hand, remained negative when compared to last year.

Year-on-year retail sales are up 10,6%, higher than expected and inflation printed 0,7%, lower than expected in March. The manufacturing PMI printed lower than expected at 49,5 and services PMI 56,4 for the month of April.

Improvements in China’s trade balance and economic outlook have favored equities and high-yield credit sentiment. Ultimately this should be more inflows and this should drive the appreciation of the CNY.

We maintain our 3- and 12-month targets at 6.75 and 6.50, respectively (value of one dollar). This suggests an appreciation of the CNY from current levels.