G10 Forecast Revision - Q3 2018

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US Dollar (USD)

The US Dollar has appreciated sharply against almost every G10 currency since the end of April, in line with our long standing expectations. Generally strong macroeconomic data and growing expectations that the Federal Reserve will raise interest rates on a total of four occasions this year has lifted the greenback to its strongest position in over a year. The currency crisis in Turkey and looming threat of a global trade war have also ramped up safe-haven flows into the greenback, which has helped the US Dollar rally by around 7% against its major peers since the beginning of the second quarter (Figure 1).

Figure 1: US Dollar Index (August ’17 - August ’18)

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Source: Thomson Reuters Datastream Date: 23/08/2018

The Federal Reserve was more hawkish than the market had anticipated at its monetary policy meeting in mid-June. Policymakers raised rates by another 25 basis points for the second time so far this year, as expected, although signalled it is ready to hike rates at a faster pace than it had indicated back in March. Policymakers once again struck an upbeat tone in the FOMC’s August communications, saying that the US economy was ‘strong’ and that ‘economic activity has been rising at a strong rate’.

Growth forecasts have recently been raised slightly higher by the central bank, with the Fed now expecting a modest overshoot of inflation that would warrant short term rates to be marginally higher than their long term levels. This was indicated in a moderately upwardly revised June dot plot. The FOMC’s median dot showed that policymakers in the US now expect rates to end the year at an average of 2.24% and 2.96% in 2019 (Figure 2). This would amount to a total of 4 hikes in 2018 and another 3 next year, a faster pace than implied by the market, which is currently pricing in around a 60% chance of two more hikes this year.

Figure 2: FOMC June 2018 Meeting ‘Dot Plot’

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Source: Federal Reserve Date: 13/06/2018

Increased optimism among committee members comes on the back of generally impressive economic data out of the US. Following its relatively solid first quarter performance, the US economy powered ahead in the three months to June, growing at a four year high pace of 4.1%. This was fuelled largely by robust consumer and business spending and a sharp increase in exports. Importantly, the US labour market has continued to show encouraging signs in the past few months, which should continue to support domestic activity in the second half of the year. A below consensus 157,000 jobs were created in the US economy in July, although there was an upward revision to the June number that ensures that the twelve month moving average is now above the 200k level (Figure 3).

Figure 3: US Nonfarm Payrolls (2013 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

The surprise increase in unemployment in June proved short lived, with the jobless rate falling back to 3.9% in July, around its lowest level in eighteen years. The jobless rate could trend lower in the coming months should Donald Trump’s recent tax cuts impact hiring and investing decisions. Wage growth decelerated in July, although the twelve month moving average is now at its highest level since January 2010. These impressive numbers continue to point to a robust jobs market that would warrant a relatively aggressive pace of rate hikes from the Fed this year.

A sharp increase in US inflation since the beginning of the year also provides a challenge to the Fed, particularly given the latest round of tariffs should, in theory, drive prices even higher in the coming quarters. Headline inflation leapt to a more than six year high 2.9% year-on-year in July, with the core measure of price growth also now at a near decade high 2.4% (Figure 4). A tight jobs market, strong level of economic growth and the threat of higher imported prices off the back of Trump’s protectionist policies could drive prices even higher next year and increase pressure on the Fed to raise rates at an aggressive pace.

Figure 4: US Inflation Rate (2010 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

The US Dollar has so far proved resilient to the ongoing threat of a global trade war that has dominated headlines in financial markets in the past few months. President Trump somewhat controversially announced the imposition of tariffs on steel and aluminium imports of 25% and 10% respectively back in March. While these tariffs were largely symbolic, Trump’s threats to impose tariffs on the entirety of Chinese goods worth $505 billion are significant and, if followed through, would undoubtedly spark retaliation from China.

Somewhat paradoxically, the looming trade war has lifted the greenback, as investors flee riskier emerging market currencies and move into the safer US Dollar. Investors have also taken on the general view that the aforementioned protectionist policies would likely have less of an impact on the largely domestically driven US economy than its trading partners, most of which are more heavily reliant on external demand.

Following the Federal Reserve’s most recent interest rate hike in June, we remain of the opinion that the central bank will increase rates on another two occasions this year at its September and December meetings. With the market still currently pricing in only a 60% chance of a total of four interest rate hikes in the US this year, we think there remains room for modest gains for the US Dollar against the Euro during the remainder of the year.

 

 

EUR/USD

GBP/USD

Q3-2018

1.17

1.32

E-2018

1.16

1.35

Q1-2019

1.16

1.37

Q2-2019

1.15

1.39

E-2019

1.15

1.42



UK Pound (GBP)


The Pound has suffered from a particularly volatile 2018 thus far, with uncertainty over the UK’s relationship with the European Union post-Brexit making Sterling one of the more unpredictable major currencies in the world this year. The currency rose to a near two year high in mid-April, although it has since shed over 10% of its value following a downturn in domestic economic data and concerns over the possibility of a ‘no deal’ Brexit. This, coupled with recent Dollar strength, sent the Pound to its lowest level against the greenback in over a year in August (Figure 5).

Figure 5: GBP/USD (August ’17 - August ’18)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Uncertainty surrounding how Brexit will impact the UK economy has been, and will likely continue to be, the main driver for the Pound in 2018. Financial markets took some comfort from the publication of the Brexit White Paper in July, which both provides a basis for negotiations and outlines Theresa May’s preference for a softer Brexit that would retain the country’s close ties with the European single market. The paper acknowledges that the UK will have barriers to trade after leaving the EU, although the new ‘facilitated customs union arrangement’ remains rather ambiguous and a significant point of contention

While May’s preference for a softer Brexit has been greeted positively by the FX market, her proposal has been met with backlash from eurosceptics within her own party, leading to the resignations of Brexit Secretary David Davis and Foreign Secretary Boris Johnson in July. There has also been growing concern among MP’s over the possibility that Britain will fail to reach an agreement on Brexit before the end of October deadline. While we think there is undoubtedly a non-zero chance of no deal being struck, we expect a deal to be ironed out in time for either the October EU summit or the following scheduled summit in mid-December. There has even been talk of an emergency summit being called in November.

Amid the growing uncertainty over Brexit, we think that Sterling should receive some decent support from the Bank of England, which hiked interest rates for only the second time in over a decade in August. The BoE delivered a hawkish surprise, unexpectedly voting unanimously for an immediate hike after investors had eyed a 7-2 vote. The central bank noted that recent economic data had confirmed that the slowdown in the first quarter of the year was indeed temporary. Policymakers also stated that while the economy was growing more slowly than in the past ahead of Britain’s exit from the European Union, it was operating close to full capacity. Governor Carney’s press conference did, however, strike a cautious tone, and the central bank appears in no rush to hike interest rates again any time soon.

News out of the UK economy tentatively appears to be turning a corner following a sluggish first three months of the year that saw growth slip to just 0.2% quarter-on-quarter. The UK economy expanded by 0.4% in the second quarter, with the slowdown at the beginning of the year largely due to the weather and not the economic climate. The latest business activity PMIs have been fairly solid and, despite easing back from June’s eight-month high, the key services index remains comfortably above the level of 50 that denotes expansion (Figure 6).

Figure 6: UK PMIs (2015 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

We think growth could pick up further in the coming quarters should an improvement in real wage growth filter its way through to an uptick in domestic activity. When taking into account the impact of inflation, wage growth in the UK slumped into negative territory in the twelve months to January, although has since turned positive in the past four months following the recent drop-off in inflation.

Figure 7: UK Real Earnings Growth (2011 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Possibly the main rationale behind the need for higher interest rates in the UK has been the sharp increase in UK inflation since the EU referendum, which has seen consumer price growth remain above the bank’s 2% target in each of the past nineteen months. Headline inflation in the UK has, however, eased since the beginning of the year, coming in at 2.5% in July. Despite easing of late, headline consumer price growth is likely to remain above target during most, if not all, of the remainder of the year. While the Bank of England has made it clear it is in no rush to hike rates again, it will be under increasing pressure to do so should inflation continue to remain stubbornly above target in the coming months. We do, therefore, see a decent chance that the BoE will hike again in around the second quarter of next year, contingent on the state of the Brexit negotiations.

Fears over a ‘no deal’ Brexit have weighed heavily on the Pound in the past few weeks and caused the currency to undershoot our short term expectations. We do, however, think that the sell-off has been overdone, and expect Sterling to initiate a rebound should the UK eventually strike a deal with the European Union towards the end of the year, as we anticipate.

The prospect of a Brexit agreement that leads to a softer exit from the EU, coupled with tighter policy from the Bank of England next year should, in our view, allow room for a recovery in the Pound against both the US Dollar and the Euro. We do, however, revise downwards our short term path of appreciation to account for recent currency weakness caused by concerns over a ‘no deal’ Brexit.

 

 

GBP/USD

GBP/EUR

Q3-2018

1.32

1.13

E-2018

1.35

1.16

Q1-2019

1.37

1.18

Q2-2019

1.39

1.21

E-2019

1.42

1.23



Euro (EUR)

The Euro has fallen relatively sharply against the US Dollar since April, in line with the recent broad strength in the latter that has seen it rally against most major currencies in the past few months. The common currency was sent to a more than one year low in August following the sharp sell-off in higher risk currencies induced by the crisis in Turkey, albeit the currency has held up better in trade-weighted terms (Figure 8).

Figure 8: EUR/USD (August ’17 - August ’18)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Recent communications out of the European Central Bank (ECB) have also far from helped the common currency, with President Mario Draghi continuing to suggest that higher interest rates in the Eurozone remain a long way off. The ECB delivering some very explicit forward guidance on its monetary policy back in June, with the bank announcing plans to begin winding down its quantitative easing programme beyond the previous end date. Asset purchases will run beyond September at a reduced pace of 15 billion euros a month and, after a short tapering period, will be wound down to zero in December (Figure 9).

Figure 9: ECB Monthly Asset Purchases (2015 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Despite announcing plans to bring its QE programme to a close, the central bank has struck a very dovish tone with regards to future interest rate hikes in the Euro-area. The ECB has explicitly stated in recent statements that ‘significant stimulus was still needed’ and that it expects the key interest rates to remains at present levels ‘at least through the summer of 2019’. Mario Draghi has highlighted growing uncertainty from abroad, claiming in July that US protectionism remains a ‘prominent’ uncertainty.

Following a very impressive 2017, which saw the Eurozone economy expand at its fastest pace in a decade, growth in the currency bloc has eased back somewhat so far this year. The Eurozone economy grew by another 0.4% in the second quarter of the year, matching its slowest pace since mid-2016. The latest business activity PMIs have been relatively soft with the crucial composite PMI, which represents a weighted average of the services and manufacturing sectors, slowing sharply since January. The index declined to an eighteen month low 54.1 in May, while registering only a modestly higher 54.3 in July (Figure 10). Tightening trade tensions with the US were cited following a recent growth downgrade from the EU, which slashed its estimates for this year to 2.1%, in line with that of the European Central Bank, and an even lower 2% for 2019.

Figure 10: Eurozone PMIs (2015 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

President of the ECB Mario Draghi reiterated in July that there was increasing confidence among the committee that inflation in the Eurozone would return to target over the forecast horizon. While the headline rate of consumer price growth has finally increased back to 2%, it is important to note that the level of core inflation, the main piece of economic data the ECB looks at when deciding on monetary policy, was stuck at just 1.1% in July (Figure 11). We think it will be a long time before the improvement in labour market conditions begins to filter its way through to faster core inflation, and the prospect of this measure hitting the ECB’s ‘close to but below’ 2% target any time soon remains very remote.

Figure 11: Eurozone Inflation Rate (2013 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

We think that the recent cautious rhetoric out of the European Central Bank highlights the very low likelihood that we’ll see an interest rate hike in the Eurozone until at least the second half of next year. As we have mentioned in the past, the single mandate of the European Central Bank is to ensure core inflation returns to its 2% target. With core inflation still well below this level, it is clear that the ECB is in no rush at all to even consider raising rates. We believe that any hikes are now very unlikely until deep into 2019, possibly even early-2020.

With the prospect of an interest rate hike in the Eurozone a long way off, we continue to expect the Euro to remain at or modestly below its currently suppressed levels against the US Dollar throughout the remainder of 2018. We expect a slightly more pronounced depreciation in the Euro versus the Pound, with the EUR/GBP rate continuing to appear slightly overvalued, in our view.

 

 

EUR/USD

EUR/GBP

Q3-2018

1.17

0.89

E-2018

1.16

0.86

Q1-2019

1.16

0.85

Q2-2019

1.15

0.83

E-2019

1.15

0.81



Japanese Yen (JPY)

The Japanese Yen (JPY) broke out of last year’s 110-115 range at the beginning of 2018, with an increase in geopolitical tensions in the global financial markets increasing safe-haven flows into the currency in the first quarter. The Yen strengthened below the 105 level against the US Dollar for the first time since November 2016 at the end of March (Figure 12), gaining more than 6% in just three months and making it one of the best performing currencies in the world. This rally has eased, however, off the back of a broadly stronger US Dollar and expectations for a very gradual unwinding of accommodative monetary policy measures from the Bank of Japan (BoJ).

Figure 12: USD/JPY (August ’17 - August ‘18)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Fears regarding the escalation of a global trade war and rising geopolitical tensions in the Korean peninsula were two of the primary drivers behind the Yen’s impressive run at the beginning of the year. While the threat of a US-China trade war undoubtedly remains, investors have taken on the general view that Trump’s protectionism would have a less of an impact on the largely domestically driven US economy than many of its peers, Japan included. Japan is the fourth largest export destination for US goods, while China accounts for almost one-fifth of the country’s overall export revenue, thus exposing the Japanese economy to potentially softer external demand. The easing in European political uncertainty, and stabilisation in stock markets globally, has also caused investors to backtrack on safe-haven flows into Japan.

For its part, the Bank of Japan (BoJ) has continued to strike a cautious tone regarding its monetary policy, despite increased speculation among the market regarding a tweak in policy. The BoJ has continued to keep its deposit rate negative at -0.1% for the past two-and-a-half years and will do so until inflation exceeds the bank’s 2% inflation target. Its so-called ‘quantitative and qualitative monetary easing with yield curve control’ will also see the bank purchasing government bonds at an annual pace of 80 trillion Yen in order to maintain a 10 year government yield of around zero in an attempt to lift inflation and support the economy. The BoJ also announced that it had spent ¥833 billion ($7.8 billion) on exchange-traded funds in March alone, the largest amount since late-2010, in order to prop up Japanese equity prices.

In another sign that the central bank is in no rush to remove its very accommodative stance, the bank once again lowered its assessment of inflation. The bank now expects inflation to come in at 1.1% year-on-year in the fiscal year 2018 and just 1.5% in FY19, well below the bank’s 2% target. Even with the Bank of Japan’s very accommodative monetary policy, inflation in Japan has continued to fall short of the central bank’s target. Headline inflation increased back to 1.5% in February (Figure 13), albeit it has since eased, coming in at just 0.7% in June. The core inflation indicator has also failed to breach the 1% mark in every month since the removal of the sales tax hike from the index. We think the continuation of Prime Minister Abe’s ‘Abenomics’ and reappointment of Bank of Japan Governor Kuroda in February ensures that monetary policy is likely to remain loose so long as inflation continues to undershoot its target.

Figure 13: Japan Inflation Rate (2010 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

The Japanese economy expanded at a moderate pace in 2017, although in another blow to the BoJ’s efforts to spur activity, the economy contracted by 0.2% in the first quarter, albeit this was upwardly revised. A worsening in domestic consumption undoubtedly presents a risk to the outlook for the rest of the year. Household spending has been soft, with a fall in real wages at the beginning of the year keeping a lid on consumption. Activity in the country’s manufacturing industry has also slowed. The Nikkei manufacturing PMI has eased since the beginning of the year, slumping to an eleven-month low 52.3 in July (Figure 14).

Figure 14: Japan Manufacturing PMI (2015 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

The latest set of communications from the Bank of Japan suggests to us that monetary policy in the country is likely to remain accommodative so long as inflation in Japan continues to undershoot the central bank’s target. We see the BoJ maintaining its loose monetary policy stance this year which would, in our view, offset any safe-haven flows and lead to a gradual depreciation of the Yen from current levels against the US Dollar.

 

 

 

USD/JPY

EUR/JPY

GBP/JPY

Q3-2018

112

131

148

E-2018

114

132

154

Q1-2019

116

135

159

Q2-2019

117

135

163

E-2019

118

136

168



Swiss Franc (CHF)

The Swiss Franc (CHF) has suffered from an especially unpredictable few months of trading. Continued dovishness on the part of the Swiss National Bank (SNB) and an easing back in safe-haven flows following a recovery in stock markets globally caused the Franc to slip to its weakest position since the removal of the Euro cap in April. Concerns over a US-China trade war and, more recently, the sharp sell-off in the Turkish Lira has, however, ramped up demand for CHF, with the currency rallying back to its strongest position in a little over a year in August (Figure 15).

Figure 15: EUR/CHF (August ’17 - August ‘18)

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Source: Thomson Reuters Datastream Date: 23/08/2018


Recent safe-haven flows and subsequent Swiss Franc strength, which far from provides a supportive inflationary environment, should ensure that the Swiss National Bank (SNB) maintains its existing ultra-loose monetary policy stance for the foreseeable future. The SNB has remained one of the more dovish G10 central banks and continues to voice its discomfort over a strong Franc. Chairman Christopher Jordan has continued to call the currency ‘highly valued’ during recent communications, and there is a risk that recent currency strength means that the central bank may revert back to calling the Franc ‘significantly overvalued’. Policymakers have long been opposed to a stronger domestic currency, given it poses a risk to Switzerland’s export-oriented economy.

Interest rates have been kept deep in negative territory, with policymakers once again holding rates steady at -0.75% at the SNB’s June monetary policy meeting in order to warn off inflows. The bank has also continued to reiterate that it stands ready to intervene in the foreign exchange market to weaken the currency, should it deem necessary. Chairman Jordan claimed in June that there was ‘no end to [the] currency buying programme’, and that the central bank’s balance sheet could still be expanded, if required.

Even following its recent appreciation, the Swiss Franc remains considerably weaker than mid-2017 levels, which has contributed to a sharp increase in the rate of inflation since the beginning of the year. Headline inflation has risen in each of the past three months, increasing to 1.2% in July, its highest level since the beginning of 2010. Similarly to the Eurozone, the level of core inflation has remained stuck at just 0.5%, well below target, having now remained below the 1% mark in every month for almost a decade (Figure 16). This should lessen the need for the central bank to ease monetary policy further.

Figure 16: Switzerland Inflation Rate (2010 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

On a more upbeat note, Switzerland’s economy has picked up pace in the past few quarters after a strong showing in domestic household consumption and a sharp increase in manufacturing production. The economy powered ahead in the first quarter of 2018, growing by a healthy 2.2%, its fastest pace of expansion since 2015. The country’s manufacturing sector has been a bright spot, expanding in each of the past four quarters and growing by another 8.6% in the first quarter, just shy of its fastest pace in a decade (Figure 17).

Figure 17: Switzerland Manufacturing Production (2006 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Despite the improvement in the growth outlook, low inflation and a stronger Swiss Franc means that the Swiss National Bank is likely to maintain its ultra-loose monetary policy stance for the foreseeable future. The SNB has continued to voice its discomfort for a stronger Franc and appears committed to continue intervening in the currency markets and maintaining an accommodative monetary policy to prevent a significant appreciation in the currency. On the other hand, Switzerland’s massive current account surplus and safe-haven status will, we believe, prevent a significant depreciation of the Swiss Franc from current levels. We do, therefore, continue to forecast a stable EUR/CHF in the long run, albeit at modestly lower levels than we had previously anticipated.

 

 

USD/CHF

EUR/CHF

GBP/CHF

Q3-2018

0.99

1.16

1.31

E-2018

1.00

1.16

1.35

Q1-2019

1.00

1.16

1.37

Q2-2019

1.01

1.16

1.40

E-2019

1.01

1.16

1.43



Australian Dollar (AUD)

The Australian Dollar (AUD), much like its New Zealand counterpart, has born the brunt of the recent sell-off in high-risk currencies. Following the turmoil in Turkey, lower commodity prices and amid a broadly stronger greenback, AUD slipped to its weakest position in over a year-and-a-half in August and has now shed around 10% since the end of January (Figure 18). For its part, the Reserve Bank of Australia (RBA) has continued to signal that it is likely to maintain interest rates at current record low levels for at least another year.

Figure 18: AUD/USD (August ’17 - August ’18)

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Source: Thomson Reuters Datastream Date: 23/08/2018


The RBA held rates steady at 1.5% in August, where they have been for the past two years. Policymakers have voiced general optimism towards the domestic growth outlook, citing a strong labour market and business confidence, while emphasising that the next move in rates is more likely to be up than down. The central bank did, however, strike a less upbeat tone over the state of the global economy in August. Governor Philip Lowe noted that China’s economy, to which Australia is heavily linked through trade, had ‘slowed a little’. With demand from China accounting for around one-third of the country’s overall export revenue, the Australian economy is one of the more exposed within the G10 to the threat of a US-China trade war.

Policymakers in Australia have also warned that inflation in the country is ‘likely to remain low for some time’, despite picking up pace in the second quarter of the year. Headline inflation increased back up to 2.1%, although this remains below the RBA’s 2.5% inflation target, having done so in every quarter since 2014 (Figure 19). Core consumer price growth has remained equally as soft, coming in at 1.9% in the three months to June. The RBA now expects inflation to reach 1.75% at the end of 2018, a downgrade from the 2% that it had pencilled in earlier in the year.

Figure 19: Australia Inflation Rate (2008 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Keeping interest rates at their currently subdued level would also help reduce unemployment and lift wages over time according to the RBA. Australia’s labour market has improved, although wage growth of just over 2% remains low by historical standards (Figure 20). Encouragingly, the rate of unemployment fell back to 5.3% in July, its lowest level since November 2012. This has fed its way through to a broadly stronger Australian economy, which has continued to expand at a solid rate, growing by a better-than-expected 1.0% quarter-on-quarter in the first three months of the year. Despite the solid growth backdrop, there are few signs that the central bank is in a rush to raise rates anytime soon, having last hiked its main rate back in 2011. Financial markets are now only pricing in around a 10% chance of a rate hike before the end of the year, much lower than the near 80% probability that we saw at the end of January.

Figure 20: Australia Real Earnings Growth (2002 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Recent communications out of the Reserve Bank of Australia confirms our expectations that the central bank is unlikely to begin raising interest rates until deep in 2019, possibly early 2020. We expect stable policy from the RBA to keep the Australian Dollar around its currently subdued level, although an unwinding in safe-haven flows could provide some support for the currency in the short term.

 

 

 

AUD/USD

EUR/AUD

GBP/AUD

Q3-2018

0.74

1.58

1.78

E-2018

0.75

1.55

1.80

Q1-2019

0.75

1.55

1.83

Q2-2019

0.75

1.53

1.85

E-2019

0.75

1.53

1.89



New Zealand Dollar (NZD)

The New Zealand Dollar (NZD) has fallen sharply since the first quarter of the year, having spent much of the first three months of 2018 stuck in a narrow range. The threat of a US-China trade war, and more recently the Turkish Lira crisis, has caused investors to pile into those currencies deemed safer and sell higher yielding currencies like the New Zealand Dollar, seen as a riskier investment. To make matters worse for the currency, the Reserve Bank of New Zealand (RBNZ) has pushed back its expectations for what would be its first interest rate hike since 2014. This sent the currency tumbling to its weakest position in two-and-a-half years in August, which has now lost almost 10% of its value in a little fewer than four months (Figure 21).

Figure 21: NZD/USD (August ’17 - August ‘18)

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Source: Thomson Reuters Datastream Date: 23/08/2018


The Reserve Bank of New Zealand (RBNZ) surprised the market in early August with a much more dovish assessment than had been expected. Rates were held steady at 1.75%, although Governor Adrian Orr stated that the next move in the bank’s main rate could be either up or down and that it doesn’t expect to tighten policy until the third quarter of 2020, a significant delay on the late-2019 that the bank had pencilled in back in May. Comments out of the meeting highlighted growing downside risks to the outlook, with the bank stating that ‘the decline in GDP growth over the past year suggests momentum in the economy may have eased’.

Recent dovishness on the part of the central bank has followed a broad downturn in macroeconomic news out of New Zealand. The New Zealand economy grew by just 2.7% year-on-year in the first quarter of the year, its slowest pace of expansion since the beginning of 2014. The largest drag on growth was that of the construction sector, which contracted by 1% and offset much of the expansion from the economy’s dominant services industry. Business sentiment has also been weak since the centre-left Labour-led government won the election last October, with the business confidence index falling to a near one decade low in July. Activity is expected to pick up pace over the rest of the year, although the RBNZ did warn in August that the recent moderation in growth could last longer.

New Zealand’s labour market does, however, remain a bright spot, and its performance could begin to filter its way through to a pick-up in economic activity in the coming months. Wage growth in the country has been steadily increasing since the start of last year, rising to a six-year high 1.9% in the second quarter (Figure 22).

Figure 22: New Zealand Weekly Wage Growth (2010 - 2018)

22.png

Source: Thomson Reuters Datastream Date: 23/08/2018

Headline inflation also accelerated in the second quarter, although the central bank has underlined that it is expected to be low in the near term and rise only gradually over the forecast period. The main rate of inflation increased back to 1.5% in the second quarter of the year from the previous 1.1%, although still remains comfortably below the midpoint of its 2-3% target range (Figure 23). With the outlook for inflation relatively subdued, the market is now pricing in near zero chances that the central bank raises rates before the end of the year, a sharp departure from the near 80% that was priced in earlier in the year.

Figure 23: New Zealand Inflation Rate (2010 - 2018)

23.png

Source: Thomson Reuters Datastream Date: 23/08/2018

The lack of urgency on the part of the RBNZ to raise interest rates in the footsteps of the Federal Reserve is a concerning development for the New Zealand Dollar. The currency has already raced to our previous long term projections following the central bank’s latest meeting and a renewed flight away from higher yielding currencies following the crisis in Turkey. We are, therefore, revising our forecasts lower across the board, and expect a delayed process of monetary policy normalisation to lead to a gradual depreciation in NZD from current levels against the US Dollar.

 

 

NZD/USD

EUR/NZD

GBP/NZD

Q3-2018

0.66

1.77

2.00

E-2018

0.65

1.78

2.08

Q1-2019

0.65

1.78

2.11

Q2-2019

0.64

1.80

2.17

E-2019

0.64

1.80

2.22



Canadian Dollar (CAD)

The Canadian Dollar (CAD) has sold-off fairly sharply so far in 2018. The currency has fallen in line with every other G10 currency, all of which are currently trading lower against the broadly stronger US Dollar since the beginning of the year. Concerns over the possibility of a full-blown global trade war and risks of a collapse in the North American Free Trade Agreement (NAFTA) sent CAD to its lowest level in a year in June, albeit it has rebounded somewhat (Figure 24).

Figure 24: USD/CAD (August ’17 - August ’18)

24.png

Source: Thomson Reuters Datastream Date: 23/08/2018

Despite currently trading around 4% lower for the year so far against the USD, the Canadian Dollar has actually been one of the better-performing currencies in the G10 in 2018. CAD has been supported, in part, by the Bank of Canada (BoC) which has been one of the few G10 central banks, with the exception of the Federal Reserve, to engage in a monetary tightening cycle. Despite growing concerns over trade tensions, the BoC raised rates by another 25 basis points at its July meeting to 1.50%, the bank’s fourth rate hike since it became only the second G10 central bank to raise rates since the sharp decline in oil prices in 2014.

The Bank of Canada cited the country’s strong labour market and on-target inflation for the need for higher rates. Communications out of the meeting were, on the whole, fairly hawkish, suggesting that at least one more rate hike is on the cards during the remainder of the year. BoC Governor Stephen Poloz addressed the risks posed by the escalation of trade actions, although stated that while it was part of the discussions, was not a basis for the bank’s decision. Financial markets are now pricing in around an 85% probability of at least one rate increase before the end of the year (Figure 25) and around a 40% chance of another two rate hikes before the year is out.

Figure 25: BoC Rate Hike Probability [December] (June ’18 - August ’18)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Policymakers have noted that progress on the dynamics of wage growth and inflation would warrant more interest rate hikes, although trade protectionism remains the biggest risk to the economy. Canada’s economy has continued to expand at a solid pace, although expansion slowed to 2.3% in the first quarter of 2018 from the upwardly revised 3% recorded in the final quarter of last year (Figure 26). 2017 was the economy’s best yearly performance in six years and matching such a strong performance this year was always a tall order. Retail sales throughout last year were particularly impressive, up by 6.7% on a year previous, its largest yearly jump in twenty years. This has, however, eased back in the last few months, with sales declining to a three year low 2.1% year-on-year in April.

Figure 26: Canada Annual GDP Growth Rate (2007 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

The relatively sharp increase in domestic demand last year was fuelled by an impressive labour market performance. Jobs growth during the year was its fastest pace since 2002, although this has since slowed, with the 88,000 contraction in jobs in January its worst monthly performance since the financial crisis.

Geopolitical tensions remain a significant risk factor, with the prospect of a US-China trade war a particular cause for concern given the US accounts for three-quarters of the country’s overall export revenue. Negotiations over NAFTA have continued to drag on since our last CAD update. While Canada was left out of talks at the end of July, it is expected to re-join in August. Discussions appear to be making progress, with optimism in the US that an agreement could even be reached this summer.

The Canadian Dollar should also continue to be well supported by the recent rebound in oil prices. Brent crude oil has remained above $70 a barrel since breaking through the physiological level in early April, and has now risen by around 50% in the past twelve months following OPEC production cuts and tensions in the Middle East. CAD has followed a fairly similar path to that of oil prices, given the commodity accounts for around a quarter of Canada’s overall export revenue. As has been the case with other commodity currencies, there has been somewhat of a dislocation between the two in the past few months (Figure 27). A recommencing of this trend should help offset much of CAD’s recent losses against the US Dollar, in our view.

Figure 27: CAD/USD vs. Crude Oil Prices (2014 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

We remain optimistic over the outlook for the Canadian Dollar and continue to think that it will be one of the best performing G10 currencies this year. The Bank of Canada is currently the only other central bank, with the obvious exception of the Federal Reserve, to be engaging in a full-on hiking cycle. We expect the BoC to continue raising rates in the coming months, with the next hike likely at the October meeting.

We also think that risks to NAFTA have been exaggerated and that a deal is likely to be struck that will limit downside risks to the currency. These factors, combined with the recovery in oil prices, means we expect CAD to reverse much of its recent losses against the US Dollar this year. We do, however, revise our forecasts modestly higher to reflect recent US Dollar strength.

 

 

USD/CAD

EUR/CAD

GBP/CAD

Q3-2018

1.28

1.50

1.69

E-2018

1.25

1.45

1.69

Q1-2019

1.23

1.43

1.69

Q2-2019

1.22

1.40

1.70

E-2019

1.22

1.40

1.73

 


Swedish Krona (SEK)

The Swedish Krona (SEK) has remained fragile in the past few months, though the currency has at least recovered some ground against the Euro, having fallen to its weakest position against the common currency in almost nine years in May (Figure 28). The sharp decline experienced by the currency in the first four months of the year has made the Krona the worst performing G10 currency so far this year, with SEK currently trading over 6% lower than the beginning of the year against the Euro and almost twice that much against the US Dollar.

Figure 28: EUR/SEK (August ’17 - August ‘18)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Weakness in the Krona this year is explained mostly by dovish rhetoric out of Sweden’s central bank, the Riksbank. Despite a solid economic performance and uptick in headline inflation the Riksbank has, in the recent past, been reluctant to signal that a first interest rate hike in Sweden since 2011 is on the horizon. The central bank has maintained its main interest rate deep in negative territory at -0.5% since early-2016 in order to lift inflation back towards its 2% target.

The tone of the most recent communication in July was, however, far more upbeat and markedly different from April, reigniting hopes that the bank’s main rate could be raised at some point before the end of the year. Policymakers highlighted the recent stronger-than-expected inflation news, high volatility in foreign exchange markets and the emergent housing bubble as the rationale for the need for revised monetary policy. Two of the five members of the committee, Henry Ohlsson and Martin Flodén, have already called for tighter policy before December and it could be a matter of time before others follow suit. Crucially, the central bank also now expects inflation to exceed the 2% target in 2018-19, which would necessitate a more aggressive pace of rate hikes.

Sweden’s headline inflation has been steadily increasing since the beginning of 2018, when it slipped to its lowest level in almost a year. Headline CPIF inflation, the Riksbank’s preferred measure of price growth that strips out the effect of changes to mortgage rates from the CPI measure, jumped back above target to 2.2% in July (Figure 29). The bank’s core inflation rate has, however, continued to disappoint, falling to a one year low 1.3%. As with the case in the Eurozone, we think that policymakers in Sweden may remain reluctant to vote for an immediate hike, unless they see signs of a sustained rebound in the level of core inflation.

Figure 29: Sweden Inflation Rate (2013 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Encouragingly, the Swedish economy has shown some steady signs of an uptrend in the past few quarters, which is likely to provide the central bank with an incentive to normalise policy. The economy grew by 3.3% year-on-year in the second quarter of the year, matching the two-year high growth recorded in the three months of 2018, despite a modest decline in a number of indicators towards the end of the quarter that suggest momentum could be easing. Retail sales dropped off sharply in June, contracting by the second largest monthly amount since October 2012, with consumer confidence falling in seven straight months through to June. The country’s manufacturing PMI has also eased, albeit still remains above historic levels and comfortably above the level of 50 that denotes expansion (Figure 30).

Figure 30: Sweden Manufacturing PMI (2013 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

We remain optimistic over the outlook for the Swedish Krona. The increase in headline inflation, and more upbeat comments out of the Riksbank, means that we think there remains a chance that interest rates will be hiked in Sweden before the end of the year. While the still soft level of core inflation means that any hikes may well be delayed into early next year, the central bank still looks likely to tighten policy much sooner than the ECB, which we think should lead to gains for the Krona against the Euro. The recent sell-off in SEK has also left the currency at very cheap levels not justified by economic fundamentals.

 

 

USD/SEK

EUR/SEK

GBP/SEK

Q3-2018

8.63

10.10

11.39

E-2018

8.45

9.80

11.41

Q1-2019

8.36

9.70

11.46

Q2-2019

8.35

9.60

11.60

E-2019

8.17

9.40

11.61

 

Norwegian Krone (NOK)

In line with our expectations, the Norwegian Krone (NOK) continued to recover ground again the Euro in the second quarter of the year. The Krone had fallen to a nine-year low around 10 to the Euro in December, although a strong rebound in oil prices, to which the currency is closely linked, has led to NOK appreciating by almost 5% since the end of 2017 (Figure 31). This has made NOK one of the best performing G10 currencies this year and our view that the sell-off in NOK was excessive appears to have been vindicated.


Figure 31: EUR/NOK (August ’17 - August ‘18)

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Source: Thomson Reuters Datastream Date: 23/08/2018

Global crude oil prices have continued to march higher in the past few months, which has provided decent support for the Krone, given oil production accounts for around two-thirds of the country’s overall export revenue. Brent crude oil prices have been on a steady upward trend since June 2017, rising by over 60% since then to back around the $75 per barrel mark (Figure 32). The Krone experienced somewhat of a divergence with global oil prices in the final quarter of last year, although this trend appears to have recommenced since May. We expect this bounce back to continue to provide solid support for the currency.

Figure 32: NOK/USD vs. Crude Oil Prices (2011 - 2018)

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Source: Thomson Reuters Datastream Date: 23/08/2018

The recent rebound in the Krone has also been supported by the rapid increase in inflation in Norway since the turn of the year that has caused the central bank, Norges Bank, to signal it is close to raising its main policy rate for the first time since 2011. Headline inflation appears to have turned a corner, jumping back above consensus to 2.6% in June, its highest level in a year-and-a-half. This is comfortably above target after Norges Bank’s significant announcement in March that it would be lowering its inflation target to 2% from 2.5%.

An increase in consumer prices in Norway has caused the central bank to take on a much more hawkish tone in recent months. Norges Bank signalled back in March that it would likely be raising interest rates sooner than it had previously anticipated, while providing explicit plans on its path of monetary policy at its most recent monetary policy meeting in August. The Board has claimed that its ‘current assessment of the outlook and balance of risks suggests that the key policy rate will most likely be raised in September 2018’, with its recent communications suggesting to us that it could hike on as many as two occasions next year.

Norway’s economy has continued to grow at a decent pace, although year-on-year growth did fall to just 0.3% in the first quarter. Macroeconomic news for the second quarter has been fairly mixed, with activity slowing at the back end of the first half of the year. The country’s manufacturing PMI fell below the level of 50 that denotes contraction in June for the first time in over a year, while retail sales posted its fourth largest decline monthly decline this side of the century (Figure 33). These are somewhat worrying signs that suggest domestic activity may be stalling in Norway.  

Figure 33: Norway Retail Sales (2013 - 2018)

33.png

Source: Thomson Reuters Datastream Date: 23/08/2018

Despite the recent soft macroeconomic news, Norges Bank appears firmly on course to hike interest rates in September following recent above target inflation. The move to lower its inflation target in March is also significant, and could accelerate the pace of hikes for next year. The market reaction following the August monetary policy meeting was somewhat puzzling, although we still believe that the prospect of a tighter policy from the central bank and further increases in oil prices should continue to provide good support for the Krone. We expect NOK to bounce back strongly against the Euro, albeit raise our short term forecasts moderately higher.

 

 

USD/NOK

EUR/NOK

GBP/NOK

Q3-2018

8.10

9.50

10.70

E-2018

7.95

9.20

10.70

Q1-2019

7.75

9.00

10.65

Q2-2019

7.75

8.90

10.75

E-2019

7.65

8.80

10.85

 


Danish Krone (DKK)

The Danish National Bank (DNB) has continued to have no trouble in maintaining the Danish Krone’s peg of 7.46 DKK to the Euro since our last G10 forecast revision. The DNB intervenes in the currency markets using its foreign exchange reserves on a regular basis in order to limit fluctuations around this rate.

Denmark’s foreign exchange reserves held at the central bank have remained around the same level for more than two years, suggesting that there has been very limited speculative pressure on the currency’s Euro peg. FX reserves were unchanged at 468.1 billion in July, the same as by the end of June, with the central bank not intervening in the foreign exchange market to ensure currency stability (Figure 34). Reports of large currency intervention from the DNB have been almost non-existent since the central bank sold 4.7 billion DKK to weaken the Krone in February 2017. Foreign exchange reserves still only equate to just 20% of Denmark’s overall GDP, with reserves now 40% lower than their peak following the removal of the Swiss Franc’s Euro cap in January 2015.

Figure 34: Denmark Foreign Exchange Reserves (2012 - 2018)

34.png

Source: Thomson Reuters Datastream Date: 23/08/2018

In order to deter speculative bets and prevent an unwanted appreciation of the currency, the Danish National Bank has maintained its interest rate deep in negative territory at -0.65%, having held its policy steady since January 2016. Recent communications from the central bank suggest that rates will remain negative for the foreseeable future. While the DNB would typically wait for an ECB policy changes before altering its own monetary policy, there may be some room for rates to be raised in order to alleviate pressure on an already overheated housing market.

The Danish National Bank has continued to reiterate its desire to maintain its peg against the Euro, claiming that they have limitless scope to alleviate appreciating pressure and deter another speculative attack on the currency. We think the still negative interest rate spread with the Eurozone and comfortable level of FX reserves in Denmark should allow the DNB to maintain the existing EUR/DKK peg at the 7.46 level for the foreseeable future.

 

 

USD/DKK

EUR/DKK

GBP/DKK

Q3-2018

6.38

7.46

8.42

E-2018

6.43

7.46

8.68

Q1-2019

6.43

7.46

8.81

Q2-2019

6.49

7.46

9.02

E-2019

6.49

7.46

9.21

 

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