USD Set To Recover; AUD, NZD, GBP Very Vulnerable To A Reversal
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There will be a strong focus on Janet Yellen’s speech at Jackson Hole on 26 August and the next US non-farm payrolls release set for 2 September. We expect markets to reprice Fed rate hike expectations and the USD to rally.
...The US Federal Reserve has begun to lay the groundwork for a September rate hike, in our view. The resulting pickup in US front-end rates should mean that the USD has bottomed out in the short term, paving the way for a broad recovery in the coming weeks. Dependent on the extent to which an adjustment of expectations of future Fed policy also challenges the risk environment, we would expect USD gains to be most pronounced versus the commodity-exporting currencies in the G10. However, with the Fed unlikely to embark on a regular series of hikes, we do not expect a large adjustment in the US curve and doubt the USD will gather much momentum.
In addition to the Fed and the US there are several other factors that will play a key role in determining the foreign exchange market trend.
The equity market’s response will be critical, especially as regards the AUD and NZD. Our STEER model indicates that global equities are the principal driver of these currencies Of the five input factors that constitute our STEER model (2 year-swap rates, relative yield curve slope, commodity prices, relative equities and global equities), the co-efficient for global equities is, by some margin, the highest. Global equities have supplanted the traditional drivers of relative yields and commodity prices. As represented by the US S&P 500 Index, they have recently posted record highs. If such bullish momentum is threatened by increasing US rate-hike expectations, the AUD and NZD would be very vulnerable to a reversal.
The AUD is particularly at risk as our FX Positioning Analysis signals that it is the second-most-owned currency among the G10 group. We forecast 0.68 on AUDUSD by year end.
The GBP also appears extremely vulnerable. This week’s relief rally, following robust unemployment data and the surprise rebound in July retail sales, is unlikely to prevent a sharp GDP output decline to zero in the UK that our economists forecast for the next three quarters. The retail sales jump is likely to prove a temporary, weather-related phenomenon. The greatest risk comes from the dramatic decline in the PMI surveys for both manufacturing and non-manufacturing surveys. Both have fallen to multi–year lows and suggest the BoE will need to ease policy further. UK output data, especially the September PMI surveys, will be pivotal for the GBP.
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