Recent rallies in Non-USD currencies resulting from poor US data have not lasted long. And those rallies resulting from strong US figures via the indirect effect of rallying equities (risk-on) have not lasted either. Broadening pro-USD sentiment may stay for longer than we had thought.
The greenback is primarily boosted by the market realization that the Federal Reserve is the central bank most likely to reduce its asset purchases program, regardless of whether it ends up not maintaining or increasing the program. What matters in currencies are relative expectations, and at the present juncture, the Fed has more chances to signal a gradual tapering of asset purchases, than other major central banks.
The case of the Bank of Japan is already well known. Aiming to double monetary base from ¥135 trillion to ¥270 trillion within two years; raising the average maturity of Japanese Government Bonds to seven years from three years—all via a monthly expansion of its balance sheet to the tune of 1.1% of GDP—compared to 0.5% of GDP by the Fed. And if that were not enough to drag down the currency, BoJ governor Kuroda is immensely experienced with verbally guiding the currency after his days four-year stint at the MoF’s International Affairs division.
The European Central Bank’s avoidance of quantitative easing had been partly the result of improving market metrics relieving the stress off peripheral bond yields. Spain was spared the sacrifice of imposing further austerity as a condition to get additional EU/ECB bailouts after 1o-year bond yields tumbled by 50% from their July highs. With market metrics in better shape, the ECB is now occupied with deepening recessions throughout the bloc; sixth consecutive quarterly GDP contractions in the Eurozone, seven straight contractions in Italy and the second quarterly decline in France. Chatter of negative ECB interest rates may end u being just than mere talk or currency jawboning. The euro is increasingly seen as a selling-on-the-bounce rather than buying-of-the-dips.
The Bank of England has not added to its £375 bn asset purchase in nearly a year. The BoE has already raised questions about its own credibility after failing to bring inflation towards the 2.0% target for the past 40 months. Such failure had been highlighted by the fact that GDP growth posted four quarterly contractions during the 40-month period. This implies that upcoming BoE governor Mark Carney will do away with the 10-year practice of targeting EU-harmonized CPI of 2.0%, in order to focus on the job of more aggressive stimulus policy. And thus, markets anticipate at least more of the same in the way of quantitative easing, at the expense of sterling.
Commodity currencies are already being hit by the comprehensive damage in the commodity complex damage (Nat Gas is the only commodity up in double digits this year, while most metalsand iron are down double digits with the exception of palladium). The Reserve Bank of Australiacut interest rates to 53 year lows, while the Reserve Bank of New Zealand resorted to admitting that it sold its own currency. This leaves the Bank of Canada as the exception in avoiding asset purchases, so far. But this month’s appointment of the head of Canada’s export agency at the helm of the Bank of Canada means that Canadian exporters will finally find an ally at the central bank. Stephen Poloz is likely to be more attentive to the needs of exporters via capping the Canadian dollar, which was not the case with Mark Carney. And as anecdotal evidence of swelling Canadian household debt becomes a legitimate banking concern, the combination of weak commodities and questionable loans quality is not conducive to a tight monetary policy.
The US dollar index may well be pressured by continued policy easing, but the role of relative expectations across G7 policy accommodation, US energy savings and asset market channels suggest that upside is the logical route and 88.0 on the USD index to finally be tested after a three–year absence.
May 16, 2013 5:30 pm by Ashraf Laidi
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